Is The Market Efficient?

The implications of market efficiency for investors are sweeping. If asset prices always fully reflect available information, there are only two ways to profit: by taking a risk that has been priced into the market, which can be done cheaply with an index fund. If the market is not efficient, then it should be possible to profit by consistently selecting undervalued stocks, and timing the market.
Referenced in this video:
the Efficient Market Hypothesis (EMH) - rationalreminder.ca/sensible-...
The Performance of Mutual Funds - onlinelibrary.wiley.com/doi/f...
Do Low-Volatility/Low-Beta ETFs Make Sense? - www.pwlcapital.com/do-low-vol...
On Persistence in Mutual Fund Performance - www.jstor.org/stable/2329556?...
Luck versus Skill in the Cross-Section of Mutual Fund Returns. - onlinelibrary.wiley.com/doi/a...
The Efficient Market Hypothesis and Its Critics - eml.berkeley.edu/~craine/Econ...
Interview with Eugene Fama - www.newyorker.com/news/john-c...
The Superinvestors Of Graham-and-Doddsville - www8.gsb.columbia.edu/article...
Betting Against Beta - www.aqr.com/Insights/Research...
Catch up on our latest investing advice, insights and white papers here.
www.pwlcapital.com/teams/pass...
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#investing #strategies #marketefficiency

[@theofficelab]

Big shoutout from a fellow KZbinr: Your channel amazes me with every new video. Awesome combination of science-based financial content and a calm and professional way of presenting it. Keep it up, Ben. You deserve way more subscribers!

[@BenFelixCSI]

Thank you!

[@anothercrappypianist]

Loved the Dwight False graphic at 6:00. :)

[@HamiltonRb]

I believe the markets are efficient but the human conditions of fear & greed is the difference between market returns and above/ below market returns. When the markets crashed in 07, some panicked & sold, some did nothing and waited for the market to return & some bought. Markets are efficient but people are not.

[@purplepurls77]

I'm currently majoring in finance for my undergrad and I feel like I'm learning way more from your videos/ developing a stronger passion for finance than I am in class. Thanks for the videos!

[@SoCal209]

Very nice exposition of EMH vs. inefficient. States what cannot be denied: At times the market acts reckless, whether euphoria or distressed, but no one can consistently predict outcomes or consistently take advantage of them. Buffett and Munger purchase businesses and excel in research, which minimizes risk. But even Buffet now advices indexing for most people and no longer strictly follows the precise value method of Graham, his mentor. As data streams improve, investors react and thus markets become more efficiently priced. Thank you Ben for these videos.

[@robb0995]

I’ve been addicted to your content since I found it a few weeks ago. Thanks so much for putting this evidence-based rational info out here in such an easily understandable way. Can’t wait ‘til this becomes worthwhile for you to do even more often because I’m almost out of Rational Reminder pods too! One question I’d love to see covered here is a breakdown of ETFs vs. Traditional funds. I had the question and I spotted a similar question elsewhere about why the industry has so much heat around this product and whether or not the lower costs are illusory because we’re paying more somewhere else. I originally wondered if it were something like bid-ask spread or market variance from underlying NAV when making buys that hadn’t yet been arbed away. I think you alluded in the podcast to the security lending fees being perhaps the X-factor, but I’d love to understand more so that I can trust that the lower MER is real. Talking of course about broad index funds, not the crazy fad funds like weed stocks or triple leverage. Again, thanks so much. Wish I were Canadian, I’d sign with you guys in a heartbeat for personal advice!

[@negativegains4883]

Love how simple you make larger concepts when you break stuff down. Ray Dalio-esque. bravo!

[@BenFelixCSI]

Wow! What a compliment! Thank you.

[@Markjohn91]

Hey Ben, great video as usual. Keep up the good work! Do you mind including in the description some of the studies you’re referring to? It would be nice to be able to read them.

[@BenFelixCSI]

Good idea. I will start doing that.

[@justintarlton6878]

Thank you for these videos. They've fundamentally changed my viewpoint on seeking returns with my investments. Your message meshes well with those of us looking to FIRE. I'd be very interested in your take on the financial independence retire early movement from an empirical standpoint.

