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Efficient Market Hypothesis - Hogwash!
Old 06-19-2014, 08:44 AM   #1
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Efficient Market Hypothesis - Hogwash!

I don't believe markets are efficient. There will always be plenty of stocks that are undervalued or overvalued.

However, there are two main reasons why I'll stick with a properly allocated index strategy for the vast majority of my portfolio once I divest from a concentrated position.

1. I don't think anyone can consistently pick the individual stocks that are under or overvalued.

2. Even if they could pick them, there is no guarantee that fair value may be achieved, or that during the wait, some unforeseen event occurs that changes the valuation.
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Old 06-19-2014, 09:06 AM   #2
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1. I don't think anyone can consistently pick the individual stocks that are under or overvalued.
Warren Buffet seems to have done a pretty good job at it.
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Old 06-19-2014, 09:24 AM   #3
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Old 06-19-2014, 09:27 AM   #4
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I think a person can pick more winners than losers (Warren Buffet example above), but it takes a lot of time and effort, along with the knowledge to make those decisions. Something that most do not want to do.
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Old 06-19-2014, 09:27 AM   #5
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Warren Buffet seems to have done a pretty good job at it.
But for every Warren Buffet there are plenty of also-rans
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Old 06-19-2014, 09:37 AM   #6
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It's worth noting that Warren Buffett buys companies, usually leaving management in place, then holds them forever.

The guy/gal who owns the local hardware or lawn-mowing service doesn't buy and sell his business several times a year based on market movements, so why should I?

As for efficient markets, that is not entirely true in the short- or intermediate term, but it's true enough for a long-term investor.
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Old 06-19-2014, 09:51 AM   #7
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Who knows whether Buffet is one of the outliers one expects randomly or as an insider has information others don't have, or just a really good manager of what he owns? Everyone wants to think that the market is inefficient and yet if they were inefficiencies investors would find them, and then voila the market would be efficient again. To show the market is efficient people want to point out the outliers, which of course we would have if there were perfect efficiency in the market, and not point out the statistical failures of those who have tried to find and profit from these inefficiencies.

So do I think the markets, that the known value of the company relative to others and the economy is already in the price? Yes. Do I still sometimes buy individual stocks that I think can outperform the market? Yes. Why? Because I am human.
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Old 06-19-2014, 10:01 AM   #8
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Changing my post . . .

I don't believe markets are efficient over the short to medium term. There will always be stocks that are undervalued or overvalued.

However, there are two main reasons why I'll stick with a properly allocated index strategy for the vast majority of my portfolio once I divest from a concentrated position.

1. I don't think anyone I can consistently pick the individual stocks that are under or overvalued.

2. Even if I could pick them, there is no guarantee that fair value will be achieved before I need the money (I'm not Buffet.) Nor is there a guarantee that during the wait some unforeseen event occurs that detrimentally changes the valuation.
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Old 06-19-2014, 10:02 AM   #9
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Warren Buffet is an entrepreneur and an investor. He has the capability to change the board, the CEO, the strategy and culture of companies.

Using Buffet as an example of someone who can consistently pick winners is flawed in my opinion.
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Old 06-19-2014, 10:06 AM   #10
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In any random process there will be results at either end of the distribution. Buffets continues success now has more to do with him making the market rather than any insight into future performance.
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Old 06-19-2014, 10:09 AM   #11
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Would you say that people like Buffet, Icahn, and Soros by definition front run the market -- not intentionally, but because of their reputations?

Once they announce a purchase of something the followers will come.
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Old 06-19-2014, 10:25 AM   #12
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Warren Buffet is an entrepreneur and an investor. He has the capability to change the board, the CEO, the strategy and culture of companies. .
Actually Warren said that he does not buy companies with poor culture when asked about this several years ago when I made the pilgrimage to Omaha.

This was in response to a question from the audience about how he changes companies with poor culture.

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Old 06-19-2014, 11:16 AM   #13
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As for efficient markets, that is not entirely true in the short- or intermediate term, but it's true enough for a long-term investor.
+1 Plus, it seems to me that most people who are seriously saving for retirement, or retired, are interested in long term investing.
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Old 06-19-2014, 11:55 AM   #14
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I don't believe markets are efficient. There will always be plenty of stocks that are undervalued or overvalued.
The EMH only says that stock prices reflect all information (that's everything--what people believe the company will earn in the future, market emotions, etc). It's almost a tautology--of course stock prices are the summation of the market's perception of the value of the stock. And, strictly speaking, there can't be undervalued or overvalued stocks--the market's judgement is, by definition, what the stock is worth (i.e. the highest someone will buy it for at that time).

