There are some bold-faced lies that exist in the financial markets. Don’t get into the political angle about all of the bold-faced lies you hear every day about high finance. Let’s just get down to one that everyone should understand: The “Efficient Market Hypothesis” (or the Efficient Market Theory”) is a total and complete lie and waste of time. And when you hear this used in financial media, just understand that this “theory” is nothing but a theory that is disproven every single day.
For starters, let’s defer to using “Theory” in modern times rather than “Hypothesis.” The reasons are simple enough — the word usage, spelling and ease of defining make “theory” many times more appropriate. End of that discussion.
The reality is that every day, markets are seeking to find equilibrium. This is a noble goal, and may at least be more realistic than the theory, but any efforts even to find true equilibrium still fall short.
Oggonomics would define that Efficient Market Theory as follows:
Financial markets attempt to reflect all known data that is readily available at any given time. It’s a total and complete failure.
Whether or not you choose to reflect on “alpha” (outperforming a benchmark) within the Efficient Market Theory is up to you. Oggonomics does not worry about the alpha portion of the theory because different types of investors have so many different benchmarks that pertain solely to them.
Let’s go into just how “efficient” the EMT really is. Economic data are released in the United States multiple days of each and every week. There are quarterly earnings reports that are formally set for certain days and times through each quarter. There are other company-specific and industry-specific conferences and events on a set calendar that matter to investors. Now ask yourself this about “efficiency” in any theory or hypothesis — If everything known and assumed is priced in to reflect the current price of an asset, then why do asset prices react wildly (up or down) when news comes out that was on the calendar to come out at a set time?
According to Investopedia, a site widely regarded as the king of anything related to financial and investor terminology, the shortened definition with a longer explanation says:
Efficient market hypothesis (EMH) is an investment theory stating that share prices reflect all information and consistent alpha generation is impossible.
Wall Street analysts and economists issue reports and forecasts for every single big company and every single large economic event. They often do the same sort of “previewing” for planned conferences that aren’t even about earnings. This is what makes the consensus estimates heading into these known events.
So, what are investors supposed to make of the EMT when there is a “surprise” in earnings and economic releases? Surprises at conferences can be a bit trickier because the market simply cannot know what is going to be presented without non-public information.
Now ask yourself a serious question that pertains to this exact day and pertinent news item…
The entire stock market was waiting for NVIDIA Corporation (NVDA) to report earnings. It was widely assumed that earnings and revenues would be strong. Same for its guidance. After all, the AI-trade isn’t dying today (at least that’s not what the market is pricing in). And it’s always a safe assumption that Jensen Huang was going to have a strong commentary about the future of the industry and NVIDIA itself. If these were all known or assumed heading into the earnings report, then why was NVIDIA up 8.7% at $227.90 in mid-day trading?
Now, what about a few other cases in general….
If an investor sees an analyst upgrade that is based solely on a valuation or because a price has moved too far in any direction, did the fundamentals of the company just change? Most likely, that’s a NO.
If an investor sees a “sell the news” reaction to a positive FDA approval in a drug or biotech stock, was it bad news? Most likely, that’s a NO.
If the stock market rallies on a day when a weak unemployment report suggests that perhaps the Federal Reserve might not have to raise interest rates as soon or as fast as what was feared just a day earlier, was that efficient? Most likely, that’s a NO.
If a company beats earnings and raises guidance for more than just a short period ahead, even ahead of formal expectations, and the stock sells off for profit-taking…. was that efficient? Most likely, that’s a NO.
Now ask yourself something else in this “efficiency” debate. It is common that stocks with 20 or more analysts have the equivalent of various “buy, sell and hold” ratings simultaneously. Each individual analyst theoretically has the same access to the exact same public data regarding the company they are covering. Whether or not that even has a role in the Efficient Market Theory is up to you, but it doesn’t seem efficient other than “That’s what makes a market of willing buyers and sellers.”
Investors could literally read an entire doctoral dissertation that refutes the Efficient Market Theory. The reality is that there is evidence each and every day that the Efficient Market Theory should be renamed to the Inefficient Market Theory.
Perhaps this is a good time for an Oggonomics key mantra — Always a bull, you’re a fool! Always a bear, you’re broke! Always sticking to a bullish or bearish view would not always be successful. And always being bearish would not prove to be successful.
This Efficient Market Theory is a topic that can be continually expanded upon. It can endlessly be expanded on as well. Nonetheless, the Efficient Market Theory should be renamed the Inefficient Market Theory.
