The result of the hypothesis been true has been described by Wikipedia as:
The efficient-market hypothesis was developed by Eugene Fama who argued that stocks always trade at their fair value, 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 chance or by purchasing riskier investments.
Later on, Eugene Fama worked with Kenneth French, and they developed their hypothesis further and added that the market has variants, the weak, semi-strong, and the strong forms.
The weak form of the EMH claims that trading information (levels and changes of prices and volumes) of traded assets are already incorporated in prices. If weak form efficiency holds then technical analysis cannot be used to generate superior returns.
The semi-strong form of the EMH claims both that prices incorporate all publicly available information (which also includes information present in financial statements, other SEC filings etc.). If semi-strong form efficiency holds then neither technical analysis nor fundamental analysis can be used to generate superior returns.
The strong form of the EMH additionally claims that prices incorporate all public and non-public (insider) information, and therefore even insiders cannot expect to earn superior returns (compared to the uninformed public) when they trade assets of which they have inside information.
Outperforming the overall market or beating the market refers, theoretically, to the performance of one’s investment portfolio doing 7% to 10% better on annual basis on average than the overall stock market.
Many times the ‘overall stock market’ is been reflected on the SP500 index that includes the 500 largest, by market capitalization, companies listed in the American stock market. An alternative is Russel 2000 and/or 3000 indices. Please note that this measurement applies to people who live in the USA, or simply put it, to people that live inside the “US market.” For people who live in Germany, for example, DAX index is the measuring point.
Another comparison can be done against the MSCI World index. This index includes the biggest 1,636 by market capitalization stocks from 23 countries from around the world. (Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Hong Kong, Ireland, Israel, Italy, Japan, Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, United Kingdom, and the United States).
The 23 developed and 24 emerging markets that the MSCI AC includes.
Although the above index measures a big chunk of the overall economy of the world, it’s not the only one. The 3rd measure of comparison is the MSCI AC index which includes stocks from 23 developed and 24 emerging markets of the world.
The theory that contradicts the efficient market hypothesis is called “the random walk hypothesis” and it is mentioned in the American economist’s book by Burton Malkiel, “a random wall down the wall street.” Investopedia also describes it as:
Random walk theory suggests that changes in stock prices have the same distribution and are independent of each other. Therefore, it assumes the past movement or trend of a stock price or market cannot be used to predict its future movement. In short, random walk theory proclaims that stocks take a random and unpredictable path that makes all methods of predicting stock prices futile in the long run.
If the efficient market hypothesis reflects the market’s real nature then the price respond only to unpredictable news and thus in random and unpredictable information, so the prices will move in a “random walk.” As a result
… the only opportunity investors have to gain higher returns on their investments is through purely speculative investments that pose substantial risk.
mentions Investopedia. It will be also true that investors and speculator cannot have a return that exceeds the overall market, and thus “beat the market.”
Effective market hypothesis and technical analysis.
If we take the EMH as a de facto truth about the behavior of the market then we can also make sure that the technical analysis simply does not work. Investopedia claims that:
The efficient market hypothesis suggests that markets are informationally efficient. This means that historical prices and expectations are already priced into investments and that it’s not possible to exceed market-average returns by looking at past price data. Since technical analysis is completely predicated on the concept of using past data to anticipate future price movements, the EMH is conceptually opposed to technical analysis. It should be noted that of the three versions of EMH, two conclude that neither technical analysis nor fundamental analysis can be useful when making investment decisions. Only the weak-form efficiency version of the EMH allows for some use of fundamental techniques.
The EMH is just a hypothesis, that although finds many supporters throughout the academic and professional community, remains a hypothesis investors have developed in order to understand how the markets really behave. Investopedia writes:
First, the efficient market hypothesis assumes all investors perceive all available information in precisely the same manner. The different methods for analyzing and valuing stocks pose some problems for the validity of the EMH. If one investor looks for undervalued market opportunities while another evaluates a stock on the basis of its growth potential, these two investors will already have arrived at a different assessment of the stock’s fair market value. Therefore, one argument against the EMH points out that, since investors value stocks differently, it is impossible to determine what a stock should be worth under an efficient market.
The noisy market hypothesis stands against the EMH, and Wikipedia states that:
the prices of securities are not always the best estimate of the true underlying value of the firm. It argues that prices can be influenced by speculators and momentum traders, as well as by insiders and institutions that often buy and sell stocks for reasons unrelated to fundamental value, such as for diversification, liquidity and taxes. These temporary shocks referred to as “noise” can obscure the true value of securities and may result in mispricing of these securities, potentially for many years.
The legendary investor George Soros is the biggest opponent of the EMH. He suggests the market reflexivity instead. Investopedia describes the theory as follows:
Reflexivity is the theory that a two-way feedback loop exists in which investors’ perceptions affect that environment, which in turn changes investor perceptions. The theory of reflexivity has its roots in social science, but in the world of economics and finance…
Below there are 2 lectures from George Soros talking about his market reflexivity theory.
The market reflexivity hypothesis as a thought process.The market reflexivity hypothesis as it applies to the financial markets.
Beating the market
When I started searching the internet on who has beaten the market over time a few names of individuals and companies came up. The first was Warren Buffett who, as motley fool mentions:
Between the time Buffett took the helm of Berkshire Hathaway in the 1960s to the end of 2016, Berkshire’s stock price has delivered 155 times the S&P 500’s total return.
The second name that came was Will Danof, the $108 Billion man, who beat the market
…according to Morningstar, outperforming the S&P500 index by 2.9 percent points a year.
Morning star has also published the following table that shows some hedge funds that has beaten the market.
Until today, we have not figured out how the markets really work. I believe that the truth always lays in the middle. My experience until today has taught me that stocks reflect a big percentage of the sum of the information into their price chart, technical analysis includes a big chunk of hoax inside, like some unreal indicators, and it’s more based on the overall beliefs that people have. If for example, hypothetically, tomorrow all the finance gurus meet and agreed to release a so-called super-indicator and say that this is the universal truth of technical analysis, the whole concept will succeed just because they will influence the market to accept this indicator as the truth.