Edited By Jeff Greenblatt June 20, 2006
"Efficient Market Theory states that fundamental analysts are so good at their jobs that all mispriced securities have been identified. The concept of efficient markets is such that prices are determined by expectations of future profits, risk and interest rates. To determine profits one might examine current market conditions, competition, technology, supply/demand, as well as any competitive advantages a particular company may possess. Price efficiency means the current price of any security already reflects all known information (Radcliffe)."
In simple terms, this implies that every factor is already baked into the cake at any given moment. Every one of us learned these concepts in our economics and finance classes back in college.
Friday morning on CNBC well known Wharton school professor Jeremy Siegel questioned EMT after teaching it his entire academic career and actually stated he thinks there are times when prices in the market are actually "wrong." Did you see it? Who am I to question a famous Wharton legend? The time is right. I am challenging at least part of his sudden "insight" and try telling anyone who just made or lost a bundle of money that prices are "wrong."
Mr. Siegel opens an interesting debate. While his assertion that prices are sometimes wrong is DEAD WRONG, he might be on to something. EMT followers also state there is a paradox to the theory because the only way speculators can actually profit from financial markets is when any particular market participant believes he has information that no other participant has and acts on it. The story goes that if he has information nobody else has, markets can't be priced efficiently.
The question becomes, is all information baked into the cake at any given moment or not? This is not an easy question to ponder but to get to the truth we need a new hypothesis.
The first thing we need to realize is the market is ALWAYS RIGHT. There can be no doubt about that. I am surprised anyone in academia could disagree with that. While last month's monster wave may have been overdone, try telling the folks who lost huge chunks of bankroll the market was wrong. The market is right because prices are being driven by something other than static information.
There is no doubt that markets react excessively on the bull and bear side. This is precisely why Mr. Siegel thinks prices are sometimes wrong. However, the work here has shown in every instance in every market that a reversal will take place according to some precise calculation. Every leg has perfect precision whether we can calculate it or not. From that perspective, prices can't be wrong.
What EMT academics miss is not that markets are efficient because all information is reflected in current prices, they miss because prices are a reflection of the human emotional swings from extreme optimism to extreme pessimism and back. This is the one factor they leave out and likely the most important factor of all. While fundamentals don't change much from one day to the next, ITS THE HUMAN PERCEPTION OF THOSE FUNDAMENTALS THAT CHANGES FROM ONE DAY TO THE NEXT.
The truth of the matter is that prices and price movement are not based on all known factors at any given point in time but our emotional reactions to them. Technical analysis is nothing more than a graphic picture of human emotion. Today we hear all about the crowd's concern for inflation. Is the inflation we are experiencing today very different from the inflation we experienced prior to May 11? I think not. What changed? Our perceptions changed. They changed because when the cycles expired, it was like a giant flip of a switch. Markets are ruled by Universal law as exhibited by the golden spiral and interpreted by Fibonacci/Lucas price and time calculations.
Financial markets are not static. They are in constant motion and spiraling in a precision and language all its own which is representative of the hopes, fears and expectations of all market participants which is ALWAYS PERFECT. What we must understand is people are entering and exiting the market all the time. Individuals can effect the market in a minute way. This is why certain patterns don't always work. We may see a head and shoulders pattern in the NASDAQ forming but it doesn't work out simply because the market is not made up with the exact same participants as the last time a head and shoulders confirmed in the NASDAQ or any other chart for that matter. The other consideration is while each individual brings his own fear and greed to the party, once he pulls the trigger he is susceptible to the herding complex which is the madness of crowds. When it comes to financial markets, smart people tend to do dumb things because they see everyone else doing the same thing. Last week the market rallied on good news, today it does not. Why is that? Certainly couldn't be strictly because of the INFORMATION.
Ultimately we are looking at a mass emotional response. Markets are never wrong, only our perceptions are wrong. If we don't understand why a particular wave behaved in a certain way we say it is wrong. It's not wrong, its only we are not sophisticated enough to understand the exact calculation the market is exhibiting to make it right.
You can obviously see there is a lot more going on than a clustering of data. Markets may be efficient, but they need a new paradigm. EMT may have been good for the 20th century, but we aren't in the 20th century anymore. Efficient Market Theory, we may want to rename it EMOTIONAL MARKET THEORY. . Here in the 21st century alternative research is uncovering calculations that are making sense to these markets, finally. Gann was first and 90 years later his work is still on the cutting edge. Emotion rules and we are finally uncovering why the masses behave the way they do. The academic community is going to have to realize the human element in the equation and more importantly, what is driving the human element. They are also going to have to realize that just because they don't understand why the market behaved a certain way, that doesn't make price action wrong. A whole new wave of researchers are proving otherwise.
source: email from Jeff