[@edwardmauer7442]

Hey Ben, very much appreciate the videos. Just a few questions/ ideas I'd like to throw back. 1) Your stance on picking "undervalued" stocks based on fundamentals for the long term is clear. But what about day trading and swing trading, and technical analysis in general? 2) Define "efficient". In your video you state that buyers and sellers are competing to execute trades at prices for their own best self interest. But aren't self-interests often divergent from individual to individual, or entity to entity? One may buy and sell not solely on the basis of their belief about the future price of the equity they hold, but also for risk tolerance purposes, portfolio allocation/re-balancing, hedging, or because they'll need the money in the near term. So, depending on individual circumstances, isn't it possible for a trade to happen in the best interest of both parties? You see, correct me if I'm wrong, but you would equate efficiency with accuracy. That's to say, the current price of most or all equities accurately reflects all available information. But who's to say what accurate is? One could make the argument that there is no such thing as accurate, only acceptable. A certain price for a certain stock may be acceptable or unacceptable for different individuals, depending on risk tolerance, position size, portfolio allocation etc... 3) Couldn't their be a plethora of reasons for mutual fund under performance that have nothing to do with stock picking skill? Such as scaling size (closet indexing), the need/pressure to produce near term results for their clients less they go to another fund, politics of the managers within the fund such as disagreements and turnover etc... My point being, some individuals in some funds might be able to skillfully pick stocks under less complex circumstances, such as managing their own personal portfolio. Under performance of funds may be a result of the challenges of running a fund successfully, especially as the fund gets noticed and scales up in volume. In any case, I don't dispute that mutual funds deliver substandard returns and I do agree that they should probably always be avoided. But I've thought about all this for a while, and I'm not sure that successful stock picking is as un-doable as you think. I mean, consider the fact that 90%+ of people who try day trading fail. If somebody, like a chimp at a computer, randomly bought and sold random stocks at random times, we would expect them to eventually break even. So, 90% of people are doing worse than a random chimp. Is this not evidence that most people involved in the market are simply gambling or trading off emotion rather than being rational/efficient? Therefore, one who was intelligent, experienced, educated, and didn't trade off emotion could consistently profit; assuming they were investing for themselves without the complicated bureaucracy of a mutual fund. Thanks, looking forward to your reply.

[@elliottmiller3282]

I think the big thing is just the volume of trading. And the amount of people that are bringing in sophisticated information. I think it makes for a tall order to be able to consistently profit. But I also think that, if you want to try, to do so responsibly. Even for passive investing. Know what you need to to be able to throw money in at appropriate times.

[@happywanderer5632]

What is your view of the VectorVest product? That claims to be able to use market timing and contains many tools like backtesting, to create investment timing strategies that have a higher probablities of success. I'd enjoy seeing an episode on VectorVest from you

[@joelman1989]

I've always said that by the time I find a flaw in market prices, there are probably thousands of experts who wake up every morning and watch the markets and read WSJ and many other forms of news and who have been doing this for years who have likely figured that out hours if not days or weeks before I have. Me, an average investor, would have to be ignorant or arrogant to assume I could get it right consistently without taking on an unreasonable amount of risk.

[@mjlyco9752]

The market is a ton of cars that are driven down the road by looking at the rear view mirror and surmising where to go. It has to be efficient because we’re all looking at the same past data. That doesn’t mean the valuations are correct. True market inefficiencies are illegal or impossible (insider trading and seeing the future).

[@sillypeachy33]

Great video as always. My number one tool in winning debates against my active trading friends who believe they can beat the market.

[@mmabagain]

Jeff Y: Active Vanguard Wellesley (40/60) has been far better than passive Vanguard Lifestrategy Conservative Growth (40/60) over the last 28 years. Far better.

[@mikeg9b]

This was a good one. Have you done a video on what determines long-term stock market performance? Why have US markets (VOO & VXF) outperformed developed (VEA) and emerging markets (VWO) over the last 10 years? I'm an American invested in all of these funds (40% VOO, 30% VXF, 20% VWO, and 10% VEA). I would have been so much better off if I was 100% US. Is there any way that I should have known that 10 years ago? How will they do in the next 10 years?

