Have you ever wondered if the stock market is truly efficient? Seth Klarman once said, “Markets are inefficient because of human nature—innate, deep-rooted, permanent. People don’t consciously choose to invest with emotion—they simply can’t help it…. In short, we believe market efficiency is a fine academic theory that is unlikely ever to bear meaningful resemblance to the real world of investing.”
Whether the stock market is efficient is a widely debated topic among investors and academics.
Academics believe the stock market is efficient because share prices reflect all available information.
If the market were truly efficient, beating it would be impossible.
But in reality, the market only exists to make it easier to buy and sell, not to set values.
This does not mean you only have to be rational to beat the market but that you also must have exceptional analytical ability.
Richard Feynman, a theoretical physicist, said it well “Imagine how harder physics would be if electrons had feelings” highlighting the unpredictability of human behaviour in markets.
We must remember that humans have emotions, making it difficult to predict their actions, especially during times of high uncertainty.
The question is, would they act the same way if all the market participants had access to all the available information?
Have you ever wondered why Christians have different denominations when they have only one book, the Bible?
In 1970 Professor Eugene Fama when he published his theory, Efficient Capital Markets, mentioned the three forms of the efficient market hypothesis.
- The weak efficient market hypothesis assumes prices might not reflect new information unavailable to the public.
- Semi-strong efficient market hypothesis, where in this scenario, neither fundamental nor technical analysis can generate excess returns since all new public information is immediately priced into the market.
- A strong efficient market hypothesis implies that all information, both public and private, is incorporated into a security’s current price. Therefore, not even insider information can give investors an opportunity to generate alpha.
If you believe the market can’t be beaten and is efficient, buy an index tracker fund.
However, I would argue that the market is not efficient, especially in the long-term.
Renowned investors like Warren Buffet and Peter Lynch have proven the market can be beaten as long as you have a great process and you make rational long-term investments.
Sometimes the current information only tells us a little about the future as we do not have the privilege to see it, but we can make our best probabilistic estimate of whether the business will get to the promised land.
I love Nick’s Sleep destination analysis and we use it in our investment decisions to minimise the errors by asking such questions.
What is the intended destination for this business in ten or twenty years from now?
If I could only invest in 20 companies in my life would this make this one of them?
Is this something I would be perfectly happy to hold if the market shuts down for 5-10 years?
Many investors prefer to take a short-cut rather than do their homework, but If you take the time to read and digest the annual report, you will have the ability to make a rational decision.
After you have done your homework, ask yourself this question, if you were looking to invest given all the current information you have, would you invest in this stock today?
Our research shows that wealth creation in the stock market comes from only 4% of businesses, with significant wealth generated by an even smaller fraction.
The question you should ask yourself is, will this business be one of the 4% that generates wealth for investors?
If the answer is yes buy the stock, if not move on to the next one.
In the end, there are both good arguments for active and passive investors but you have to decide which strategy suits you.
Remember, investors are not always rational, especially during high uncertainty, leading to market inefficiencies.
Investing is a long-term game requiring patience and discipline. Act with conviction when opportunities present themselves, even if it means going against the herd. That’s what ultimately matters.
As of this writing, the fund has gained 6.44% this year to date, while IA Global has gained 5.4%.
Awet Ghirmay, Head of Investment Research
If you want to learn more about this topic, please find the link here.
More information about our fund can be found here: Hargreaves Lansdown or AJ Bell
Risk warnings
The value of investments and the income derived from them may fall as well as rise. You may not get back what you invest. This communication is for general information only and is not intended to be individual advice. You are recommended to seek competent professional advice before taking any action. All statements concerning the tax treatment of products and their benefits are based on our understanding of current tax law and HM Revenue and Customs practice. Levels and bases of tax relief are subject to change. This blog is based on my own observations and opinions.
