Hulbert Attacks Efficient Market Theory By Will McClatchy September 14, 1999

The New York Times lends great authority to everything it publishes. It is generally thorough and conscientious. That is why it is shameful to see the dignified institution let a paid stock picking professional use it as cover for misleading, simplistic, self-interested drivel such as "Dot-Com Makes a Company Smell Sweet", which appeared in The Times on August 15.

The author, Mark Hulbert, publishes the Hulbert Financial Digest, but contributes to The Times frequently. His articles are distributed across The Times wire service and often appear in regional newspapers as if he were a bona fide Times reporter whose articles are read by a world-class copy desk. Clearly they are not.

This article pounces on a thoughtful academic study which uncovered limited evidence of inefficiency in the superheated Internet sector. The article makes the claim that efficient market theory is dead and useless with laughable logic and evidence.

"Accepting the [efficient market] hypothesis means accepting that all money managers' attempts to beat the markets are doomed," writes Hulbert.

How did that ridiculous statement get past the copy editors? Apparently Hulbert has no knowledge of grade school mathematics, much less efficient market theory. Many individual money managers will outperform the market and many will not. The average investor will match the market, by definition. Before fees. Outrageous fees over time squeeze performance for investors in most actively managed funds.

What the most popular "semi-strong" form of efficient theory suggests is that reliably predicting performance from published information is a waste of time because that information is factored into a stock price. Inefficiencies are few and far between and extremely hard to predict.

Clearly his aim is to prop up the sad performance of newsletter publishers and money managers alike.

Of course after fees are included, the odds turn decidedly against the active investor, especially after many years of returns are compounded. That is why smart investors prefer money managers over Las Vegas, and really smart investors prefer indexing over money managers.

Just to make sure we didn't misunderstand this quite readable study, we called one of the co-authors of the study, "A Rose.com by Any Other Name", by Michael J. Cooper and P. Raghavendra Rau, both assistant professors of finance at Purdue University. An interview of Professor Rau contradicts much of what Hulbert insinuates.

According to Rau, this study does not offer conclusive evidence against even the rigorous "semi-strong" form of efficient theory, and it certainly does not claim that inefficiency is pervasive and easy to spot in advance. Investing in companies signaling their desire to operate in the Internet is not necessarily irrational. Personally I suspect he may have uncovered fleeting inefficiency, but then again the Internet will only come once, so it was hard to predict.

"It doesn't disprove efficient markets completely," he said. "It is evidence against it."

Clearly not all markets operate efficiently at all times. Many wild speculative bubbles have been recorded, with none so outlandish as the Dutch tulip craze in which speculators invested their life savings in tubers. Some made out fabulously, if they got out before the crash. Does that prove that it is easy to spot insanity?

Imperfect efficiency is not always easy to exploit. There is no consistent theory of inefficiency, according to Rau. With work like his there may yet be betters predictors of inefficiency. But knowledge of it will be no doubt exploited quickly so as to remove it from the market. Certainly at this time there is no demonstrable long-term strategy for deciding how to exploit inefficiencies such as Cooper and Rau have uncovered, much less for choosing money managers that can do so consistently.