[@Kralnor]

I think this is related to factors not necessarily working out over long periods of time. For instance, the value factor hasn't paid off over the last decade. Have a look at Ben's previous video here kzbin.info/www/bejne/aH65hKaMnpaSm5Y

[@alex2143]

Past returns are a bad predictor of future returns. The fact that US stocks have outperformed the world in the past does not guarantee that that'll be the case in the future. If you'd have put all of your money on one stock that went to the moon, you'd have made even more money. If only you'd have known in advance that the stock was gonna go to the moon.

[@Svar-uc8zn]

But participants with more money and easy/cheap credit access have more weight into the final price giving more importance to their "information"/"opinion", is there any study on that ?

[@Teolulz]

how does momentum investing fit into this hypothesis? some people have given very convincing data supporting the strategy.

[@grantmaxted1160]

Perhaps a good way to think about this is that markets are efficient most of the time (during normal times) but at bull market peaks and bear market bottoms they can, and mostly do, become inefficient. But the bottom line is that markets are efficient enough that’s it’s extremely difficult to them, and the probability of success is so low that it’s not rational to try. Which is why Charlie Ellis calls trying to do so a loser’s game.

[@garyl881]

Love your videos! I have a question unrelated to this video: do speculative stocks have a place in a diversified low-cost ETF portfolio? If yes, what would be the max % you would allocate to such assets? Thank you :)

[@andersbodin1551]

The portion you can aford going to 0

[@nils6189]

Probably late, but this is called "core satellite strategy", you could research into this topic

[@mikesmith2315]

Love these videos. Each one is a chapter of an up2date textbook condensed into a few minutes. Perfectly distilled. People who appreciate these videos should check out vanguard's asset allocation page which shows historic returns of various stock and bond allocations since 1927. Very interesting.

[@BenFelixCSI]

Thanks Mike!

[@ekananda9591]

I really don't know whether market is efficient or not, but i know that minimizing the cost of investing is always good things to do

[@jakel8627]

I beleive the inefficiencies are so small and a rare that they're not worth pursuing

[@malcolmcallis1398]

What about the momentum effect? Isn't that inconsistent with efficient markets?

[@AdithiaKusno]

If we assume that CAPE was incorrect because corporate future earnings are nowadays calculated differently, then with modified CAPE we may find that the market is somewhat efficient. I think when scholars argue for inefficient market they weren't denying its efficiency but rather argue that over long time horizon there will be mean reversal eventually which will make index funds inefficient. Other than my previous request on Vanguard versus Dimensional, can I request a video on mean reversal? This is important because John Bogle predicted that future gain may decline to 4% due to mean reversal.

[@mpower2386]

Edges obviously exist, just look at virtue or rennaissance technologies. But for retail investors, those edges are rarely atteignable. Looking at charts and 10-K on the weekend and expect to beat the market consistenly is delusionnal.

[@itsjacob7239]

Therefore should an investor buy a total market index? How about a global total market index?

[@hworldsystem300]

Thanks Sir, for sharing precious information about the Nature of Financial Market. if appraisal ratio is greater than Sharpe Ratio could it be the manager skill to justify inefficient market? looking forward your view Thanks and Regard.

[@tariqabughofa9730]

Hi Ben. Appreciate how you videos are very informative and easy to follow. Great Work! Please do a video on REITs. Their benefits and whether there is a benefit from including in a diversified portfolio. In VCN for example, I noticed there is no considerable weighting for the real estate sector.

[@BenFelixCSI]

This has been requested a lot, so I think I will do it.

[@SUBPARkour2013]

how is this not the most subscribed to channel on youtube

[@krishnaiyer2556]

exceptional

[@KevinConwayChannel]

Summary: Kinda. Hah great video, man! Awesome content.

[@NimW]

Can you make a video about leveraged ETFs?

[@jakel8627]

I relate to Ben a lot. I even got the same haircut. We probs have the same dad

[@Knightshield]

do you think Dwight Schrute would be an Index Investor? or more of a land guy?

[@theconqueror1111]

The markets can only build you so much wealth, everyone has to respect the efficiency of the markets and understand that no one can obtain higher returns without taking on an unacceptable amount of risk. Throwing your money into index funds is not dismissive advice, it is the best advice even for professionals. There is nothing fundamentally rational about the price of stocks, it is just whatever people are willing to buy and sell them for, for whatever billions of random reasons, you can't predict this stuff. The only edge that exists is immediately taken by extremely powerful teams of professionals, leaving not even highly skilled and knowledgeable fund managers a chance.

