Views on market efficiency

"What everyone knows is not worth knowing."

"The market will usually do what it needs to do to prove the majority wrong."

"When one learns how to play the stock market game, they change the rules."

- Ned Davis

From Justin Fox, in the FT:

There are two efficient market hypotheses. One is the bold, unsubstantiated proposition that financial markets are close to perfect and all-knowing. This theory was ferociously and convincingly attacked by Robert Shiller and Lawrence Summers three decades ago and quietly abandoned by its progenitors in the 1990s – although it lived on zombie-style in textbooks, central bank policy and some parts of the financial press until recently. When, these days, a pundit or government official rails against “efficient market theory”, this is what they mean.

A second efficient market hypothesis, however, deservedly survived the financial crisis. It holds simply that it is very hard for any investor (or regulator, or journalist) consistently to outsmart the market. Evidence keeps pouring in to back up this “No Free Lunch” theory, as economist Richard Thaler dubbed it in these pages last year, even as its “Price is Right” counterpart has been shown wanting.

Put another way, financial markets are perfectly competitive and most of the excess profits have been eliminated. The only way to generate extraordinary profits is to produce or generate a new system of returns. Once this system is known, extra profits will be eliminated and a new system has to be adopted.