The Efficient Market Hypothesis: A Populor Misconception

The Efficient Market Hypothesis, first asserted by Professor Eugene Fama of the Chicago School of Economics in the 1960s, is often cited by Indexing fans as a case against actively managed portfolios. According to the hypothesis, which I will show to be false, prices on traded assets such as stocks and bonds reflect all known information regarding said assets. If the Efficient Market Hypothesis is correct, it would be impossible for market timing strategies or individual security selection to yield results greater than the market consistently over the long run. As to what EMH advocates mean by subjective terms such as "consistently" and "long term" is unclear for the terms are never defined. However, a safe assumption for the period of time, referred to by EMH advocates, when they utilize the phrase "long term" is anything over ten years. The fact that many investors produce returns far above that of the market consistently and over the long term refutes directly the conclusions reached by EMH advocates. Investors such as Peter Lynch, Warren Buffet, Benjamin Graham, and many others can attest to this. However, the case of the EMH is not just a case of advocates of a theory misinterpreting its necessary conclusions. Indeed, if the EMH were correct, the conclusions advocated by EMH theorists would be correct for their arguments, in this one aspect, are valid. As previously stated, however, the problem with the EMH is that it rest upon false assumptions. First, according to EMH, all investors have access to all relevant information about a traded asset and make use of that access. This is clearly a false assumption. Just think of how many investors who do not even know the names of the CEOs of the companies they own stocks or bonds in. The second assumption is that all investors are perfectly logical. Last time I checked, investors like all other humans were illogical more often than not, choosing to make decisions based upon emotion rather than facts and logic. The third assumption is that there is no time delay between when a relevant event occurs that affects a particular asset and when investors learn of the event. This last assumption is just as insane as the other two. In summation, the EMH is clearly wrong. Investors who base decisions regarding their choice of investment strategies on the conclusions of EMH would be wise to reexamine their portfolios.