Some claim that widely "analyzed" securities are efficiently priced but that micro-cap equities, exotic bonds, carbon emissions, shipping freight, movie financing, special situations and distressed debt might not be. But even in widely followed, liquid markets I have found that the more participants then the more wrongly priced that market is. The more money in an asset, the greater opportunity for smart investors to generate alpha out of the many more stupid investors. DUMB money includes 100% of "passive" index funds, 90% of mutual funds and 80% of hedge funds">hedge funds. There will always be plenty of alpha to extract from unskilled journeyman fund managers in the zero-sum, alpha redistribution game we all play.
Security returns are driven by market agent behavior and interaction; the impact of new, fundamental information on an equity, bond, currency or commodity is undecideable. The absurd efficient markets hypothesis not only costs investors money, it can even put people in jail. The EMH is useless and dangerous as a market assumption, as are ALL models, theories and laws derived from it. It is unfortunate for investors, including myself, that reasonable doubt will always exist in "explaining" stock falls. Yes, convict people for cooking the books but entering into evidence the noisy, leptokurtic, heteroskedastic stock price should be inadmissible. Fraud on the company can be prosecuted, but not fraud on the market based on EMH.
The US Supreme Court set the EMH legal precedent back in 1988, choosing to overlook the devastating counterevidence of the extremely inefficient moves of October 1987, just a few months earlier. Little economic news broke on Oct 19 that year yet a 20 standard deviation, never in a zillion years "fluctuation" occurred. Quite rightly, no-one jailed Treasury Secretary James Baker or the Bundesbank Chairman or the academics pushing portfolio insurance or anyone else for the enormous losses that day because the extent of fault of any single risk factor can NEVER be determined. We have no idea how to apportion blame, only that there were more sellers than buyers for numerous known AND unknown reasons. I blame no event and no person for ANY moves; I don't care about the WHY or trying to conjure up an "explanation" for every tick.
Security prices just offer a temporary, irrational opinion poll of what is hot and what is not. Equities markets are NOT a measure of value, they simply give a rough idea of the current bull versus bear voting split. Stocks go up when there are more buyers than sellers, that's all. WHY there are more buyers than sellers at a particular time is generally unknown and probably irrelevant. It is impossible to isolate blame for a particular fluctuation, though the financial media tries to every day. The causal link between new information and equity price movement is not clear. To assume that all investors receive and react to incoming data immediately is just plain wrong. That prices move much more often than new information hitting the market is obvious. Fundamental analysts get it so wrong, so often, because they analyze the company when they should be analyzing the stock.
Stocks often fall when interest rates are raised; does that mean central bankers can be sued for damaging equity prices? Call your lawyer next time Greenspan raises rates and see what response you get! Should we put Toyota TM on trial for hurting Ford's market cap through business Darwinism? How much is Google GOOG to blame for Yahoo's YHOO stock price drop this year? The success of some companies damages other companies. Of course many stocks collapse due to the fraud or incompetence of a firm's management. And as we saw with Enron and WorldCom, the law punishes them if necessary. But invoking EMH to "prove" causality and to calculate attribution for financial loss is wrong.
Management actions do not affect stock prices anywhere near as dependably as commonly assumed. Founders, entrepreneurs and skilled management teams are obviously key when a firm is private, but once it goes public its value becomes at the mercy of greed, fear, illogicality and investor emotion. This is where stock option compensation skates onto thin ice; did management add alpha or was it just beta? Many large stocks in the 1990s went up regardless of who was in charge.
Take a major "blue chip" like General Electric. GE's earnings are higher than five years ago but the stock is down over that period. Jack Welch was LUCKY to be in charge when mega caps were "in", Jeffrey Immelt is unlucky to be in charge when mega caps are "out". The price of GE stock provides no insight into who was the better CEO. GE is widely traded, followed and analyzed, but the stock can NEVER be "correctly" valued by the market. And as we saw with "star" GE alumni Robert Nardelli, the Home Depot HD board could probably have picked a random person as CEO and possibly got better stock performance. New fundamental information on GE or HD will emerge, but it is the balance of irrational buyers versus irrational sellers that will determine where those stocks go.
Michael Dell founded DELL and the stock went up throughout the 1990s, Kevin Rollins was "officially" CEO in recent years and the stock fell under his "watch" although the reality is they BOTH managed DELL in close consultation. It probably would not have made much difference if Michael Dell himself OR anyone else had been in charge. Investors would love to think management decisions directly affect the stock price; if only things were so simple. If Jack Welch had become CEO of GE in 2001, he would never have been regarded as a managment "guru".
The possible reasons to buy or sell are too numerous and varied to identify a single, logical, explanatory variable. I don't know why the weak-form EMH survives when it has been proven to be nonsense. Partly it is brokers, analysts and the media needing to provide a "reason" for market noise. Partly it is finance academics; ironically the math of random, no memory processes is much easier than the complex math behind deterministic, long memory, non-linear systems like security markets. The EMH persists because it is simple and intuitively appealing but the real world is just not that easy.
It is impossible to assign the financial impact from a stock fall due to a single event. The noise to signal ratio is too high to be able to measure and isolate a fundamental cause. Markets and individual stocks move, often significantly, on no new information. Sometimes prices don't change on unexpected news or go up on negative data. The price impact of a single action or exogenous event simply cannot be calculated. Markets are neither efficient nor random.
by Veryan Allen. Copyright 
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