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Is the Market Efficient?

The Efficient Market Hypothesis, or EMH for short, is a concept that has gained a following over the past few decades. It is an investment theory that postulates that the stock market is efficient enough in pricing the share price of all companies that it is impossible to achieve returns greater than the market. It basically slams the idea that using either technical or fundamental analysis, we will not be able to earn any excess returns from the what a passive investor will earn by simply buying a passive index such as The Straits Times Index (SGX: ^STI).

Some truth in it

There seems to be some truth in the hypothesis. Generally, it can be difficult for investors to “beat the market” and some investors may be better off buying passive indexes through ETF such as the SPDR® STI ETF (SGX:ES3) and the NIKKO AM Singapore STI ETF (SGX:G3B) that tracks The Straits Times Index.

Some false in it as well

The most obvious error in the theory is from its assumptions. It states that

1)     Investors are rational

2)     Investors have access to the same amount of information at the same time.

Both are assumptions that are obviously flawed. Investors are hardly rational creatures as we are constantly affected by market sentiments. Secondly, it is not possible for all investors to have access to the exact same information at the same time.

Institutional Attention

One of the arguments against EMH is that the amount of attention a company gathers from the institutional investors can have a strong effect on its share price. Companies with strong institutional backing tend to trade at a much higher valuation compared to companies in similar industry but not followed by large investors. If the market is efficient, shouldn’t companies in the same industry with the same business model and operating in the same market trades at similar valuation?

Foolish Bottomline

There are believers both for the theory and against the theory.  The arguments are never ending and both might never be proven wrong until the end of time. However, one thing is for sure, investing (Not Speculating) will always beat not investing at all.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Stanley Lim doesn’t own shares in any companies mentioned.