I believe in weak stock market efficiency. And recently the market is making me think it is weaker than I believed :-/ I believe that the market does a decent job of factoring in news and conditions but that the “wisdom of crowds” is far from perfect. There are plenty of valuing weaknesses that can lead to inefficient pricing and opportunities for gain. The simplest of those are spotted and then adopted by enough money that they become efficient and don’t allow significant gains.
And a big problem for investors is that while I think there are plenty of inefficiencies to take advantage of finding them and investing successfully is quite hard. And so most that try do not succeed (do not get a return that justifies their time and risk – overall trying to take advantage of inefficiencies is likely to be more risky). Some Inefficiencies however seem to persist and allow low risk gains – such as investing in boring undervalued stocks. Read Ben Graham’s books for great investing ideas.
There is also what seems like an increase in manipulation in the market. While it is bad that large organizations can manipulate the market they provide opportunities to those that step in after prices reflect manipulation (rather than efficient markets). It is seriously annoying when regulators allow manipulators to retroactively get out of bad trades (like when there was that huge flash crash and those engaging in high frequency “trading” front-running an manipulation in reality but not called that because it is illegal). Those that were smart enough to buy stocks those high frequency traders sold should have been able to profit from their smart decision. I definitely support a very small transaction tax for investment trades – it would raise revenue and serve reduce non-value added high frequency trading (which just seems to allow a few speculators to siphon of market gains through front running). I am fine with speculation within bounds – I don’t like markets where more than half of the trades are speculators instead of investors.
Related: Market Inefficiencies and Efficient Market Theory – Lazy Portfolios Seven-year Winning Streak – investing in stocks – Naked Short Selling
Comments
3 Comments so far
John,
I believe that markets are almost perfectly efficient (except for spreads) while the market is open and would be much more so if the markets were open 24/7. After all, at any given moment in time, a stock’s price is a pretty close to the actual collision of supply and demand for that stock.
I think that market inefficiency increases as you move in time frames up to about a month long period. Then I think it gets more efficient again as you extend the time frame out more than a one month period.
As you look at markets over the course of years, they are very efficient indeed. What other better representation could you possibly have for the real equilibrium of supply versus demand for any given stock?
I forgot to mention that I think your blog is pretty cool. I am a bit of an economics geek so I am into the subjects you are talking about here. Very clean well written posts that got me to think a little bit.
“These incentives to take huge risks do mean a few hedge funds do spectacularly well each year (of course more usually do spectacularly poorly over time).
Warren Buffett knew this and wagered a long term investment in a low cost Vanguard S&P 500 Index fund would beat a hedge fund over the long term…”