Why the Efficient Market Hypothesis Is Bunk


“I believe there is no other proposition in economics which has more solid empirical evidence supporting it than the efficient market hypothesis.”

– Michael Jensen, Harvard Business School professor emeritus of business administration
You may have heard of the efficient market hypothesis (EMH).

Put simply, it states that stock prices reflect all information in the markets.

As a result, a stock will always trade at its fair value.

That, in turn, makes it is impossible to “beat the market” consistently.

So you should give up on picking stocks and invest all your money in index funds, right?

By matching the market, you will ensure that you end up better off than most investors – with next to no effort.

That’s a compelling argument… and one that is tough to refute.

Nevertheless, today I want to reveal why I think the EMH is bunk…

And why you should devote at least a part of your portfolio to trying to beat the markets…
An Idea With an Illustrious Pedigree
To mainstream financial economists, the EMH is an article of faith.

Eugene Fama of the University of Chicago developed the EMH in the 1960s.

Princeton professor Burton Malkiel popularized it in the 1970s in his best-seller A Random Walk Down Wall Street.

Like John Bogle, the founder of Vanguard index funds, Malkiel argued that the best strategy as an investor is to buy the entire stock market through a traditional S&P 500 index fund.

Even Warren Buffett recommends investors buy low-cost S&P 500 index funds and stay in them for the long term.
Do as I Say, Not as I Do
The EMH is a product of the 1960s and 1970s. But economists had very different views both before and after it became the accepted religion in academia.

English economist John Maynard Keynes developed a reputation as an outstanding investment manager of Cambridge’s Kings College Chest Fund endowment from the 1920s through the 1940s.

Keynes believed that you could achieve outstanding results by making large contrarian bets on undervalued stocks.

Plenty of economists preach the water of efficient markets but drink the wine of active investing.

The late MIT professor Paul Samuelson – the first Nobel Prize winner in economics – published a 1965 paper in support of the EMH.

Ironically, Samuelson personally made a fortune as a founding investor of Commodities Corporation, a secretive trading group that produced some of the greatest traders in history. (He was also a significant investor in Berkshire Hathaway in the 1970s.)

University of California, San Diego professor Harry Markowitz never invested his own pension fund using the EMH… for which he earned the Nobel Prize.

But the economics profession has come around in recent years.

Yale’s Robert Shiller won a Nobel Prize for highlighting the importance of mass psychology in the markets. In his 2009 book, Animal Spirits, Shiller (along with UC Berkeley’s George Akerlof) argued that investors make decisions based on emotion rather than on the rational assessment of underlying value.

Just think of the stock market crash of 1987, the dot-com bubble of the 1990s… or even cryptocurrencies today.
Why EMH Is Bunk
Here’s why I think the efficient market hypothesis fails to …read more

Source:: Investment You