
That Time Buffett Smashed the Efficient Market Hypothesis - tacon
http://thereformedbroker.com/2014/01/03/that-time-buffett-smashed-the-efficient-market-hypothesis/
======
Animats
Back then Buffett was pure Graham and Dodd. (This refers to the book
"Securities Analysis". The more readable version is "The Intelligent
Investor", by Graham. Anybody with money should at least read the latter.) The
basic concept is to only buy stocks which are priced lower than the value of
the company. Value is based on solid assets, an ongoing profitable business,
and some degree of protection from competition. Value investors buy very
boring companies. This is, historically, quite profitable over a decade or so.

As Buffett got more money, Berkshire Hathaway became a conglomerate, rather
than a fund. Berkshire Hathaway owns outright eight insurance companies,
including GEICO, which is where Buffett originally got rich. They own the
Burlington Northern Santa Fe Railroad, which is most of the railroading west
of the Mississippi. Dairy Queen. See's Candies. Fruit of the Loom. A bunch of
furniture chains. Acme Brick Company. Boring, important companies that have
been around for half a century or more and make useful stuff, and money.

Berkshire Hathaway doesn't trade much. They just study companies, pick
carefully, then buy and hold, forever. They do sell occasionally, as the world
changes; Berkshire and Hathaway were US-based textile companies, and that
industry is dead in the US.

~~~
AnimalMuppet
One minor nit. Burlington Northern Santa Fe Railroad is _not_ "most of the
railroading west of the Mississippi". The Union Pacific Railroad is larger,
including larger west of the Mississippi.

~~~
Animats
You're right, of course. UP is bigger than BNSF.

------
typedweb
A Joke from A Mathematician Plays The Stock Market (I think):

Two Efficient Market theorists were walking down the street and see a $100
bill lying there. They both keep on walking and one says to the other "If that
was real, someone would have picked it up by now."

~~~
Symmetry
That's funny but there are actually several forms of the EMH.

Strong from: There are no $100 bills on the ground. Semi-Strong: By the time
you hear about a $100 bill on the ground someone has already taken it. Weak
form: You cannot predictably find $100 bills on the ground.

~~~
RickHull
Another useful way to apply EMH to the real world, especially considering that
real world markets are not perfectly efficient, is in terms of asymptotic
behavior, hyperbolas, mathematical limits. Paradoxically, Warren Buffett's
investing performance, far from being a counterexample to EMH, plays an
integral part in the drive towards perfect efficiency. But this drive will
never be completed.

It's very easy and common to make the leap from EMH, a purely theoretical
construct, to asserting that real world markets are perfectly efficient and
must therefore behave as EMH entails. This view is mistaken, and the author
merely knocks down a straw man with the Buffett counterexample. Instead, in
order to use EMH in the real world, one must first judge the efficiency of the
market in question.

The broadest, deepest, most active and open markets are the most efficient,
which is why "the stock market" (in the US) is a favorite example and testing
ground. The idea is not that it's perfectly efficient but that it's the most
efficient we can access. The real question is: is it efficient enough for
efficiency effects to dominate? A fair view of the evidence (i.e. not hunting
for or cherry-picking counterexamples) suggests that efficiency effects do
dominate.

EMH is really about the futility of systematic approaches to achieving excess
returns. It was conceived (in some part) as a general refutation to systematic
investment proposals. Systems could range in sophistication from _always bet
on black_ to _virtual Warren Buffett_. Only where the system sophistication
exceeds (in some sense) the current market efficiency is it able to collect.
Soon the unsophisticated have no chips, and the efficiency rises accordingly.
The bar is raised, over and over, chewing up new challengers and enshrining
champions.

That some real world markets are subject to EMH effects also explains the
cliché about the highly paid fund manager who performs no better than a dart-
throwing monkey. If you find this idea appealing yet EMH is icky, you should
check your priors.

------
tokenadult
Saying that the efficient market hypothesis is false is like saying that the
principle of entropy is false because you can heat a pot of water on your
stove. The efficient market hypothesis as a long-term, general phenomenon is
consistent with short-term, local arbitrage and other examples of information
asymmetry in markets.

