Are Markets Efficient?

Are Markets Efficient?

Have you ever been going about your day and then suddenly, get hit with a revelation on The Efficient Market Hypothesis? You know, have you ever been agonized suddenly with the thought “are markets efficient?” You haven’t!? What a surprise. Well, you’re in luck. It just so happened to me and now you’ll have to sit through my pontification of the Kapitalust Interpretation of The Efficient Market in 4 Simple Graphs. What a mouthful. I bet it’s going to be fun.


The Data

The data for the graphs were pulled from multpl and are based on the data from Robert Shiller. You know, that Robert Shiller who won the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel Nobel Prize in Economics. Ok, enough history. Let’s cut to the chase.

Graph 1

Are Markets Efficient? Kapitalust

This is the S&P 500 Real Price by Year throughout history. What are some patterns you notice? I’ll give you a hint…

Graph 2

Kapitalust are markets efficient?

Look at all those peaks and valleys, dips and highs. Look at all the volatility! You might be tempted to believe that the markets are actually inefficient with all this action.

Graph 3

Kapitalust Are Markets Efficient?

Oh, hello there nice smooth red line. What may you be? Oh, right, that is all that volatility smoothed out. Notice a trend? Up. Interesting.

Graph 4

Kapitalust - are markets efficient?

Sometimes Oftentimes people seem to focus only on the inefficiencies – the volatility – and forget that overall and given enough time, the markets are very efficient. Focus on the red line, not the black ones. The red line is a simple visualization of my own take on the efficient market.

Voting & Weighing Machines

Benjamin Graham, the father of value investing, said it best when he stated:

In the short run, the market is like a voting machine.

But in the long run, the market is like a weighing machine.

What he meant by this is that in the short term, the markets tally up which companies are popular and unpopular in a given moment. But in the long term, the markets actually separate the wheat from the chaff and accept and discard companies based on their underlying economic and business strength.


In the moment, it is a popularity contest. Given enough time, it’s an economic contest.

That is why the markets can seem so random and volatile day-to-day. But when you look at market history with enough scope, the randomness and volatility smooth out into consistent growth: the red line.

When your investment time horizon becomes ‘forever’, nothing the market throws at you will faze you at all.

Disclaimer: Past performance is no guarantee of future performance. Conduct your own due diligence. Learn market history. Your mileage may vary.

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18 thoughts on “Are Markets Efficient?

  1. In the long term the market is efficient and returns about 6% annually. However in the short run the behaviour of the market is anyone’s guess. Love the graphs you used to explain the concept.

  2. Market inefficiencies can last a long, long time. There’s a huge disconnect right now between the U.S. stock market and the U.S.’s real economy. This overvaluation has been going on for almost 2 years, hence the world’s “Most hated bull market”.

    1. Completely agree that markets can remain inefficient for a looooooong time. That’s why it’s prudent for most/average investors to just stay committed to their investments for the long haul (decades of buying and holding) and filtering out all the noise (bulls and bears) because it won’t do them no good.

  3. Markets definitely are not efficient, sometimes even in the long run. The day people turn into emotionless calculated robots is the day we’ll see 100% efficient markets.

    Fun and to the point post, Steve, just the way I like ’em!

    1. I mean the future is extraordinarily difficult – if not impossible – to project, but enough understanding of history shows gradual, consistent progress.

      If shit hits the fan and we end up in the apocalypse a la The Road, well nothing besides weapons and survival equipment will be worth anything of value 😀 😛

  4. Oh wow, I don’t even know where to start on this one. I think about EMH all of the time actually. For the most part, I think it is a bunch of sh*t.

    These days, computers do most of the trading. They trade for very short periods of time. We’re talking milliseconds after analyzing a piece of information. So, the markets are efficient, but it only applies for minutes or less.

    Long term, I don’t think the markets are efficient at all, just because the trading robots and most people don’t think long term. It seems that most don’t care or think about where a company will be in 5 years. It’s all about the next earnings call 3 months out or less.

    This short term mindset presents opportunities for the smart people. Those of us that are willing to buy in, buy quality and sit, sit, sit for 5 years or 5 decades have a big advantage.

    This is the kind of stuff I could talk about over a beer or 3 for hours. Vancouver is calling!

    1. I have some skepticism towards the actual nitty gritties of EMH, like stock prices factoring in all available information and market participants being wholly rational beings, but I think the general idea that the markets will be efficient over the long run holds true because true business/economic value will prevail.

      Wouldn’t the idea of buying quality – say Vanguard index funds – and holding for 5 decades be faith in the idea that the market will be efficient over the long run? Or am I missing something?

  5. Geez, looks like I should have been following your posts this week. I need to add you to my blogroll so I don’t forget.

    Anyways, very good post as to why we should all be long term investors! One question on your graph, your red line matches the spot of an efficient market in one spot, looks like around the 2008/2009 market drop.

    1. Thanks Kipp! The red “efficient market” line is just suppose to be an aggregate average of all the yearly S&P 500 prices over the entire time frame. Over time, the smooth red line is just a conceptualization of the average growth year in, year out.

  6. I believe in “weak form” efficient markets — there are clearly inefficiencies there, somewhere, but I’ll be damned if the average person can do anything about it. Therefore, index funds.

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