Now, a particular analyst might see things differently than the market as a whole, he might ascribe higher importance to some factors, etc. That analyst may believe some securities are "undervalued' or "overvalued" but to make any money from ths observation the market must eventually see things the same way he does.
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Old 06-19-2014, 01:33 PM   #15
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The EMH only says that stock prices reflect all information (that's everything--what people believe the company will earn in the future, market emotions, etc). It's almost a tautology--of course stock prices are the summation of the market's perception of the value of the stock. And, strictly speaking, there can't be undervalued or overvalued stocks--the market's judgement is, by definition, what the stock is worth (i.e. the highest someone will buy it for at that time).
Now, a particular analyst might see things differently than the market as a whole, he might ascribe higher importance to some factors, etc. That analysts may believe some securities are "undervalued' or "overvalued" but to make any money from ths observation the market must eventually see things the same way he does.
+10^6

The market is efficient, in that it responds instantaneously to new information, heck even gossips or rumors, but that does not mean that it is rational. Market prices are determined by humans, and if people are all rational, we would not have wars, criminals, drug addicts, corrupt politicians, stock bubbles, guys like Jordan Belfort who made a million a day pumping and dumping stocks.

And yet, it is indeed impossible to beat the market in the short run. How do you like to fight against a mad man? In the long run, I believe an investor with a cool head can beat the market, but even that is tough. It is because of our human nature. When even kids could make money buying "new-economy" dot-coms, one felt foolish holding stalwarts like Procter and Gamble, utility companies, etc...

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Old 06-19-2014, 02:26 PM   #16
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Changing my post . . .

I don't believe markets are efficient over the short to medium term. There will always be stocks that are undervalued or overvalued.
I take it you've modified your view vs the thread title. Markets are relatively efficient in the long term, but not in the short term. And for investors with a long horizon, that's the beauty of active investing IMO. The herd ALWAYS overreacts on the upside (creating outsized returns) and the downside (creating outsized opportunities). I'm glad markets aren't efficient in the short term...

Quote:
Originally Posted by aim-high
However, there are two main reasons why I'll stick with a properly allocated index strategy for the vast majority of my portfolio once I divest from a concentrated position.

1. I don't think anyone I can consistently pick the individual stocks that are under or overvalued.
You're right no one can pick an individual stock that's guaranteed to go up or down, short or long term. Letting your portfolio ride too heavily on one/few stocks is crazy gambling "ill-advised," not even Buffett does that. But a knowledgable person who does their homework can pick a group of stocks (10-20 or more) with more winners than losers over the long term. Many here have, and it's not simply luck. Putting together a portfolio of individual stocks is just a (more volatile) subset of a mutual fund - some go down, more go up in the long run (so far in our market history).

BTW, I'm not advocating picking stocks over passive/index investing, that's not the point. Efficient markets influence index funds too.

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Originally Posted by aim-high
2. Even if I could pick them, there is no guarantee that fair value will be achieved before I need the money (I'm not Buffet.) Nor is there a guarantee that during the wait some unforeseen event occurs that detrimentally changes the valuation.
If it's money you might "need" short term, it probably shouldn't be in individual stocks in the first place.

If you're looking for "guarantees" in investing, you'll be disappointed often. The best you can do is weigh the probabilities, invest according to your risk tolerance, monitor your holdings and have a plan B/C/D...
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Old 06-19-2014, 09:59 PM   #17
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Regarding making money off market occasional idiocies, it is often difficult because good timing is of utmost importance. As John Keynes said, "Markets can remain irrational longer than you can remain solvent".

In March 2000, the late Sir Templeton who was one of the legendary value investors made $80M for himself by shorting some dot-coms. He did not need the money, but I guess watching the stupid crowd bidding up these worthless stocks made him itchy.

In the same time frame, another big investor, a hedge fund manager, also shorted some dot-coms, but was too early by about a couple of weeks, and had to cover and lost several tens of million.
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Old 06-19-2014, 10:16 PM   #18
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Regarding making money off market occasional idiocies, it is often difficult because good timing is of utmost importance. As John Keynes said, "Markets can remain irrational longer than you can remain solvent".