P.S. The blog from which this submission comes bears the usual signs of hype
exceeding performance. The author's firm was established in 2008, which means
it

1) doesn't really have a very long-term record,

and

2) what record it does have was established during a recovery from a worldwide
financial shock and depression, an atypical period during my lifetime.

~~~
reduce
In the long term, all stocks become worthless and the heat death of the
universe occurs.

If you can't state a particular time period over which a finance model's
prediction should be valid, then you haven't actually made any prediction at
all.

~~~
Guvante
The main point of the efficient market hypothesis is that the average investor
won't consistently beat the market average.

Also note that most of the people beating the efficient market hypothesis
aren't doing the kinds of transactions they are being compared to.

Can you really compare moves like bailing out Coca Cola to buying and selling
stocks based on market estimates you derive?

~~~
jbooth
If the efficient market hypothesis is confounded by moves like bailing out
Coca Cola, what good is it?

~~~
infinite8s
The efficient market hypothesis presumes that you can't affect the performance
of the market (except possibly the shirt term price action). Bailing out Coca
Cola presumably entails gaining enough control to drive the future directin of
the company.

------
lern_too_spel
Here's Buffett betting that the magnitude of the inefficiency is actually
quite small. [http://longbets.org/362/](http://longbets.org/362/)

~~~
debacle
That's actually entirely not what he said there. He said "On average, active
investors will do just as well as passive investors, but due to fees will
actually perform worse."

That doesn't mean that some active investors are not going to do incredibly
well. Some of those active investors will be smart and lucky, and some of them
will be very good at what they do.

~~~
hsitz
Efficient market hypothesis does not disagree that some active investors will
do incredibly well. It does say that those who do will succeed based on luck
rather than smarts/skill.

Also, the efficient market hypothesis is of course not completely true. I take
it that Buffett is a good counterexample to the strongest possible form of
efficient market hypothesis. However, I also take the fact that there are not
many Buffetts in the world as evidence that markets are very efficient.

Buffett, I believe, is a genuine counterexample to EMH. Most other people
offered as counterexamples are not; i.e., their results are completely
consistent with proper statistical understanding of investment results in
perfectly efficient markets.

------
etjossem
The analogy of the coin-flipping game has one crucial flaw: in the securities
trading world, the coin-flips are not independent. At any point, a participant
may decide not to flip a coin, and instead make the result of _someone else
's_ coin their win condition.

Efficient-market theorists would say "Buffett was good at convincing a lot of
people to follow his trading strategy instead of flipping their own coins, and
he also happened to be lucky." It would actually be more surprising if the 40
people who won _weren 't_ in the same lucky group.

------
throwawaymsft
Imagine a drug that beat a placebo in 38/46 trials. It would be approved.
Everyone on HN would love an A/B test with such clear results.

Call the drug "Berkshire Hathaway performance" and the placebo "S&P 500
performance" and suddenly it's a coincidence.

~~~
dllthomas
Those 46 trials weren't anything like independent.

~~~
derf_
Buffett addressed this criticism in 1984, when he presented the public records
of all of the students of Graham and Dodd it was possible to track:
<[http://www4.gsb.columbia.edu/null?&exclusive=filemgr.downloa...](http://www4.gsb.columbia.edu/null?&exclusive=filemgr.download&file_id=522>)

The relevant bit:

"So these are nine records of “coin-flippers” from Graham-and-Doddsville. I
haven’t selected them with hindsight from among thousands. It’s not like I am
reciting to you the names of a bunch of lottery winners — people I had never
heard of before they won the lottery. I selected these men years ago based
upon their framework for investment decision-making. I knew what they had been
taught and additionally I had some personal knowledge of their intellect,
character, and temperament. ... While they differ greatly in style... all
exploit the difference between the market price of a business and its
intrinsic value."

~~~
tempestn
First, there was considerably less access to information in 1984 than now, so
the market almost certainly _was_ less efficient. Second, thanks to Fama and
French, we now know that there is indeed a value premium. However, the
majority view is that it is a risk premium: still useful because it exposes
one to different risk than pure market beta, but not a free lunch. (Also it is
most likely more efficient to capture the premium using low-cost "tilted"
(value) funds, rather than by picking individual stocks and unnecessarily
taking on unsystematic risk.)

------
viggity
Is the market 100% efficient? No, certainly. But just because it isn't always
efficient, doesn't mean that it isn't monumentally better at advancing the
human condition than an economy run by a few central planning bureaucrats.

