Are Markets Efficient? – Comments by Howard Marks

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Howard Marks’ latest memo is a good read and discusses two very interesting topics 1) Role of luck in investing and 2) Are market efficient?  I’m not going to cover the role of luck in investing in this post, but I do believe luck plays a role and luck happens to people who position themselves to take advantage of it.

Market Efficiency

The theory of efficient markets makes sense, as the more freely and quickly information flows, the market can incorporate that information instantaneously always providing “accurate” pricing using the latest information.  However, humans still play a role in the market and humans can act irrational.  With the proliferation of technology and specialized investment firms, it is hard to find markets that seem deeply undervalued.  In today’s world, I think the markets are close to efficient, but sometimes a wrinkle causes the market to become inefficient.  The latest “wrinkle” occurred during the 2008 Great Recession when the market did not know how to price securities based on the current information.  It is during these times that value investors can make strong positive expected value bets.  However, most of the time markets do not present these types of opportunities.

I think that Marks’ remark that markets are not perfectly efficient is correct

Ultimately, there’s one reason why I think  no markets are perfectly efficient. Remember the assumptions underlying market efficiency: the participants have to be objective and unemotional. Regardless of the market, few investors pass that test.

I typically search for smaller companies that tend not to have as much analyst or institutional coverage because the market may not properly price the company on any given day.  The difference between the perceived value of a company and the market price will be largest among small (micro) companies and illiquid stocks.

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