In March 2000, the late Sir Templeton who was one of the legendary value investors made $80M for himself by shorting some dot-coms. He did not need the money, but I guess watching the stupid crowd bidding these worthless stocks made him itchy.

In the same time frame, another big investor, a hedge fund manager, also shorted some dot-coms, but was too early by about a couple of weeks, and had to cover and lost several tens of million.
People were more than a little crazy over internet stocks back then. I was even getting consulting business from people who didn't care what the product was as long as it had an internet play, expecting that later someone would buy them out. It was insane.

But as you say, timing is everything, while I kept my retirement funds index fund invested, I sold all my stocks outside of that, the first and only time I tried to time the market. But I sold a YEAR too soon. I am glad I didn't go short! As you said the market can stay crazy longer than you can stay solvent. I figured the market would stabilize as soon as Amazon filed for bankruptcy.
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Old 06-19-2014, 10:25 PM   #19
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In an interview a few months afterwards, Templeton said in jest that his motive was to help people. When they wanted to sell, he bought from them. And when they clamored for dot-com stocks, he sold to them even if he did not have the stocks!

The other short seller who was early and got hurt was Julian Robertson, the manager of the hedge fund Tiger, if my memory serves. Either Templeton was not leveraged and could wait for the stocks to crash or his timing was good, but I remember him saying that he never did have to cover his shorts; these dotcoms all eventually disappeared. And Templeton was already retired at that point, and was trading for his own account. Nice!
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Old 06-20-2014, 01:39 AM   #20
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The father of value investing, Benjamin Graham, explained this concept by saying that in the short run, the market is like a voting machine--tallying up which firms are popular and unpopular. But in the long run, the market is like a weighing machine--assessing the substance of a company.

So in the long run yes the market is efficient, but for years on end it isn't. We are a society that likes fads and stocks are no different than hemlines, or boy bands. Some fashion buyers are better at anticipating which way fashions will go than others, and some record producers are great a figuring out which boy band will appeal to teenage girls. I suppose it is possible that this all just random chance, but when I hear these people interviewed they always strike me as being smart, and very insightful.

I think one of the big disservices, that Bogleheads community has done is over generalize from the oft quoted statistic that only 25% of actively managed funds beat their index. The performance of active funds increased to 40% over the last five year period.. While it certainly makes sense that on average active management is going to under perform indexes. It doesn't follow that just because most funds can't beat indexes, individuals can't.

Mutual funds are not individuals. They generally are run by teams of people, and supported by others (e.g. researchers), the team member change often in the same way that the coach staff for a pro team changes a lot. A good offensive/defensive coordinator can make a good coach look bad and vice versa. None of the research on mutual fund performance I've seen tracks even head managers much less everybody on the team.

Mutual funds suffer from significant disadvantages that individual don't.
Several comments on this thread talk about the unique advantages Warren Buffett has. While these are true, Buffett suffers from a huge disadvantage that rest of us don't, he has to buy so much stock to make a difference that his buying and selling moves the market. For instance it would take 35 days for Buffett to sell his stake in Wells Fargo at WFC normal trading volume if he was the ONLY seller. Even a typical actively managed mutual funds like Wellesley has a day supply of stock for its top holdings. If you look at Warren his greatest out-performance occurred early in his career long before he was household name.

Second mutual fund manager decisions to buy and sell are dictated at the whim of the masses. I suspect very few active money manager were anxious to sell stock in early 2009, yet they had no choice due the masses of people redeeming their shares. I am pretty sure that hedge funds and probably closed end funds did better simply cause they didn't have to
redeem shares at the market bottom. But again these money managers aren't tracked by academics.

Some stock pickers are good at figuring out which stocks are going to be popular in the short term, and others are good at assessing the true long term value of a company. And yes a significant chunk of these people are just lucky, same thing is true for record producers and buyers. Still when I listen to the average person talk about investing or even plenty of stock brokers, financial advisers and such. I say to myself I know more than these people. Then when I read many of the folks on the board I say these folks are smarter than I am about this stuff. I started tracking my investment pretty careful shortly after I retired and in general about 1.3% above 75/25 mix, lately Schwab has been telling me I'm doing it with less risk. I wouldn't be at all surprised if many on the board are doing even better.
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