Another reason the “efficient market” is only a hypothesis

From Wikipedia:

Weak Efficient Market Hypothesis (EMH) claims that prices on traded assets (e.g., stocks, bonds, or property) already reflect all past publicly available information. Semi-strong EMH claims both that prices reflect all publicly available information and that prices instantly change to reflect new public information. Strong EMH additionally claims that prices instantly reflect even hidden or “insider” information. There is evidence for and against the weak and semi-strong EMHs, while there is powerful evidence against strong EMH.

What I want to look at is delays as they relate to the semi-strong version of the efficient market hypothesis. Whether or not asset (stock) prices change to reflect all publicly available information, they do not adjust instantly. Information cannot be immediately incorporated because of delays in communication, in interpretation and in prompting action. Further, the markets are groupings of the actions of hundreds of thousands of individuals, investment managers and pension managers. Each of their actions happen on a different time scale.

Information is not immediately communicated. Companies may have internal controls that report their revenues or costs or profitability daily, weekly or monthly. But it is normal to only report these (and other) numbers once a quarter. This is the reason that insider trading is illegal. (If all information, including inside information, were immediately reflected in stock prices, insider trading would not need to be made illegal.) It is normal to release earnings after the market closes, preferably on a Friday afternoon, to give investors the maximum amount of time to receive that information. If it is released during the trading day, traders will see it first, whereas people with other day jobs will have to wait until the end of the day before they receive it.

Once information is received, it isn’t immediately interpreted. It takes a couple hours to read through the financial statements including all the notes and management’s discussion and analysis for a single company. On top of that, multiple companies will release their financial statements on the same day. For someone who is very familiar with the company, it may be very simple to spot variations and trends. For someone else, they may need to consult financial statements from past quarters or years. Even then, does a weak quarter indicate the beginning of a new trend, or simply an exception from otherwise good performance? This all takes varying amounts of time to digest.

Once a decision is reached about fair value, not all traders operate on the same time scale. An individual might be panicky and react immediately by buying or selling their position. A professional investment manager may have the ability to trade large amounts more quickly, but may also be more gradual in accumulating or divesting a position. A pension manager may own such a large amount that they may choose not to trade, except to rebalance.

Finally, assuming each of these types of investors are basing their strategies on fundamental research (price vs. value information), they may have a different level of sensitivity. Due to trading costs, an individual may only buy or sell a stock that is extremely under- or over-valued. A pension manager may be able to profit by accumulating a stock that is slightly under-valued and selling when it is slightly over-valued. Since transactions have the effect of moving the stock price, each of these actions will tend to move the stock price and trigger other actions by other investors.

Delays mean volatility (oscillation) as people with different amounts of information trade, then people with different interpretations tug-of-war, then as additional people finally decide to act. The stock price will bounce around its fair value rather than moving in a smooth line that follows the best perception of the fair value of the company. This is what happens in real life, disproving the semi-strong (and strong) versions of the efficient market hypothesis.

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