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Berkshire Hathaway
Why I am Not an EMTer

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By EliasFardo
January 3, 2003

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I know, I said that an earlier post was my last one on EMT [Efficient Market Theory]. Consider it my penultimate post instead.

I wrote:

5) OK, there are a few, rare souls who can profitably exploit those inefficiencies for long periods of time, but you can't predict who they will be before hand.

JDCRex writes:

Do you have any evidence that you or anyone can predict who they will be before hand?

What I am doing is making fun of the "yes but" nature of EMT. Every time someone points out an exception or fault, a new "yes but" answer is carved out.

Here are the "yes but" answers I have seen so far:

1) Yes, but they beat the market through luck or chance.
2) Yes, but they can't beat the market consistently.
3) Yes, but you can't predict who will beat the market beforehand.
4) Yes, but those who can beat the market are rare.
5) Yes, but their research costs eat up their excess profits.
6) Yes, but their transaction costs eat up their excess profits.
7) Yes, but we never said that markets were 100% efficient.
8) Yes, but we never said that nobody could ever beat the market.
9) Yes, but they can't beat the market over long periods of time.
10) Yes, but they can't predictably beat the market.

Please, feel free to add to this list as determined necessary.

This is why getting EMTers to commit is like nailing Jell-O to a wall. They are constantly sliding around and off the nail. The believers in EMT will never be convinced that they are wrong, they will just carve out yet another "yes but" to argue away any discrepancies.

JDCRex writes:

How much reading have you done into the EMT, and how well do you feel you grasp the concepts involved? I ask because I'm not entirely sure that you have given them as much consideration as you should have before dismissing them.

Which theory of EMT are we talking about here? I feel that I grasp the concepts well enough to agree with the Weak Form of EMT. If I understand it correctly, it says that past prices have no predictive value for future prices. So, analyzing past prices will not allow anyone to beat the market. I agree with that.

Where I totally disagree with EMT is when it says that it is almost impossible for investors to identify miss-priced securities, and then profit from that information. In fact, it claims that there is no reason to believe that prices are either too high or too low; that the price of a security always equals its value. The reason I talk about cars and sweaters is that people spend their lives comparing price to value. Do the EMTers insist that there is no reason to believe that a car, or a house is priced too low or too high? If it is possible for almost every other product to miss-priced, why is it not possible for a security to be miss-priced? I know, I know, there is another whole list of "yes, buts" why the market for cars is not the same as the market for securities.

The problem with the stronger forms of EMT is that they deny the everyday experience of people.

Tens of thousands of investors can line up and give examples of how and where they determined that a security's price was totally whacked. The EMTer will say, "yes, but" the price adjusted too fast for you to profit from such a discrepancy. The thousands of investors will respond, "no, it lasted for weeks, or months. The gap even widened!" The EMTer will say, "yes, but (insert dismissal of choice)." In other words, EMT denies ordinary experience. EMT denies how the world works.

I understand the desire to embrace EMT. Warren Buffett said at an annual meeting that the key to investment success was not a high intelligence, but realism and discipline. EMT allows the believer to avoid the keys to success, realism and discipline, and forgive himself for doing so. You see, in an EMT world, realism and discipline carry no advantage.

Realism involves seeing the world the way it really is. It involves seeing clearly how different actions effect other things. This is hard work; it takes commitment, study and attention. Buffett insists that success comes from looking at changes that are occurring, and determining how those changes will affect an industry, a geographical region, a company, a product line, or a service. How easy EMT makes this. It just says that you need not bother will all this wasted, hard work. Since all these changes will immediately be reflected in the price of an asset, you can't benefit in any way from such changes, so forget about it. Don't worry about the effects of changes in taxes, spending, consumer preferences, wars, rising or lowering interest rates, rising or lowering rates of inflation, foreign competition or new technology. It just doesn't matter!

Realism also involves clear seeing and clear thinking. The person must be grounded in what is real and not real. This not only applies to commerce, but to the inner, emotional self as well. Much of investing success is temperament. And the person who is best grounded emotionally, allowing himself to make decisions based upon facts and not feelings, will have an advantage over those who are not grounded. Such a balanced temperament is harder to achieve than an economic education. It does not come so much from learning, but from introspection. This is also hard work: dealing with ones inner turmoil. So, fortunately for the EMTer, this need for a balanced emotional life is also removed. If there is no difference between the price of a stock and the underlying value of a stock, and if all prices are always perfect; it matters not whether a mad man or a serene soul is placing an order to buy.

Why wouldn't this be an attractive idea for those who are not inclined to work this hard?

Nor does an EMTer need to be disciplined. Discipline requires sticking to your practice. An EMTer does not have a practice to apply. Discipline requires being patient, waiting for those pitches that are waist high, over the plate. To an EMTer, all pitchers are the same, forget differentiating. Discipline means keeping wishful thinking in check. What a bonus EMT is for the wishful thinkers! You are reassured that the company that you desire is selling for its perfect price, no need to worry about research or waiting for a better price. Just buy it and buy it now. You can have the portfolio you want, when you want it, and your performance will not suffer.

So, EMT allows the believer to avoid all the hard work and discipline that Buffett claims is required for success. EMT in fact rests in the belief that others are doing all the hard work of bringing price and value into equilibrium for you. If you do not want to think, work, study, analyze or practice discipline, EMT is just the thing. Others will do all those pesky tasks for you!

Instead, EMT adopts what Buffett rejected: the need for a high intelligence. I doubt if any dull people believe in EMT. Hell, they can't even understand it. I think I only half understand it myself. And it has so many forms, and variations on those forms, and exceptions, and nuances (yes, and the "yes, buts" ) that no one but a highly intelligent people could understand it. I almost hate to say this for I will insult some of the readers (as if I haven't already): but EMT is for smart, lazy people.

It is no accident that Buffett is usually the person held out as a refutation of EMT. Not only does his record speak against it, but his theory of investing success is exactly opposite that of EMT.

So, what is your verdict? Do you think I understand EMT well enough to dismiss it, or do I need to study it some more? I have no doubt that my understanding is lacking. I think there are some more "yes, buts" that I missed, and for that I apologize. But, I have been studying Warren Buffett for over 20 years. And I completely bought into what he was saying. Buffett has said that in his experience, people either get the value concepts immediately, or never at all. I got them immediately. From all that I have learned and experienced over more than 2 decades of investing, EMT defies common sense. It is the exact opposite of what I have grown to believe: that value and price are not equal. So, I think I understand it quite well enough, thank you.

One last thought. We need not look only to those who have outperformed the market to discredit EMT. The existence of bad investors also argues against it. If there is no difference between price and value, then the truly awful investor can do himself no harm. For every dollar he spends, he receives full value. The bad investors quickly disappear, unless of course they are running money for other people, so their presence and track record is usually short and hidden. So how can truly horrific investors exist in the sanitized world of efficient markets? They too are an embarrassment to EMT.


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