The “efficient market hypothesis” (EMH) is an important concept in academic finance. It says that (because of intense competition amongst investors and the wisdom of crowds) stock prices are more or less correct at all times. It is impossible to beat the market, other than through luck or by taking on more risk than the market.
If the EMH is correct, the best approach for investors is to invest in index funds.
A recent paper by fund manager Clifford Asness argues, however, that the stock market has become less efficient over the past 30 years.
papers.ssrn.com/sol3/papers.cfm?abstract_id=4942046
He cites as evidence the 2019-2020 rally of Growth stocks, and the poor performance of Value stocks during the same period, which in his view was irrational.
Asness offers a number of explanations for the less efficient markets of today:
1. Index funds, which buy stocks no matter whether they are attractively valued, have distorted markets.
2. Low interest rates made investors overpay for Growth.
3. New technologies, instead of improving how markets work, have turned the stock market into a casino where irrational traders move prices away from fundamentals.
Asness is particularly critical of social media, which he views as providing fuel for reckless users of gamified, 24/7 trading platforms. These users trade stocks they know little about, all in the same direction, depending on the exhortations of social media gurus.
I agree only partially with Asness. The stock market remains highly efficient: otherwise 90% of professionally managed funds would not underperform the market.
www.spglobal.com/spdji/en/research-insights/spiva/
I also think that instead of blaming social media, it would be better to explain the Growth stock bubble of 2020 by invoking a favourite pattern of Asness himself: momentum.
Investors like to invest in strategies that have done well recently. On eToro, 12 to 24-month track records are important; professional investors evaluate their managers using 3-5 year past performance.
So, if a strategy has done well for the past 1-5 years, more money will tend to flow into it. This will push up the prices of stocks held in the strategy, and it will tend to do even better, leading to more inflows. This process continues until the strategy becomes so popular that it fails because the stocks it holds have simply become too expensive.
Those who have the mental discipline and strength to bet against these kinds of multi-year strategy bubbles will, I agree with Asness, stand to gain in the long run. That is why I stick with Value stocks, which in my view continue to have more upside potential relative to Growth stocks.
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