~~~
kaonashi
My knowledge of history shows no such correlation.

Russia and China developed through central planning, and free markets do a
terrible job helping other countries develop.

The best outcomes seem to rise through some combination of both central
coordination and market-base approaches.

~~~
tokenadult
The divided country examples of west Germany versus east Germany, south Korea
versus North Korea, south Vietnam (an especially poorly governed country, but
still) versus north Vietnam, and Taiwan (or Hong Kong) versus mainland China
all suggest that free market economies in general do better for all their
people than centrally planned economies. The recent economic growth in China
resulted from basically relaxing central planning in several keys areas of the
economy on the examples of Hong Kong and Taiwan.

~~~
kaonashi
Those examples seem to me to illustrate the importance of access to foreign
trade, which the central planning economies were cut out of for political
reasons.

------
sharemywin
Since when it buying majority shares in companies anything like "putting money
in the market"

~~~
wstrange
Exactly.

Buffet is not a passive investor - he takes an active role in how the company
is managed.

------
api
I read once -- but cannot remember where -- that a market cannot be perfectly
efficient if P!=NP. I'm curious if anyone else has ever heard this and where
it comes from.

~~~
noblethrasher
"Markets are efficient if and only if P = NP"[1]

I read it when it was first posted on HN a few years ago.

[1][http://arxiv.org/pdf/1002.2284.pdf](http://arxiv.org/pdf/1002.2284.pdf)

~~~
api
... and HN delivers. :)

------
throwaway7808
""" Friedman, laureate of the Nobel Memorial Prize in Economics, said: "You
want more insider trading, not less. You want to give the people most likely
to have knowledge about deficiencies of the company an incentive to make the
public aware of that." Friedman did not believe that the trader should be
required to make his trade known to the public, because the buying or selling
pressure itself is information for the market.

------
polemic
How about: a theory of eventually efficient distributed markets.

------
chad_strategic
Just an FYI, nobody seems to pick up on this. But in 08 when the market
crashed. Mr.Buffet had large stakes in BAC and WFC. Mr. Buffet says that he
always studies his purchases so forth and so on. Well in the summer of 08, it
wasn't difficult to see the banks where in trouble. (I figured it out, and
made $$)

However, Mr. Buffett didn't, even know he always says that he does due
diligence. Had the banks not been bailed out by the US GOV in Oct 08, (TARP,
low interest rates) we would be having a different conversation about Uncle
Warren right now, because his stakes in WFC & BAC would be zero.

Josh Brown is a clickbait / SEO / yahoo groups shill for the market. I don't
believe this type of article is of interest to Hacker News. If I want this
crap, then I can just click over to cnbc or business insider?

~~~
MaysonL
Of course, Buffett did also make a fair amount of money on his $5B purchase of
Goldman Sachs preferred stock during the crisis – it paid 10% dividend for a
few years, got bought back at a 10% premium last year, and he got a couple
billion worth of GS stock by exercising the warrants he got given to sweeten
the deal.

Josh Brown works with Barry Ritholz, who's one of the more perspicacious
commentators on the market around, so lumping him with cnbc and business
insider is really a low blow.

~~~
chad_strategic
You understand that Josh Brown is on CNBC right? That silly little half time
report. [http://www.cnbc.com/id/100831613](http://www.cnbc.com/id/100831613),
I'm just going to leave that there for you. But don't worry he is reformed!

Are you seeing how easy it is get lumped in with the CNBC crowd?

------
discreteevent
I think the bottom line seems to be that if you have a day job (e.g. software
development, running your own company. whatever) you are highly unlikely to to
have the time to come anywhere near beating the market with investing your
spare cash. Just stick to what you're good at.

~~~
jeffreyrogers
You are almost guaranteed to beat the market using a very simple strategy:
just buy the lowest decile ranked by price-to-earnings.

