Hi everyone, According to Efficient market hypothesis (EMT) prices on traded assets, e.g. stocks, bonds, or property, already reflect all known information and therefore are unbiased in the sense that they reflect the collective beliefs of all investors about future prospects.
It also means that is not possible to consistently outperform the market by using any information that the market already knows, except through luck.
Through this I undertand one could not under or overvalue a stock or bond. This also supports passive against active management.
To be honest with you it is hard for me to accept this.
Turtle, to me what you quoted is a general principle of EMH. In application, I think EMH is more properly worded in terms of stock price tendencies in response to generally available information.
I confess I think it is possible to exploit through careful study of company fundamentals, for example, panics in stock prices when a potential lawsuit is announced. The latter is a Ben Graham concept. One of the reasons I hesitate to buy mutual funds these days is because I'd rather swoop down on a stock that has fallen into my view of "value" territory rather than trust a mutual fund manager will do so at the same time (Graham also talks about constraints on fund managers, IIRC). Granted, this is not for the feint of heart in general. Nor is it for those without the time to study a company.
The truth is that an efficient market reflects not only all current knowledge about a commodity, it reflects all current suspicions, infatuations and projections about the commodity. Just like the Tulip Mania or the Internet Bubble, the market doesn't filter or validate the 'information' and motivations of the buyers and sellers, it simply conveys desire, which may vary widely in it's rationality. It does nothing to prevent wild over/under-evaluation on emotional bases. If you project a different future than someone else for a commodity, that makes a sale. High-def TVs will do nothing to improve the quality of programming. Market activity reflects a difference in opinion on value. However, theory is not needed to support passive investment over active management. A simple observation of the performance of SP500 and Wilshire 5000 indexes compared with managed funds shows that the indexes beat the vast majority (~85%) of managed funds over any significant period, in aggregate by approximately the difference in operating costs.
Jeremy Siegel in _Stocks for the Long Run_ claims that the very successful investment record of Peter Lynch could not have been due to luck statistically. However, he does not really present his statistics nor does he name any other money manager as being skilled (and not just lucky) in stock picking. Of course, Peter Lynch lived and breathed stocks.
I'm a stockpicker, too, but I have a day job and spend a lot of time on things other than investing. Yet I have consistently beat the market (as measured by various stock indices) with the notable (to me) exception of the 2000 - 2002 bear market where I suffered much worse than the market (this may be an indication of the volatility of my portfolio). I started picking stocks before I really knew about the EMH (I'm sure that I had heard of it, I just didn't really know its arguments) so its existence has not influenced me much. I had early successes that really sucked me in. Had I had more early failures, maybe I would have given up long ago. Indeed, I've tried my hand at technical analysis of stocks (wiggle watching) and rental property, both of which I had early failures at and decided that they weren't for me.
I might just be lucky with my investing success anyway. I haven't found a good way (in my opinion) to test the hypothesis that I am just lucky. In the meantime, if it ain't broke, don't fix it. If my returns start to approach that of the market, or if I get tired of the work involved (reading annual reports is seriously boring) I may give it all up and go to indexing.
There are certainly others besides Lynch. Warren Buffet is a great example. When I was in school for my MBA, I mentioned Buffet to one of my finance professors. He claimed to have never heard of him. (made a mental note to avoid other courses with him). Given Buffet's record was already decades long at that time (1991), I'd think this professor would have admitted there are guys who can beat the market, and at some point, it can't be attributed to luck. In the 15 years since that conversation, Buffet continued to blow away the indices.
It would take quite a bit of math to figure whether your returns are luck or talent. Consider, even if you only beat the market half the time, but in those years you beat by 5% (actual return), and in the years you underperform, only do so by 1-2%, you're still ahead.
If you dont mind me asking, what did you do during the 2000 - 2002 bear market ? Did you change into bonds, or wait till the storm was over (which I think I would have done) and go on further?
Imagine a world where people didn't realize that flipping a fair coin heads was pure chance, but (falsely) believed there was an element of skill to it.
One day they decided to have a heads-flipping manager contest.
1,048,576 people entered it. After 12 intense rounds of coin flipping, 256 people had flipped 12 heads in a row. The coin-flipping press wrote glowing articles about their flipping prowess. Coin-Flipping Magazine wrote profiles discussing their awesome skill. People flocked to buy books about the winners' coin-flipping philosophy and methodology.
Then one day some ivory tower academics published the Coin-Flipping Hypothesis (CFH). The CFH asserted that flipping a coin heads was entirely due to luck. They further calculated that if 1,048,576 people started flipping coins, chance alone would predict that on average 256 of them would flip 12 heads in a row. There was much wailing and gnashing of teeth, and the coin-flipping media led the attack on the ivory tower academics.
Buffet is rather different. Unlike Lynch and other "star" fund managers, Buffet takes an active management role in the companies he buys.
One other note on "beating the index". One has to compare to the correct index. For example, some stock-picking value investor may proudly (and truthfully) point out that he's beaten the SP500 for quite a few years running. But then it turns out that he's been trailing (for example) the Russell 1000 Value index. Oops!
The statistics show that runs like Lynch's, while rare, are not entirely unexpected. The trick, or course, is to identify such runs
*in advance.* If you can do that, then you can beat the market. The Efficient Market Hypothesis says you're very unlikely to be able to do that, though. Note that the Fidelity Magellan fund that he ran has now essentially reverted to the mean, and the long term returns are fairly consistent with the market as a whole.