[@matt9060]

“Price is what you pay. Value is what you get.” “Risk comes from not knowing what you are doing.” “Never invest in a business you cannot understand.” "If past history was all that is needed to play the game of money, the richest people would be librarians.” “The investor of today does not profit from yesterday’s growth.” “The stock market is designed to transfer money from the active to the patient.” -Warren Buffett I think there are a handful of people out there who really can value stocks and received outsizes returns, Warren Buffett, Mohnish pabrai, Peter Lynch. But for the rest of us, yeah index funds it is.

[@ProfessionalTycoons]

thank you for thsi video

[@ProfessionalTycoons]

also what kind of video editing software do you use?

[@jieyang7146]

Hi Ben, thanks for all the education in this channel. Please please respond to Dr. Michael Burry's recent prediction of the index fund ETFs "bubble." As an ordinary investor, there's no way to ignore what he said and I'm eager to know your responses even if you might think you have said enough to cover this topic. Thanks!

[@christophteichmann4741]

Do a video abot the MSCI World Quality Index an the MSCI World Momentum Index. They beat the market over long periods (with a lower volatility with the Quality factor) so the market is not efficent.

[@lizhang9898]

hi Ben, a humble suggestion here: Considering the possibility of a fed rate cut, Can you do a segment on the likelihood of mutual fund managers beating the market in a high or low interest environment. I wonder if there's any academic research published on this subject.

[@BenFelixCSI]

Interest rate environments I am not sure, but performance in bear markets has been studied. Here is a good summary advisors.vanguard.com/VGApp/iip/site/advisor/researchcommentary/article/IWE_InvComMYTHActvMgmtPfrmsBttrBrMkts

[@pipebliss]

The market is definitely not efficient, like you stated. The problem, in order to exploit the inefficiencies you need to understand businesses to a high degree or you need to be Jim Simons. For the average Joe Six Pack, it's probably better just to buy the s&p and call it a day but that is extremely boring and you will always be average.

[@theconqueror1111]

Not even extremely talented and knowledgeable fund managers can beat the markets. You basically need to be Jim Simons.

[@pipebliss]

@@theconqueror1111 lots of people and managers beat the market

[@user-bn7su4hp3x]

Modern portfolio theory in two minutes!

[@Skaahn]

But what are the inefficiencies, if any?

[@chrisv9977]

I worked at a prop firm where traders consistently beat the market for +10 years. Not long term investing but still trading it. So this would explain inefficiency right?

[@BenFelixCSI]

Sort of. Try this video kzbin.info/www/bejne/nqe4qqilapieh7M

[@WhiteWulfe]

Ooooh, new intro.

[@thatpointinlife]

Hi Ben, Thank you for your very informative videos, and for being so handsome. What are your thoughts on Target Retirement Funds, particularly Vanguard's?

[@BenFelixCSI]

I think that they are fine. Anything with total market exposure and low fees will give you a pretty good outcome. There has been some research showing that target date funds are sub-optimal, but in reality they make it so easy to implement that they're hard to argue with. One of my PWL colleagues has researched this extensively. www.pwlcapital.com/wp-content/uploads/2018/06/2017-06-08_Westmacott_TargetWealthTheEvolutionofTargetDateFunds.pdf

[@meeeeeeeeeeeify]

The video description says that there are two ways to profit if asset prices always fully reflect available information, but the video says there is only one!

[@BenFelixCSI]

Weird. 1. Security selection 2. Market timing Sorry you don’t have a dog.

[@dvrka]

I personally think that the market is eventually efficient :)

[@herkfsu]

I know you guys always preach about efficient markets paired with risk as the reason factors like value, for example, provide excess returns. I saw some good research from Rebeco where they analyzed the riskiness of value stocks and they came to the conclusion that the riskier value stocks actually under performed the less risky value stocks. Risk was measured via several different ways(debt, earnings quality, volatility etc), all giving the same results. Their conclusion was value premium was behavioral. Thoughts?

[@herkfsu]

and I looked for the paper and was unable to find it. If I come across it again I will provide the link.

