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Comment by 55555 | Hacker News Reader

The efficient market hypothesis is pretty hilarious. In theory, the market caps of companies should accurately reflect their value. So what exactly happens when the DOW drops 20% in a day and then recovers the next? When Tesla jumps 5x in a year due to investor sentiment, is their company 5x more valuable? It's incredibly divorced from reality. Nevermind that the efficient market hypothesis, when applied to business, completely discounts the ability to start a profitable company. The efficient market hypothesis is a never-reached universe end-state, and getting there requires arbitragers in the present, and this profession can be quite profitable.

The more Warren Buffet I read, the more I want to become a value investor due to the above premise.

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The EMH doesn't really say that a 20 % rally means an equally sudden 20 % improvement of fundamentals.

The EMH says that you cannot, in the long run, make money on your prediction that there will be a 20 % rally tomorrow, because this, along with the relevant probabilities, are already priced in.

This is related to something that used to confuse me too: the most thickly traded commodity futures are extremely efficiently priced. Yet they exhibit clear seasonal patterns. Why wouldn't someone just buy in the low season and sell high for a near-guaranteed profit? The keyword is "near" -- the prices are such that they counterbalance the risk of deviation from the seasonal pattern.

To answer your specific question about what happens when markets drop: information happens. Events can have nth-order consequences that echo through the markets for months or years, as we find out more about them.

Edit: I should also say that market efficiency isn't a black and white thing. A market can be efficient to me even if someone like Ed Thorp can find mispriced assets.

The market is only completely efficient in the limit. For every mispricing someone finds and exploits the market gets a little efficienter.

Correct me if I'm wrong, but the EMH doesn't guarantee there will be "the right amount" of buyers or sellers.

There could be too few, in which case the asset can be mispriced vs its true value.

There could be too many, in which case the asset can be mispriced vs its true value.

Both of these are often true, because equities don't trade in a vacuum. There are other asset classes. And limited amounts of buyers and sellers.

A market in which prices _always_ 'fully reflect' available information is called 'efficient'. [Fama 1970]

This is also a matter of degree. How long a market takes to fully reflect available information is a range, from "immediately" to "never"

And the EMH says "immediately". One could then discuss to what extent the EMH holds depending on how immediately does it happen (if it happens).

My point is that if we take this definition literally, then it's trivially true that no markets are efficient by this standard. It's also true there's nothing to talk about since everyone agrees on this.

The interesting version of this discussion is where we acknowledge there's a spectrum of applicability where we can argue about statements like "some markets are pretty efficient sometimes" or "markets are almost never efficient" etc.

I’m not sure everyone agrees.

EMH serves the same purpose to economics as Euclidean space serves to geometry. If the hypothesis were true I can make a bunch of proofs and predictions in economics. The problem is when people confuse EMH with a fact, not an idea that is never really true in the real world, like an infinite perfectly flat plane.

> what exactly happens when the DOW drops 20% in a day and then recovers the next

This almost never happens. Individual stocks do it sometimes, but not the Dow. The circuit breakers also mostly prevent this.

Which isn't to say there aren't issues with the efficient market hypothesis.

Market efficiency doesn’t mean prices always exactly match current value. Only that they reflect all available information and take expected future returns as well as risk into account.

That's only true to a certain extent. Current prices have more to do with the Fed buying 10s of $T of everything than will actual company values (minus a small handful of companies). 2022 will be interesting as life gets back to "normal" and the Fed has to unroll the Titanic.

> and the Fed has to unroll the Titanic.

It remains to be seen whether the Fed can, or will unwind the QE that they’ve performed. It’s not a given.

Wouldn't that be the definition of "current value"?

> The more Warren Buffet I read, the more I want to become a value investor due to the above premise.

I love Buffett, but probably it's expected to be convinced by whatever you're consuming right now.

If you spend a lot of time watching Ben Felix[0] you'd probably think "the more I listen to Ben Felix the more I want to become a factor investor".

Replace with Kathie Woods, Ray Dalio or whoever. They are all convincing!

[0] a pretty popular youtuber/investment advisor/passive investor

> I love Buffett, but probably it's expected to be convinced by whatever you're consuming right now.

Do you mean “those people are notorious for a reason, they can convice” or “our minds are susceptible to believing something we hear repeated several times”?

I believe the first is likely true, but I was thinking of the latter: most investing arguments are reasonable and when there is no contradictory it's easy for our brain to be swayed into believing what you're hearing.

I think this is true of all topics. Unless you already know about something you may believe what you're told if it seems reasonable, see also the Gell-Mann amnesia effect.

Why not both?

ehh... Cathie Wood and a YouTuber who needs a footnote do not belong on the same list as Ray Dalio and Warren Buffet.

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