Are Markets Efficient? by Matt Ingram Invest Ed® All Rights Reserved Oklahoma Securities Commission July 2016

How Do We Judge Investment Managers? We begin by asking a basic question : Can you, as an investor, consistently “beat the market?” It may surprise you to learn that evidence strongly suggests that the answer to this question is “probably not.” Even professional money managers have trouble beating the market. 2

What Does Mean? The excess return on an investment is the return in excess of that earned by other investments that have the same risk. “Beating the market” means consistently earning a positive excess return. 3

Can We Predict Stock Prices in the Future? Random Walk: the theory that stock price movements are unpredictable, so there is no way to know where prices are headed Studies of stock price movements indicate that they do not move in neat patterns. This random pattern is a natural outcome of markets that are highly efficient and respond quickly to changes in material information. Definition of random walk: The best prediction of the future price is today’s price. 4

What is the EMH? The Efficient Market Hypothesis (EMH) is a theory that asserts : As a practical matter, the major financial markets reflect all relevant information at a given time. 5 Efficient Market : a market in which securities reflect all possible information quickly and accurately To have an efficient market, you must have : - many knowledgeable investors actively analyzing and trading stocks. - information widely available to all investors. Events, such as labor strikes or accidents, tend to happen randomly. Investors react quickly and accurately to new information.

Levels of EMH Weak Form EMH –Past data on stock prices are of no use in predicting future stock price changes. –Technical analysis does not work. Semi-Strong Form EMH –Abnormally large profits cannot be consistently earned using public information. –The relevant information is "all publicly available information, including the past data and information just released to the public." –Fundamental analysis is of no use. –Any price anomalies are quickly found out, and thestock market adjusts. Strong Form EMH –There is no information, public or private, that allows investors to consistently earn abnormally high returns. –Inside information does not help. 6

Strategies Based on Your Attitude Towards Efficiency Active Management  Security analysis  Timing strategies Passive Management  Buy and Hold portfolios  Index Funds or Index ETFs (Exchange Traded Funds) 7

Anomalie s Three facts to keep in mind about market anomalies –First, anomalies generally do not involve many dollars relative to the overall size of the stock market. –Second, many anomalies are fleeting and tend to disappear when discovered. –Finally, anomalies are not easily used as the basis for a trading strategy because transaction costs render many of them unprofitable. January effect, day of the week effect, small stock effect, value effect 8

Violation of Efficiency 9

Violation of EMH Merger announcements 10

Bubbles and Crashes Asian Financial Crisis 2000 Dot-com Mania 2006 Housing bubble (global) 2008 Financial crash (global) 11