Couple of points here: Buffet himself has said that most folks would be better off with index funds. This is due, in large part, to the fact the Mr. Buffet of more of a businessman (and a darn good one) than an investor. Most of his success is due to this, rather than some extraordinary stock picking ability.
When Buffet buys a stock, he doesn't just buy a few hundred shares like you or I do. He buys a significant position - enough to get him seats on the board and a say in how the company is run. By identifying companies with good prospects that aren't being well run, he can get in cheaply and then bring his considerable business talents to bear. This has proven a successful formula for him, and he's done extraordinarily well. But, this should never be confused with stockpicking.
It is still possible that Buffet's record is just luck. Nobody knows. Maybe chances of a distinguished record are one in a million, but if a few million people are making the choices, it is entirely possible that one or two will have produce that record by chance.
But there aren't 1 million known mutual fund managers. If I came to you and spoke of my flipping ability, then asked for a coin from your pocket, and proceeded to flip heads 90% of the time, you would at least have to question your own senses.
Your analogy works for those who claimed to forsee the crash of 87 or
2000, on any given day, some advisors claim we are heading for a crash, and when it happens, well, there's Elaine Garzarelli claiming to be one of the clairvoyant. Whether she provided any valuable info before or since, I don't know.
I know that statisics only offer probability, not a definite answer. That many outcomes are considered 'no better than chance'. I'd need to understand the math a bit better to answer Gil and others as to whether a particular track record appears to be better than random.
That is very true. Still, there is an element of chance in business success just as in stockpicking. What may look like a string of shrewd decisions may in truth be a run of luck. Not always but sometimes. Maybe a whole lot of business people start with superior abilities and produce good records, but only one or two, with the help of chance, produce super-spectacular records.
Beating the index consistently doesn't mean that the EMT is not correct. You need to consider also the volatility -i.e., riskiness- of those portfolios which beat the market. For instance, Warren Buffett has beaten the market by a wide margin, but the riskiness of his portfolio -as measured by its standard deviation- is also much higher than the market's.
What the EMT says is that, > joetaxpayer writes:
======================================= MODERATOR'S COMMENT: Please trim the post to which you are responding. "Trim" means that except for a FEW lines to add context, the previous post is deleted.
The coin-flipping analogy goes back to Buffett himself (he may have stolen it from someone else, however): "The Superivestors of Graham-and-Doddsville". I inadvertantly plagiarized this example sometime back on this newsgroup. In any case, to finish Buffett's story of the contest, what would you conclude if the 256 most successful flippers all studied under the same coin-flipping master? Buffett claims as part of this story that most or all of the folks who studied under Benjamin Graham make it into coin-flipping stardom, despite the fact that these folks use widely varying stock-picking methods.
Not according to Siegel. Presumably Lynch's record was some significant number of standard deviations away from the mean during his tenure at Magellan to make Siegel say this. Siegel did mention that the odds of Lynch achieving his record by luck were 1 in 500,000, but as I mentioned earlier, he presents no further evidence than this.
Right. I wasn't suggesting that Magellan was an example of beating the market by picking the right mutual fund. My point was that at least one person (Lynch) has been able to beat the market in a way that suggests it was not luck. Given that, it may be possible for others to beat the market.
I didn't do either of these things, I stayed ~100% invested in equities all the way down, and I continued to invest new money, too. Moving into bonds or getting out of the market only makes sense if I believed that the market was going to continue to go lower. But I never have any idea which way the market is going to go. I do believe that the shares of the companies I buy will increase in value over time, otherwise why would I buy them? But I don't know when. So I largely ignore the market as a whole. As a result, I bought a lot of cheap securities during the bear market (judging from their value now), was fully invested at the bottom, and made back my losses before the end of 2003 (this is not the same as my portfolio reaching its pre-bear level, I am not booking new investment money against losses here, only earnings against losses).
"Rich" is insisting former Fidelity Magellan fund manager Peter Lynch is the 1 of, say, 4096 mutual fund managers who beat the S&P 500 something like 12 years in a row, specifically from about 1977-1990, when he ceased to manage it.
The biggest problem with the analogy to me is that Lynch did not simply beat the S&P 500 for nearly 12 years in a row. He beat it by a lot.
Also, I am not sure exactly how many funds existed from
1977-1990, but it seems it would be between about 270 (end of 1960s number of mutual funds that is much quoted) and
10,000 (number today). One report
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puts the number of equity funds at under 300 in 1980. So it would seem more like Lynch was 1/1000 (to be generous) to have achieved immense success at "coin tossing," when in fact probability predicts the odds of this happening to be much lower. Remember, also it was a single round of 1000 people "tossing a coin" some 12 years in a row. This reality also raises the statistical significance of Lynch's feat. I think fairness demands at least the suggestion that Lynch had unique skills as a fund manager.
Reality also demands an acknowledgment that Lynch's feat absolutely has not been repeated. In other words, investors should not go around betting their life savings on a certain mutual fund or ETF, believing its manager is the next Peter Lynch.
I made this claim much too wide. Buffett's claim was that all of the folks that he personally knew that followed Graham's principles became coin-flipping stars.
I think the original post was reasonable for this forum, as did the moderators, apparently. I don't think accusations of trolling should be made lightly.
Indeed, the follow-up question seems to indicate that the OP has a genuine interest. I don't think he was just trying to be argumentative or disruptive. That would be me :)
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