The market is not efficient

stock-market-not-efficient HT to my friend James, for bringing this to my attention today.  In the last hour, the market ran up dramatically, then quickly dropped.

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This kind of price movements is hardly an unique occurrence in the world of stock charts, where institutional investors by and large dictate pricing with their gargantuan orders.  The market has been relatively quiet for the whole day, with little data released, nor shocking announcements made.  So either there’s a large investor (or several) out there running up prices, then quickly dumping them.  Alternatively, there’s information or rumours swerving around, privy to a few.

This happens, regularly.

Plus, Joe Nocera is poking holes in the efficient market hypothesis.

Jeremy Grantham from GMO rails:

“The incredibly inaccurate efficient market theory was believed in totality by many of our financial leaders, and believed in part by almost all. It left our economic and government establishment sitting by confidently, even as a lethally dangerous combination of asset bubbles, lax controls, pernicious incentives and wickedly complicated instruments led to our current plight. ‘Surely, none of this could be happening in a rational, efficient world,’ they seemed to be thinking. And the absolutely worst part of this belief set was that it led to a chronic underestimation of the dangers of asset bubbles breaking.”

Academia has largely accepted the theory within the vacuum of its constructed economies, with little challenges.

As Mr. Fox describes it, much of the early academic work that led to the efficient market theory was aimed at simply showing that most predictive stock charts were glorified voodoo — just because a pattern had developed didn’t mean it would continue, or even that it had any real meaning. Dissertations were written showing how 20 randomly chosen stocks outperformed actively managed mutual funds. (Hence the phrase “random walk,” to connote the near impossibility of beating the market regularly.) Mr. Thaler, the Chicago behavioralist, says that evidence on this point — “the no free lunch principle,” he calls it — is clear and convincing.

Addressing market volatility over the 30 years, Grantham says:

“There are incredible aberrations,” he told me over lunch not long ago. “The U.S. housing market in 2007. Japan in the 1980s. Nasdaq. In 2000, growth stocks were three times their fair value. We were quoted in The Economist in 2000 saying that the Nasdaq would drop by 75 percent. In an efficient world, you wouldn’t have that in a lifetime. If the market were truly efficient, it would mean that growth stocks had become permanently more valuable.”

picture source: kaz0085

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  • http://www.LearnFinancialPlanning.com/ Shaun

    I don't think anyone trustworthy would argue that the market is completely efficient. Nothing is completely efficient save the laws physics themselves. :)

    That said, I'm going to make a blind guess, and suggest the huge leap towards the end was caused, at least in large part, by day traders trying to surf the surge. I dislike day traders. 😉

  • investoralist

    I think the thing is that, people generally believe in a weak version of the efficient market theory, without which, few investors would invest in the stock market.

    So in a way, traders are theoretically in the market to make it more efficient. But when they collude, or rely on private information to trade, then we get the opposite result.

  • http://www.LearnFinancialPlanning.com/ Shaun

    I don't think anyone trustworthy would argue that the market is completely efficient. Nothing is completely efficient save the laws physics themselves. :)

    That said, I'm going to make a blind guess, and suggest the huge leap towards the end was caused, at least in large part, by day traders trying to surf the surge. I dislike day traders. 😉

  • investoralist

    I think the thing is that, people generally believe in a weak version of the efficient market theory, without which, few investors would invest in the stock market.

    So in a way, traders are theoretically in the market to make it more efficient. But when they collude, or rely on private information to trade, then we get the opposite result.