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