[@BenFelixCSI]

Interesting, because I recently read a Robeco paper that attempted to prove that value is a risk premium. I thought they did a good job. www.robeco.com/docm/docu-20141016-what-drives-the-value-premium.pdf

[@r29]

Talk about adaptive markets of andrew lo

[@miked412]

The market is clearly more efficient than inefficient.

[@Aubatron]

I think the (roughly) efficient market is accurate. The more mature and the more people making orders, the more efficient the market is. If the orders were being made by perfect computers, it would be almost completely efficient, but most of the orders are still made by impulsive, emotional, egotistical people, so there will always be inefficiencies. You take value investors like Warren Buffed and his recently deceased business partner Charlie Munger, they’d sometimes wait a decade to find an inefficiency, and they’d use a formula to calculate future cash flows to value the business into the future. Their investment strategy wouldn’t be viable if markets were completely efficient.

[@PW060284]

Fama shared the Nobel that year with Shiller, whose work disputes efficient markets. How does one explain that?

[@BenFelixCSI]

Their disagreement comes down to the philosophical explanation of the empirical results. When Shiller sees a bubble, Fama sees asset prices that reflect rational investor expectations. Fama says that it can only be a bubble if we can predict when it will pop. They view the world differently. Fama has a model to prove market efficiency empirically. Shiller still can't predict the future in a way that can generate profits (predict exactly when bubbles will end). Both of them have made amazing contributions to the literature. Trying to invest based on Shiller's work will lose you money. Using Shiller's work to estimate future expected returns is probably a good idea. This email exchange does a good job of illustrating what I mean www.ivo-welch.info/teaching/famaconversation.html

[@PW060284]

@@BenFelixCSI I would say that recent literature is becoming more and more receptive to active risk management. You simply trade the risk of whipsaw for tail risk. Whether that is compelling or not is up to the individual

[@BenFelixCSI]

The recent literature is getting less theoretical and feeling more like data mining. Anything that I am going to implement needs to have a theoretical basis and empirical backing both in sample and out of sample. I agree though that many of these decisions are ultimately based on preferences.

[@saifakib8346]

Hii. I was in ottowa for Canada day 😁 didn't see you though

[@BenFelixCSI]

I was in St. John's NL

[@RoelVanderauwera]

I think some stocks are priced irrationally.

[@RoelVanderauwera]

@Jacob L I can't. Some people probably can over the long run.

[@alexxx4434]

Wouldn't "efficient market" not have volatility and cycles?

[@alankoslowski9473]

Not at all. If information indicative the near future is highly uncertain, investors will act accordingly. Sometimes they will overreact. As he said, it's not perfectly efficient, but it's efficient enough to beat active management.

[@739jep]

Efficient markets means known information will be reflected in prices. New information, not previously known and thus not reflected in prices yet, can be random and extreme and thus when it gets priced in it can lead to volatility.

[@the_primal_instinct]

I don't like the term "efficient" because it implies people that use information to make their desicions are perfectly smart. But people by the virtue of not being gods are on average pretty stupid. I prefer to say that market is "complete" that better reflects the fact that all available information is already reflected by the price rather than that is correct.

[@_Digitalguy]

Ben, you would not consider factors as systematic inefficiencies at all? If you look at studies such as those by MSCI about factors, they tend to attribute their premiums to systematic errors and biases (such as overconfidence, overreacction, myopic loss aversion, lottery effect, etc.) or to (institutional) investors constraints...In your other videos you seem to say that these premiums are due to a higher intrinsic risk of these assets and not to those systematic inefficiencies. Have I understood correctly? If so, I have not fully understood what those higher intrinsic risks (of small and value stocks for instance) that are not reflected into standard deviation are...

[@BenFelixCSI]

There are two opposing views on the explanations for factors: risk-based and behavioral. If one explanation is correct, the other is incorrect. Whether factors are behavioral or risk-based affects how you might choose to invest in factor strategies. It also affects how realistic it is to expect them to persist into the future. We talked about this on some of our past podcast episodes www.pwlcapital.com/the-rational-reminder-podcast-ep-32-active-or-passive-management-the-behavioural-explanations-of-factors/ rationalreminder.ca/podcast/2019/7/3/episode-52-a-closer-look-at-the-cppib-report-what-you-need-to-know

[@ootakamoku]

Renaissance Technologies?

