An Example of Why I am Not Sure I believe in The Efficient Market Hypothesis

Every morning I watch CNBC as I get ready for work in the morning.  I think the best part of the show, Squawk Box, are the guests and interviewees.  They literally have everyone on from the CEOs of some of the biggest companies in the world to Presidential hopefuls.  There is nothing like when the main host, Joe Kernan, goes after a politician and asks the seemingly simple question of how the hell could you believe whatever he may believe/spouting?  I also like watching the ticker as it shows what is being traded…and I couldn’t believe my eyes this morning when I saw a 50% drop in Green Mountain Coffee Roasters, Inc. (Owner of Keurig):

GMCR Stock

Down 47% on bad earnings and a lowered guidance for next quarter! Four Billion dollars, yes – $4,000,000,000, of value was erased in one day!

For curiosity purpose I then brought up the three year chart from the beginning of 2008 to end of 2011:

It split (2:3) twice and was up over 400%!

What is The Efficient Market Hypothesis?

According to Investopedia EMH is,

An investment theory that states it is impossible to “beat the market” because stock market efficiency causes existing share prices to always incorporate and reflect all relevant information. According to the EMH, stocks always trade at their fair value on stock exchanges, making it impossible for investors to either purchase undervalued stocks or sell stocks for inflated prices. As such, it should be impossible to outperform the overall market through expert stock selection or market timing, and that the only way an investor can possibly obtain higher returns is by purchasing riskier investments.

But if all the information is out there? how can any stock drop 47% in one day? how can it go up 400% in 3 years?

If the EMH says that the stock is priced correctly for the information out there, then what solace does anyone have that it won’t drop like that? Meaning what good is the theory?

14 Responses to An Example of Why I am Not Sure I believe in The Efficient Market Hypothesis

  1. I too am increasingly skeptical of EMT as it is usually pushed. My current thinking is that it’s a correct theory for the market as a whole, over long periods of time. If the market was 100% efficient 100% of the time, Warren Buffet would be an average investor.

    As you start to examine specific stocks over shorter periods of time, the market is clearly not efficient. It’s these blips, or hiccups in efficiency that guys like Buffett exploit.

    • I wonder if Buffet ever talked about the EMH/EMT? I don’t think there is anyone that will argue that Buffet is king of exploiting inefficiencies

  2. Let me dispel something. The market is not efficient. There, now you are free. How will this change your life? :-)

    Also, the GMCR leap call option I bought yesterday is up 6% already. Woohoo for market inefficiency!

  3. Those guys are reporters/journalists. And a lot of the stuff on CNBC is noooooise.

    One of the main things I want readers on FS to do is think for themselves and stop being zombies.

  4. And this is another example of why I think most people with time and the willingness to learn how to read annual reports and examine industries can beat the market.

    Interestingly, the reason GMCR got obliterated was mostly to do with efficient markets. After losing its patent protection, it’ll actually have to compete for K-cup coffee sales. I guess shareholders were way too optimistic about how much of its monopolized sales it would keep after it lost its patent protection. It was only a few minutes into the conference call that after hours trading pushed it down 50%. Nuts.

    • But if that information was always public couldn’t one argue that it wasn’t efficient? meaning why wasn’t it until the conf call that it dropped.

  5. I think in the short term there is no way that EMT is correct. It can be proven over and over again. Over a longer stretch I think the principles of EMT make a little more sense. I continue to think that competing with the hedge fund guys in terms of analysing information is a bad idea over the long-term. I’ll stick to ETF investing and let you all fight it out while I take the average!

  6. EMH has weak foundation and loopholes which are the reasons for market crash like that back in 1987. And no one can clearly anticipate or explain as to how this crash happens.

    In similar manner with price variations, buyers and sellers becomes panicky when prices crash. A drop in stock’s price means that his portfolio is at lower value. Nevertheless, this implies an increased future returns. There is cancellation of outputs, which is actually the same with price gains.

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