What Is the Efficient Market Hypothesis (EMH)? Is it True or False, Half-True or Half-False?
The efficient market hypothesis (EMH), also known as "efficient market theory" states that share prices reflect all known information in the current moment and that ergo they are valued fairly. This in turn infers that consistent alpha generation cannot be achieved and that it is also fruitless to try and beat or out-perform the markets.
According to the EMH, stocks always trade at their fair value. Therefore, expert stock selection or market timing is a myth being chased by investment bankers, analysts and brokers at the expense of investors. Why should Wall Street be paid high fees if they are not outperforming the market. EMH states that the only way an investor can potentially beat the market is by making riskier investments. A low cost ETF or balanced fund that tracks the market is all that most investors need.
EMH or efficient market hypothesis fails however to take one key factor into account, namely human beings. Human beings are not rational. Stock market or housing or art bubbles and busts are littered along the path of progress in human history. They come and go. They repeat, again and again. We can probably go back a lot further in history to illustrate this point but we will start with what was referred to and more commonly known as "The Dutch Tulip Mania" in the 17th century when tulips reached absurdly inflated prices and then collapsed in 1637. Fast forward to the roaring 1920's and crash of 1929 and then to the dot.com bubble leading up to 2000 and the housing bubble of 2007. You get the point. Every one of these bubbles was fuelled by human "greed" and an infinite supply of hope that things would keep getting better or that stocks or property would go higher and higher. Not exactly rational given that the battle hardened and tested "theory-not" of "market cycles" which states that all markets whether it be commodities, stocks and collectables move in cycles.