General Thoughts

Quick Example of Why “Efficient Market Hypothesis” is Wrong

The Efficient Market Hypothesis (EMH) has long been a staple among academics and business schools. The basic premise behind EMH is that markets are efficient in the processing of information; meaning that stock prices always reflect all publicly known facts, and as new facts become public knowledge, the market instantly updates this information and the stock price fluctuates accordingly.

The EMH implies that there is no possible way (absent of illegal insider information) for an investor to consistently pick a group of stocks that do better than the S&P 500 or some other relevant average.

I just noticed Apple shares are down 4.5%. In trying to find out why, I saw that there is an explanation out there that because certain brokerages are raising margin requirements, sellers are unloading their some of their shares of AAPL. I have no idea if this is true, but I do know that forced selling happens fairly often in markets, and that selling has absolutely nothing to do with the intrinsic value of the asset being sold. Apple is no more and no less valuable today because some brokerage firm decided to raise the amount of money needed to hold AAPL shares on margin.

Here is a quick excerpt from a Business Insider piece on the story:

Apple’s stock is down as much as 4.25 percent this morning.

Why? Street Insider is speculating that “clearing firms are raising the margin requirement for clients,” and this is causing Apple’s stock to nosedive.

A higher margin requirement means investors need to either put up more of their own money to buy Apple stock, or just sell what they have so they don’t have to put in more cash. Margin requirement increases generally happen when a stock becomes volatile. For a long time Apple was a rocketship. Now it’s not, so a change in margin requirements makes sense.

I believe the market is quite efficient at certain times, but largely inefficient at other times. But on balance, the market is not very efficient. Many think that the liquidity in the market causes efficiency, but I think liquidity actually helps create inefficiency. In liquid markets, it’s very easy to sell anything for any reason (rational or not).

Margin requirements might be of small importance in the big scheme of things, but it’s one small example of how liquid markets can be very inefficient.

2 thoughts on “Quick Example of Why “Efficient Market Hypothesis” is Wrong

  1. i’ve always railed against believers in EMH for three simple reasons. 1). Not everybody reviews all readily available information. 2). Not everyone processes that information the same way, and 3). Not everyone will make the same calls with that information.

    Many investors are prone to rumors when it comes to planning their investments, and so they rely on someone elses opinion to make their purchasing decisions.

    Also, if you are a technical (or the new term “Quantitative) analyst you will not be interpeting information the same way as a fundamental analyst.

    And even if you do hapoen to process the same information the same way it doesn’t guarantee a person will inevitably make the same decision.

    EMH depends on a fictional perfect investing world where every involved party plays their assigned roles in the exact same way in order to be true, but one doesn’t exist. It is my experience that most humans are irrational and lazy. If they can find an easier way, even if it’s not the better, then they’ll take. EMH gives people too mich credit.

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