There are actually two issues 1) Is the market efficient? and 2) Can someone, using public information, systematically earn higher returns than those on a suitably risk-adjusted market basket?
These issues are related but they are not the same. If the market is efficient the answer to the second question is certainly no. If the market is inefficient, however, it does not follow that the answer (in practice) to the second question is yes. Some types of inefficiencies such as two different prices for the same good can and will be eliminated through profitable arbitrage but when arbitrage is not possible eliminating market inefficiencies is risky. Even if you knew that X was a bubble, for example, you can short the stock but you then run the risk of the bubble flying much higher before it bursts. Essentially, the failure of Long Term Capital Management was precisely this problem - right theory but they ran out of capital before they could profit from the elimination of the inefficiency. In addition, we must also face the fact that if the market is inefficient due to investor irrationality it is very likely that we (yes, you and I) and our agents are also irrational in some respects. Thus if we care about issue 2 then pointing to bubbles of the past or arguing that people are irrational or greedy etc. misses the point. The real test of issue 2 is, Do portfolio managers/stock picking newsletters or other active strategies outperform a passive index strategy? And the answer to this question is a resounding NO. Taken as a group and taking into account transaction costs the active strategies actually *underperform* the indexing strategy. I don't know anyone who disputes this finding - note that whether this is because the market is efficient or portfolio managers are just as irrational as everyone else is open to question but not relevant to question 2. At any given time, of course, some portfolio managers beat the market but, again as a group, no more than you would expect by chance. Of course there are a few outliers, Warren Buffet and Templeton, for example. It's quite reasonable to mark these down as a chance but my own view is that there are a few geniuses out there and that Buffet is to stock picking what Michael Jordan was to basketball. I no more think that I could duplicate what Buffet does than I could duplicate what Michael Jordan does even if Jordan wrote a book explaining how he plays the game. (Indeed, careful observers of Buffet find that how his investing decisions cannot be explained soley by reference to his rules of investing.) Alex -- Dr. Alexander Tabarrok Vice President and Director of Research The Independent Institute 100 Swan Way Oakland, CA, 94621-1428 Tel. 510-632-1366, FAX: 510-568-6040 Email: [EMAIL PROTECTED]