I say the Efficient Market Hypothesis is STUPID!!!

Key Concepts

• Efficient Market Hypothesis (EMH): The theory that asset prices fully reflect all available information, making it impossible to consistently "beat the market" through active investing.
• Value Investing: An investment strategy that involves buying securities that appear underpriced based on fundamental analysis.
• Active vs. Passive Investing: Active investing involves trying to outperform the market through stock selection and market timing, while passive investing typically involves tracking an index (e.g., S&P 500).
• Margin of Safety: A core principle of value investing, referring to the difference between an asset's intrinsic value and its market price, providing a buffer against errors in judgment or unforeseen events.
• Risk: Defined not as volatility (price fluctuations) but as the permanent loss of capital from a fundamental perspective.
• Circle of Competence: The understanding of businesses and industries an investor has, limiting investments to areas they can comprehend.

Discussion on Market Efficiency and Active Investing

The video challenges the prevailing Efficient Market Hypothesis (EMH), arguing that it's counterproductive to value investing. The premise of EMH is that markets are so efficient that active investors cannot consistently outperform passive index investing. This is supported by statistics suggesting that a vast majority of professional money managers (around 90%) fail to beat the market, even after accounting for fees. The speaker posits that this underperformance is exacerbated by client expectations, withdrawals, and the pressure to avoid prolonged underperformance.

The "10%" Argument

The speaker reframes the statistic of 90% of professionals underperforming. Instead of accepting this as a universal truth, the goal is to be part of the 10% who do consistently beat the market. The argument is that hard work, education (e.g., PhD), and extensive experience should differentiate an investor from the average, rather than leading to average results. The speaker contrasts this with the "flat earth society" analogy, suggesting that most people adhere to conventional wisdom without critical examination.

The Role of Clients and Mindset

A significant point is made about the irrationality of many clients in asset management. The speaker shares an anecdote of finding only one rational client among many, leading to a decision not to manage money for irrational individuals. This highlights how external pressures and client behavior can complicate professional investing. The speaker emphasizes that when investing gets tough, the right mindset is crucial, and this is where the real difference is made, not by yearly performance metrics or constant market comparison.

Personal Investment Philosophy and Performance

The speaker shares their personal investment journey, starting in 2002. They claim to have achieved a 40x return on their initial investment over approximately 23 years, significantly outperforming the S&P 500's 11x return (including dividends) over the same period. This personal success story is presented as evidence against EMH and a justification for their biased perspective. The speaker attributes their ability to achieve financial goals, such as pursuing a PhD and leaving a stable job, to their investment approach, which they contrast with being a "poor teacher in Croatia" if they had simply followed the market.

Real Investing vs. Efficient Markets

The core of the speaker's argument is the distinction between "real investing" and what the efficient market hypothesis suggests. While the market may perform well during certain cycles (like the last 15 years of low interest rates and no recessions), "real investing" shines when the market stagnates or declines. The speaker's portfolio, with a P/E ratio of 10, has performed comparably to the market over the last seven years, but they anticipate outperformance during market downturns.

Market Cycles and Risk

The speaker stresses the cyclical nature of markets and warns against complacency during prolonged bull markets. They recall periods of significant market downturns (e.g., down 60%) and argue that in such scenarios, outperforming the market by a smaller margin (e.g., losing 40% when the market loses 50%) would be considered a remarkable achievement, not a failure. This challenges the notion that simply tracking the market is always the best strategy.

Warren Buffett and Value Investing

Warren Buffett's writings are referenced, particularly his 1984 article "The Superinvestors of Graham and Doddsville." Buffett observed that academic circles had moved away from teaching value investing, yet those who followed Graham and Dodd continued to prosper due to persistent discrepancies between price and value. Buffett's letters to shareholders are also cited, suggesting that opponents who are taught that "thinking is a waste of energy" are at a disadvantage.

Research and Long-Term vs. Short-Term Investing

The speaker acknowledges that in the short term (e.g., 12 months), research might not provide an advantage in picking stocks that will beat the market. However, for long-term investments (5-10 years), research is crucial for identifying quality businesses at the right price. The example of Tesla's high market capitalization relative to its cumulative profits is used to illustrate how current market valuations can seem irrational, but research becomes vital when market conditions change.

Redefining Risk and Value

A key distinction is made between the academic definition of risk (volatility) and the value investor's definition (margin of safety). The speaker argues that risk is fundamentally tied to price relative to fundamentals, not just price fluctuations. Value is defined not by low P/E or P/B ratios alone, but by a margin of safety that ensures the inability to lose money from a fundamental perspective over the long term.

Passive Investing Becoming Active

The speaker points out the irony of passive investing strategies becoming active when they fail. The example of French bonds and the potential need to redraw rules to avoid market liquidity issues illustrates how even passive approaches can necessitate active intervention when market realities diverge from theory. The speaker uses the example of Long-Term Capital Management as another instance where efficient market theory failed when reality intervened.

Accumulating Risks and Exuberance

Despite the current market exuberance, the speaker believes risks are accumulating, particularly in areas like private equity where pricing is less transparent. They express hope that these risks won't materialize but acknowledge the possibility of prolonged market uptrends. However, they emphasize that the disregard for risk in current market pricing could lead to significant problems in the future.

Buffett's Performance and Real Value Investing

The speaker addresses the common comparison of Warren Buffett's performance to the S&P 500. While some argue Buffett's returns are not significantly superior, the speaker differentiates between academic value investing (low P/B, low P/E) and "real value investing." Real value investors, like Buffett, seek value wherever it exists, whether in insurance, mining, or other sectors. The speaker also notes that over 30 years, Berkshire Hathaway has outperformed the market, but reiterates that the focus should be on compounding wealth and reaching financial goals, not just beating an index.

Defining "What Market" to Beat

The speaker questions the premise of "beating the market" by highlighting the varied performance of different global indices. The S&P 500 has performed well, but other indices like the Nikkei and the Dutch index have shown stagnant or poor returns over extended periods. This suggests that the definition of "the market" is crucial and that focusing on a single benchmark might be misleading. The speaker concludes that the future performance of any market is uncertain, and the goal should be to build a strategy that performs well regardless of market conditions.

Maximizing the Lower Bound of Wealth

The speaker's ultimate investment goal is to maximize the "lower bound of wealth," meaning to ensure downside protection even in extreme market conditions. This is achieved by focusing on risk-adjusted returns and building a strategy that works for them personally, rather than trying to outperform others. They aim to maximize the minimum plausible wealth, ensuring that even in adverse scenarios, their wealth is preserved and grows.

Conclusion and Personal Stance

The speaker reiterates their commitment to value investing and their belief in being part of the 2% of investors who disregard the efficient market hypothesis. They express a desire to continue their "boring" approach to investing, hoping to avoid the negative societal consequences that can arise from market crashes. The video concludes with a wish of good luck to those who adhere to passive investing and the efficient market theory, while maintaining their own distinct approach.