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By John De Goey, CIM, CFP
Special to Financial Independence Hub
I have long been interested in the interplay between politics and the stock market. We had a fascinating real world case study that played out in real time last month.
Those who know me will likely know that I have long been a proponent of the Efficient Market Hypothesis, which was put forward by Nobel Laureate Eugene Fama as a means of explaining capital market behaviour. It comes in three forms: weak, semi-strong, and strong: each representing different levels of market efficiency.
The Weak form asserts that all past market prices and data are fully reflected in current stock prices. Therefore, technical analysis methods, which rely on historical data, are deemed useless as they cannot provide investors with a competitive edge. However, this form doesn’t deny the potential value of fundamental analysis.
The Semi-strong form extends beyond historical prices and suggests that all publicly available information is instantly priced into the market. This includes financial statements, news releases, economic indicators, and other public disclosures. Therefore, neither technical analysis nor fundamental analysis can yield superior returns consistently.
Finally, the Strong form asserts that all information, both public and private, is fully reflected in stock prices. Even insiders with privileged information cannot consistently achieve higher-than-average market returns. This form is criticized because it conflicts with securities regulations that prohibit insider trading.
Examples supporting EMH
While the EMH has faced criticisms and challenges, it remains a prominent theory in finance that has significant implications for investors and market participants. It has been both supported and challenged by various market phenomena. Here are some notable examples supporting EMH:
Random Walk Theory: Stock prices appear to follow a ‘random walk,’ meaning past prices do not predict future movements, something that is disclosed and disclaimed on every prospectus.
Index Fund Performance: Passive index funds often outperform actively managed funds, suggesting that markets efficiently price securities, especially once fees are taken into account.
Earnings Announcements: Stock prices quickly adjust to new earnings reports, reflecting the semi-strong form of EMH.
Examples challenging EMH
The obvious example that challenges EMH is the existence of stock market bubbles. Events like the Dot-Com Bubble and the 2007-2009 Global Financial Crisis show that prices can deviate significantly from intrinsic values and for prolonged periods of time. Such anomalies suggest that while markets are generally efficient, behavioral biases and structural factors can lead to inefficiencies, include macro-level mispricings. A well-known industry chestnut is that “markets can remain irrational longer than you can stay solvent.” Here’s where the story gets interesting …<
Donald Trump’s tariff reversal and social media post encouraging stock purchases just before the announcement has raised serious and credible accusations of market manipulation. When you know the market will move based on a Presidential post, telegraphing that move by encouraging supports to buy hours before it is announced is tantamount to insider trading.
Remember that the efficient market hypothesis suggests that stock prices reflect all available information, making it impossible to consistently achieve above-average returns through timing or insider knowledge.
Now, if Trump’s actions led to predictable market movements that benefited insiders, the result could be held out as a challenge to the strong form of EMH, which asserts that even private information is reflected in stock prices. However, since the market quickly adjusted to the new information and prices stabilized thereafter, the events of last month [April] would support the semi-strong form of EMH, which holds that publicly available information is rapidly incorporated into stock prices.
The controversy surrounding Trump’s tariff pause and its impact on stock prices is still unfolding, and investigations into potential insider trading could provide further insights into how efficiently markets processed this information. Do you think this sequence of events exposed weaknesses in market efficiency; or, as is the case with me, did it merely validate your previous views? Speaking personally, I still believe in EMH, and more specifically, I subscribe to the Semi-strong version of the theory.
John De Goey, CIM, CFP, FP Canada™ Fellow, is a Portfolio Manager with Toronto-based Designed Wealth Management. He is the author of three books on the financial industry: The Professional Financial Advisor, Standup to the Financial Services Industry and most recently, Bullshift. This blog is republished from the May edition of John’s blog and is republished on Findependence Hub with permission.
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