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Don’t let anyone tell you the markets are ‘efficient’

I had to sit down, I was laughing so hard.

I’d just remembered that some people say the stock market is ‘efficient’, and that everything that’s known is built into the price.

It’s the funniest thing I’d heard since Steve Smith said the Australian Cricket Team didn’t have a culture problem before Sandpapergate.

Let’s see what the market ‘knew’, shall we, using the US S&P 500 as our test case:

Last Friday, the S&P closed at 2,416.6 points.

On Monday, it fell 2.7%, because, well, your guess is as good as mine.

Tuesday was Christmas Day.

On Wednesday, it rose 4.96%, because, well…

And Thursday? Well, as of 6.20am AEDT, when I started writing this, shares were down 2.5% to 2,405.6 points.

And I’ve had to update this piece 3 times since. Because between 6.20am and 8am AEDT, when US markets closed, the S&P 500 has gone from a drop of -2.5% to a gain of 0.9%. (That’ll teach me for being conscientious!)

Are you laughing yet? I guess you would be, if this wasn’t so serious.

You’ll likely remember yesterday’s headlines. You know, about the biggest points gain in history. The headline-writers use the Dow Jones, of course, in part because it’s old, but mostly because a gain of 116 points in the S&P isn’t anywhere near as exciting as a 1,000 point gain in the Dow.

And now? Well, I was up early this morning, and Yahoo Finance’s headline writer just kept changing the points fall in this sentence: “Dow drops more than ‘X’ points after Wednesday’s historic gain”. He or she gave up late in the session. Seriously, just changing that number was a full-time job – and that was before it went positive!

Now, let’s bring it back to the real world for a second.

The US stock markets, as a whole, are likely worth around US$25 trillion at the moment. That’s the market capitalisation of all of the listed businesses, added together.

So a 5% rise, on Boxing Day, added around US$1.3 trillion in the space of 6.5 hours. On the basis of what, you ask?

Talking heads are paid to speculate, but there was not a single jot of new news of any consequence to explain it.

And today? Well, investors decided that US$650 billion of that gain was a mistake… and then it wasn’t.

Leaving us roughly where we finished last week.

If Shakespeare was alive today, he’d be a stock market commentator: “Full of sound and fury, signifying nothing”.

So all of those celebrations? The commiserations? The whipsaw turnaround?

Nothing.

The ‘record’ gains and big falls?

Nothing.

In fact, worse than nothing. Of course, the Dow Jones rose by a ‘record’ amount measured in points. Stock markets go up over time.

When I was 5 years old, adding 20% to my lifespan was the equivalent of one year. These days… well, let’s just say it’s not one year anymore.

If I was to tell you that the last 10% of my life was a ‘record’ number of years, you’d look at me like I was stupid.

But when we say the Dow gained a ‘record’ number of points, people nod sagely, and/or pop the champagne.

Let me put it another way: In September 1982, if the Dow had gained 1,000 points, it would have doubled in a day. More somberly, if it had lost 1,000 points, it would have closed at -18.

Yes, Minus 18.

These days the Dow is over 22,000. Is anyone really surprised that a 5% move is a ‘record’?

In 1982, a 5% fall would have been 49 points.

Indeed, the Black Monday 1987 crash (the marker tanked 22% in a day) was a fall of 508 points — less than the 550 point fall as of 6am this morning.

I trust you’re getting my point.

And that historical comparison makes another handy point:

While the headlines trumpet big daily gains and losses, the bigger picture is far more interesting.

The S&P 500 is up 19-fold since 1982. That’d turn $10,000 into $190,000.

And with dividends?

Adding back those payments takes us to 49 times your money. Your hypothetical $10,000 is now worth half a million.

If you’d added money regularly? Let’s just say you wouldn’t have too many financial worries.

And yes, that was despite the ‘87 crash. And the dot.com bust. And the GFC.

So feel free to talk about ‘efficient markets’. And celebrate and commiserate over ‘records’ and volatility.

Me? I’ll take the long term return, thank you very much.

Perspective is a wonderful thing. Don’t lose it among the hype. (Yes, you too, Smithy.)

Fool on!


Scott Phillips
Chief Investment Officer
Motley Fool Australia

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Motley Fool contributor Scott Phillips has no position in any of the stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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