At the start of the 70s, one of the most influential waves of economists was in a golden age.
A new, third wave of economists was emerging from the University of Chicago Economics department.
These macroeconomists would, in time, tag on even more Nobel prizes to the faculty’s already dominant lead, which stands at 12 these days, for the most decorated staff worldwide.
One of these future Nobel winners at the heart of the vanguard was Eugene Fama.
Professor Fama had already built upon a body of work, going as far back as the 1860s to a French broker named Jules Regnault. His 1965 PhD thesis concluded that short-term stock price movements are unpredictable and approximate a “random walk.”
In simple terms, past performance does nothing for predicting day-to-day price movements. Markets respond to what happens today, not yesterday.
In 1970, he built on it further, cementing his role as the father of the Efficient-Market Hypothesis, and his Nobel prize 43 years later.
And thus, one of the longest-lasting, corrosive ideas was introduced to stock traders: the idea that the market immediately incorporates all new information.
The Forgotten Flaws
Don’t blame Professor Fama though. He knew of the two big problems with the hypothesis, and explained them.
Instead, blame the people who only pay attention long enough to get the main idea, without all the caveats and conditions.
First, it created a joint hypothesis problem — you can never actually tell how right or wrong any measure of market efficiency truly is.
When the hypothesis breaks down, you have no way to test, or ever know, if it is because a bad model was used, or because the market had become inefficient. All you can determine is how far off the mark you were using past data.
The second was something called a fat-tailed distribution problem. Instead of a normal distribution, the data was often heavily skewed.
Wildly abnormal and extreme glitches consistently popped up in his data that far exceeded anything that could be easily accounted for by the hypothesis.
Combine these problems and you have one hell of a flaw. One that is completely forgotten in the “Cliff Notes” version we normally hear, or glossed over in Econ 101.
As late as 2014, Professor Fama has tried to minimize these glitches, going from a three-factor model, and now to a five-factor model, to try and account for what is happening.
He has made some progress, but these glitches persist. No matter what indicators he tries, he can never tell why his model is wrong, if the market has become inefficient, or both.
What Do You Really Know?
Now, we’ve come back to how a corrosive and long-lasting assumption is hurting small investors. To make matters worse, they’re missing out on great investments as a result.
Too many people assume that the market is efficient across the board. They apply the idea to every stock they see, at every time, and even to themselves.
Nothing could be further from the truth.
The efficient market hypothesis makes three large assumptions: trading costs aren’t factored in, all investors have access to the same information, and the cost of that information is nothing.
Professor Fama focused on mutual funds over longer time frames. In these types of investments, the efficient market hypothesis holds up reasonably well.
These funds trade in large companies with widespread coverage. Fees are low and detailed information is constantly covered by business news, which is free.
Even computers are being used to analyze and act on new information as quickly as possible, making large-cap trading even more efficient in recent years.
But large-caps hardly represent the full market, and two kinds of stocks consistently stand out by breaking efficient market models: Value stocks with high book-to-price ratios, and small-cap stocks.
When you zoom in on the data, to individual companies, and shorter time periods, the data gets messy, and this is especially true for small-caps.
Fees are higher, rapid trading is not possible, and information comes with a high cost, either in dollars and cents, or hours and days.
Yet investors and traders assume that what they are seeing is what everyone else is seeing, and that they aren’t missing anything. They assume that they are efficient actors in an efficient market.
Get the Info
And so glitches persist, both good and bad. Investors are constantly surprised by the downturns that can be accounted for in data released to the public
At the same time, they are missing the surprise wins that early investors took advantage of before the information spread and the market priced it in.
What they are missing is the information they need to act efficiently while the market is not. That is exactly what the Outsider Club’s Gerardo del Real has been providing for over a decade.
He’s operated behind-the-scenes providing research and advice to large institutional players, fund managers, newsletter writers and some of the most active high net worth investors in the resource space, including those who count in billions.
And with him now working with our staff, that kind of information advantage is available to all of our readers.
The kind of glitches he takes advantage of are the same that led to a 138% gain in four months, 426% in three months, and a whopping 832% in six months.
If you’re skeptical of those gains, check them out. They are legit.
These are the kind of gains available to you by taking advantage of inefficiencies in the market when other investors don’t have the right information.
And new ones are popping up all the time. I’ll let Gerardo explain the opportunities that are forming now.