[@BenFelixCSI]

kzbin.info/www/bejne/nqe4qqilapieh7M

[@seanlynch8869]

Markets are mainly but not always efficient. People are not rational!

[@RRR20238]

Markets are not efficient, but when you prove it, they throw you into a jail for insider trading. And that’s why you should treat markets as efficient even if they are not)

[@guido1460]

Ben, could you please talk about technical analysis and your opinion about using it for trading? You are a great professional, it would be great to listen to your opinion.

[@BenFelixCSI]

The short answer is that there is no basis to believe that it works, other than anecdotes from people trying to sell you their trading strategies. Maybe I will cover it in a future video.

[@joceterdangi3709]

I guess capital markets sometimes efficient and inefficient because there's what we call volatility.

[@BenFelixCSI]

Volatility is not evidence of market inefficiency. It is evidence of markets constantly incorporating new information, which is market efficiency.

[@NickPeitsch]

The efficient market hypothesis is NOT true for short periods of time in the market. This is how value investors are able to make very high returns in the long run, like Warren Buffett :)

[@elliottmiller3282]

In another video, he explains that warren buffet just factor invests. however, he has done so over a long period of time.

[@BenFelixCSI]

Please show me proof of this. Warren Buffett is not proof, as I described here kzbin.info/www/bejne/gKvShZehm9qYqZY

[@imba69420]

This is funny how after dot-com crash and GFC people still make claims about "efficient markets" as if facts didn't exist.

[@BenFelixCSI]

It is explicitly obvious that you have no idea what the concept of market efficiency means. Good day to you.

[@imba69420]

@@BenFelixCSI Maybe I don't but I profited immensly from shorting another, uprofitable-tech bubble last year. "Efficient market" expected big companies with P/S > 50 to grow into their valuations. Guess what, they didn't! :D. Now the "efficient market" expects NVIDIA to grow its revenue to 0,5T at 40% margin. Let's check that in a few years :) (Today Nvidia has market cap at almost exactly 1T).

[@clamdiggerme]

Ben, sometimes I know know what to do with the information you present. You never say at the end of the video how to use the information.

[@BenFelixCSI]

Thanks Alan. At the beginning of this video I explained that if the market is efficient, index investing makes sense, and you would not expect a better outcome from any other investment strategy. I then presented the argument that the market is, in fact, efficient enough to be treated as such by investors. The takeaway was intended to be that index investing is probably the best approach to investing because the market is mostly efficient most of the time. I guess the action would be investing in index funds, or sticking to that strategy if you are already doing it.

[@clamdiggerme]

Sometimes I think index funds are almost like a self fulfilling prophecy. Money is automatically going into index funds so there is guaranteed growth. Because there is steady growth, more money goes in. Other mutual funds that aren’t actually index funds often have a similar composition. However the Russell is not growing like the S&P. Why?

[@BenFelixCSI]

Money going into index funds barely affects stock prices, if at all. Index funds only account for about 5% of stock trading. It is stock trading that sets prices. Different indexes will perform differently. The S&P 500 is 500 of the largest companies in the US. I’m not sure which Russell index you mean, but the 2000 for example is small stocks. You would not expect small and large stocks to perform the same, which explains the difference.

[@AustinPowerz-bn5ry]

I'm pretty sure that Jeremy from Financial Education, Ricky Gutierrez from Techbud Solutions, and Ross Cameron from Warrior Trading have been obliterating the market consistently for years.

[@BenFelixCSI]

Never heard of them. They must be billionaires then?

[@AustinPowerz-bn5ry]

@@BenFelixCSI They all have KZbin channels under those names. Maybe too young to reach billionaire status. They are millionaires though.

[@AustinPowerz-bn5ry]

Even if you just go all in on Visa or Mastercard stock, you would be up 100% in 2 years

[@BenFelixCSI]

That’s easy to say now. Tell me what the next Visa is going to be.

[@AustinPowerz-bn5ry]

@@BenFelixCSI TSLA

[@mohsindii]

Life will be so boring with EMH if held true. Fortunately, warren buffet and others proved its not valid hypothesis

[@BenFelixCSI]

Buffett does not disprove EMH lol papers.ssrn.com/sol3/papers.cfm?abstract_id=3197185

[@suelkoka]

Summary : No, but actually yes .

[@BenFelixCSI]

No, but close enough.