I’ve posted Entry #36 to my weekly Valuation-Informed Indexing column at the Value Walk site. It’s called Micro Efficiency Is Real, Macro Efficiency Is a Mirage.
Juicy Excerpt: The entire historical record argues against market efficiency. The case is so strong that it is difficult to imagine what it is that the millions who believe in market efficiency (this group includes many people with a strong knowledge of the literature discrediting the efficiency concept) are thinking.
The best explanation of this confounding reality that I have read is the one put forward in a research paper published in 2006 by Jeeman Jung and Robert Shiller. The paper is titled “Samuelson’s Dictum and the Stock Market.” Jung and Shiller state: “The faith that has in the past been expressed for the simple efficient markets model for the aggregate stock market is the result of a faulty extrapolation to the aggregate of a model that did indeed have some value for individual firms.”
That sounds right to me. Index funds were not available in the days when the Efficient Market Theory was being developed. The researchers responsible for the theory were not testing for macro efficiency (proper pricing of the market as a whole) because no one was interested at the time in knowing when the market as a whole offered a good buy. They were interested in learning whether individual stocks were priced properly relative to one another (micro efficiency). The paper notes that, while there is zero evidence for macro efficiency (the aspect of the theory that led to the insane bull market and the economic crisis that followed from it), there is indeed a good bit of evidence supporting claims of micro efficiency.