Critics of the Efficient Markets Hypothesis continue to get more press. Newsweek’s Barrett Sheridan recently wrote an article that discusses the Efficient Markets Hypothesis (EMH) versus the adaptive-markets hypothesis (AMH). He mentions one of the key flaws in EMH: that market participants are rational.
He goes on to focus on MIT professor Andrew Lo and his AMH work. Lo does not share the EMH tenet that the financial markets consist of cool, calm, and rational investors. He suggests that investors will behave differently depending on their psychology at any given moment. (Some of the old brokers I knew called it the fear-greed pendulum.) It follows that any investment rule based on a fixed measurement of value for the market such as yield, P/E ratio, etc. will work only sporadically over time if the AMH is valid. Nothing is set in stone because investors continually change and adapt to the market ecosystem.
Our Systematic RS portfolios use relative measurements. We believe in an adaptive approach to investing that recognizes that since markets are controlled by real people, they act like real people.
—-this article originally appeared 1/5/2010. Every advisor knows that the risk tolerance of clients changes over the course of a market cycle. I still can’t figure out why anyone thinks that the Efficient Markets Hypothesis ever made sense.