Efficient Market Hypothesis – or Not?

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Contradicting the Hypothesis


[By Timothy J McIntosh MBA CFP® MPH CMP™ [Hon]

[By Dr. David Edward Marcinko MBA CMP™]



Not everyone believes in the efficient market.  Numerous researchers over the previous decades have found stock market anomalies that indicate a contradiction with the hypothesis.  The search for anomalies is effectively the hunt for market patterns that can be utilized to outperform passive strategies.

white swan

[White Swan of the EMH]

Such stock market anomalies that have been proven to go against the findings of the EMH theory include:

  1. Low Price to Book Effect
  2. January Effect
  3. The Size Effect
  4. Insider Transaction Effect
  5. The Value Line Effect

The Anomalies

All the above anomalies have been proven over time to outperform the market.  For example, the first anomaly listed above is the Low Price to Book Effect.  The first and most discussed study on the performance of low price to book value stocks was by Dr. Eugene Fama and Dr. Kenneth R. French.  The study covered the time period from 1963-1990 and included nearly all the stocks on the NYSE, AMEX and NASDAQ. The stocks were divided into ten subgroups by book/market and were re-ranked annually.

In the study, Fama and French found that the lowest book/market stocks outperformed the highest book/market stocks by a substantial margin (21.4 percent vs. 8 percent).  Remarkably, as they examined each upward decile, performance for that decile was below that of the higher book value decile.  Fama and French also ordered the deciles by beta (measure of systematic risk) and found that the stocks with the lowest book value also had the lowest risk.

What is Value?

Today, most researchers now deem that “value” represents a hazard feature that investors are compensated for over time.  The theory being that value stocks trading at very low price book ratios are inherently risky, thus investors are simply compensated with higher returns in exchange for taking the risk of investing in these value stocks.

The Fama and French research has been confirmed through several additional studies.  In a Forbes Magazine 5/6/96 column titled “Ben Graham was right–again,” author David Dreman published his data from the largest 1500 stocks on Compustat for the 25 years ending 1994. He found that the lowest 20 percent of price/book stocks appreciably outperformed the market.


Ex-Cathedra black swan

[Ex-Cathedra or Black Swan Event]


One item a medical professional should be aware of is the strong paradox of the efficient market theory.   If each investor believes the stock market were efficient, then all investors would give up analyzing and forecasting.  All investors would then accept passive management and invest in index funds.

But, if this were to happen, the market would no longer be efficient because no one would be scrutinizing the markets.  In actuality, the efficient market hypothesis actually depends on active investors attempting to outperform the market through diligent research

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The Author

Timothy J. McIntosh is Chief Investment Officer and founder of SIPCO.  As chairman of the firm’s investment committee, he oversees all aspects of major client accounts and serves as lead portfolio manager for the firm’s equity and bond portfolios. Mr. McIntosh was a Professor of Finance at Eckerd College from 1998 to 2008. He is the author of The Bear Market Survival Guide and the The Sector Strategist.  He is featured in publications like the Wall Street Journal, New York Times, USA Today, Investment Advisor, Fortune, MD News, Tampa Doctor’s Life, and The St. Petersburg Times.  He has been recognized as a Five Star Wealth Manager in Texas Monthly magazine; and continuously named as Medical Economics’ “Best Financial Advisors for Physicians since 2004.  And, he is a contributor to SeekingAlpha.com., a premier website of investment opinion. Mr. McIntosh earned a Bachelor of Science Degree in Economics from Florida State University; Master of Business Administration (M.B.A) degree from the University of Sarasota; Master of Public Health Degree (M.P.H) from the University of South Florida and is a CERTIFIED FINANCIAL PLANNER® practitioner. His previous experience includes employment with Blue Cross/Blue Shield of Florida, Enterprise Leasing Company, and the United States Army Military Intelligence.


So, what about the “January Effect for 2015“?

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