Are markets efficient?

Discussion in 'The great financial debates' started by Marc, Mar 30, 2011.

  1. Chris

    Chris Frequent Poster

    Not a good estimate or even a right estimate, but just an estimate. As I said before this is where I believe EMH takes a leap of faith.

    I would certainly agree with this, but I think this highlights precisely why a majority of market participants can end up being incredibly wrong. During the dot com boom everyone had the same information available, but suddenly the majority of investors ignored earnings and started looking at fancy things like potential clicks per second. I don't disagree that the market shows the current sentiment of all participants in a more or less instant manner, that is precisely what a market is. But I just do not believe that people are rational and therefore markets efficient.

    This is the crux, EMH believes that buyers and sellers are much more rational than they actually are. Large scale irrationalities like the dot com and housing boom are common enough, and so are individual undervalued securities.

    I think that value investing is often over simplified when it comes to the work involved. I also think that just looking at institutional investors is a poor yardstick, even if it is the only practical one really. My personal portfolio has at times been very un-diverse and an institutional investor would probably never be able to sell such a portfolio as a fund. But taking the value investment approach to choose stocks has given me an above average return in 9 out of 10 years. Now of course this is a pretty short time period, and that theoretically could reverse. But applying the same rules my dad has "beat the market" in 26 or 27 out of 30 years.
    Without a doubt, there are thousands of institutional investors out there, but I do not believe that value investing makes up a large portion of them. Generally I find they are way to over analytical and fancy in their ideas and often stray way too far from the basics.

    I think EMH and its most public proponents are extremely vague and even dismissive when it comes to rationality. While the information reflected in the prices certainly is correct, to a large extent, the prices are quite often not a correct reflection of that information. But this is something that EMH seems to largely dismiss as a rare occasion.

    I wouldn't disagree that most fund managers make most of their money on their fees, but that doesn't mean that you cannot assess the success of their stock picking. Yes, looking at just the fund performance will often reveal a below market performance because of the fees. But we are not just talking about people investing in funds. A more accurate assessment would be an evaluation of the underlying asset values of value funds or investors.

    Risk is always a subjective assessment and I think it is not very sensible to generalise risk in this way. The majority of people would argue that my current portfolio is way too risky, but in my interpretation of the available information I have reduced my risk. When I find an undervalued stock, I look at it in the same way. I do not see myself taking more risk than others.
  2. ringledman

    ringledman Frequent Poster

    Marc, investing in index funds mid way through a secular bear market will produce below average and likely below inflation returns.

    We are many years away from entering a new secular bull market for the West based on emperical evidence. You only want to own index trackers during secular bulls.

    Also invest on the basis of dividend. In a world lacking real growth (not QE binge growth) and in a negative interest rate world dividends are king.

    Agree on fund management, 95% are a complete waste of money and fees are usually 1-2% over the TER as they unfortunatey dont tell you all their hidden costs.

    I think the way to proceed in today's market is selectively owning value stocks in defensive industries that have been ignored by the market for a while. Those with excellent fundamentals and won't collapse as much as cyclical growth stocks once the tightening begins.

    In today's market it is as much about 'return of capital' than 'return on capital'. I agree with Chris and the works of Montier and Grantham that say risk decreases the lower tha valuation (still doesn't mean you wont buy value traps occassionally).

    So firms paying a dividend are lower risk than those that don't, firms that have a high dividend cover are lower risk than those that don't, firms that are on low P/Es are lower risk than those on lofty P/Es based on a mere promise of future growth. Usually value stocks have higher cash reserves and better ROCE than growth stocks.

    In today's volotile globally imbalanced world these sort of fundamentals matter. Reducing risk through value is a way of preserving capital which I believe to be the number one issue at present. Over time value should outwin growth due to the lower risk profile in general and better/quicker return of capital to shareholders.

    Rather than buy trackers that buy into the whole secular bear market, I believe a better approach is to selectively buy ETFs investing in core secular bull markets is the better choice. I.e. commodities, energy, and I think soon to join this secular bull - pharmaceutical.
  3. ringledman

    ringledman Frequent Poster

    Chris, what is your value approach currently - sectors, fundamentals that you buy on, countries, etc?

  4. Chris

    Chris Frequent Poster

    First things I look at are price/earnings and price/book along with the level of debt. Obviously the lower these are the better. Dividends factor significantly in my assessment, especially fluctuations in dividend history and the dividend to net earnings rate.
    Geography: heavily focused on Asia directly and indirectly; I generally like large European companies with significant export revenue to Asia; I don't have direct investments in Japan, but I am looking.
    Industries: pharmaceutical, precious metals, industrial materials (steel, chemicals, plastics), gas and oil; no financials at all; on the cyclical side I do own a luxury car manfuacturer with very big growth in China.

    As already mentioned I am currently looking for exposure to Japan but will probably wait until mid year to see how things turn out there. Rushing a decision has cost me more than any other mistakes.
    I am also looking at increasing small to mid cap gold/silver mining stocks, which is proving quite difficult on a traditional value approach. Agriculture is also something I want to increase my exposure in.
  5. davegaa

    davegaa Guest

    No matter how much is pumped into Irish banks, I still think the markets will be overly cautious in the future.
  6. Marc

    Marc Frequent Poster