Reader DaveinHackensack asks:
If you weren't an EMH adherent, what are some investment ideas you
would consider to take advantage of the global economic macro trends
you see?
Canned goods and ammunition.
Seriously, I can't separate myself from EMH enough to answer this question. When I look back at decades of predicted macroeconomic trends, I see about 99% bloopers to 1% correct predictions. The only certain trend that I am reasonably certain will not reverse itself is the aging of western societies, but how you should invest in that depends a great deal on policy in those societies. If you can find someone with a miracle anti-aging pill, however, I'd buy.
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:::in a very small voice:::
what does EMH stand for?
Er, efficient market hypothesis? I had to google it. Funny, it's the investment strategy I use (dollar cost averaging of index funds).
Kate:
Efficient Market Theory.
Megan,
Not just ammo, but magazines as well. For ammunition that is. The price of a 15 round magazine for .308 rifles over the past 5 years has made them a better investment than a house.
Kate,
It stands for "Efficient Market Hypothesis", which is the theory that an active investor can't outperform the market (except by chance) because all relevant information is already priced into every stock.
It's the reason why all oil producers are at full capacity and that no one leaves reserves untapped and you've never found a dollar on the ground; if it was there, someone would have picked it up already.
Aaron neatly encapsulates the theory, but in reality the markets aren't completely efficient. Fear, greed, and ignorance reduce efficiency. One small example: An oil company I own a few shares of, Vaalco Energy (EGY), released earnings after the close on August 11th. The next day it closed at $5.76. If you are an EMH-adherent, you'd say that this was the price after the market factored in the earnings information. Since then, there has been no new information released about the company, and the stock closed at $7.22 today. That 25% move in a week, in the absence of any new information about the company, suggests a certain inefficiency in the market's pricing of the stock.
Also, it's not true that no one leaves oil reserves untapped. We do. We've got about 12 billion barrels of recoverable oil sitting untapped in ANWR, and who knows how many barrels under the outer continental shelf.
One possible flaw in the EMH is that it may not hold if the market substantially consists of non-rational investors. I don't really think that's broadly the case, but I think there's enough people that are into "moral investing" that The Vice Fund seems tempting (although vicious thrill I get from funding purveyors of vice is a bigger justification than any profit edge I might expect).
The real life criticism of EMH is that plenty of people have become fabulously wealthy using technical, fundamental analysis or contrarian approaches. Either they were all lucky or there is something to those methods.
However, for the avergage investor, EMH is probably the star to hitch yourself to in order to insure the greatest likelihood of acheiving capital appreciation while minimizing risk.
Vaildog,
Good point about the people who have consistently outperformed the market, but I'd suggest an average investor would be better off investing with one of those investors (e.g., Berkowitz, Heebner, etc.) than indexing.
Megan,
A follow up question for you if you're reading these comments: Do you think the oil market is efficient too?
When I look back at decades of predicted macroeconomic trends, I see about 99% bloopers to 1% correct predictions.
In that case, shouldn't you be able to make money by shorting index funds when someone predicts the market will go up, and buying index funds when someone predicts the market will go down?
No Comment,
The problem may be that Megan's thinking specifically of economists' predictions. Jim Rogers isn't an economist, but he has a pretty good track record of predicting macro trends. In the late 1960s, he started investing in commodities at the end of the penultimate secular bull market in stocks; in the 1970s he made a fortune in commodities, retiring at age 37. In 1982, when no one was interested in stocks, he got back into stocks, right at the beginning of the last secular bull market in stocks (1982-2000). In the 1990s, he wrote about the growth of China, and in 1999, when everyone was thinking about dot-coms, he predicted the current secular bull market in commodities. The guy's been ahead of the curve enough that he's worth listening to.
I never got why academic economists who self-identified as neo-classical were so incredibly dogmatic. EMH is a classical example, steming from a plausible sounding "arbitrage" argument, which stops dead as any attempts at bringing it closer to the real world. Listen, I like the model too, but that doesn't mean I forfeit any sense of empiricism after I hear it.
Is it any wonder there are prominent academic economists involved in finance (I say being an academic economist), or why people don't trust MBAs on issues outside the world of consulting?
Anyone who completely believes in EHM doesn't have their eyes open. Sure, the market is more efficient than the Yahoo! finance message boards would have you believe, but we certainly don't live in the world that Markowitz conjured up.
If markets were completely efficient, why did the US trade deficit stay so large for so long without an adjustment of the dollar? Why did the NASDAQ go up to 5000 and then spectacularly crash? Why did the stock market drop 50% in one day in 1987? Why to spin-offs outperform the market? How do hedge funds on average beat the market (before fees)?
Beating the market is difficult, which is why the portfolio manager of your mutual fund can't do it (hey, YOU try beating the market when you're limited to "U.S. mid-cap growth stocks"). Sure, index funds outperform mutual funds (all of you should put your nest eggs in low cost index funds), but for god's sake don't give me this as "evidence" that the EHM gospel is correct.