You've no doubt seen the news that Carl Icahn has taken a decent sized stake in
Icahn revealed that he controls a large position in the Cupertino, Calif.-based company and considers the stock to be “extremely undervalued.” In addition, Icahn says he spoke with Apple CEO Tim Cook today, and true to form, he wasted no time in sharing his thoughts with Cook. “Discussed my opinion that a larger buyback should be done now,” Icahn writes in a new Twitter message, the latest medium used by the activist investor in his continued efforts to shakeup corporate America. “We plan to speak again shortly.”
Shares of Apple immediately spiked following Icahn’s comments. The stock rose 3.8% to $485.03 in early afternoon trading.
The thing that interests me here is the rather out of favor economic theory called the efficient markets hypothesis. This theory has been blamed for all sorts of things, up to and including the recent financial crash. Indeed, there are those who insist that the very existence of that crash means that the EMH must therefore be wrong.
The problem with that idea is that it rather misunderstands what the EMH is actually saying. It isn't, for example, a statement that markets are always efficient: always efficient in the sense that we should only ever use markets to do things. It's also not saying that a market economy is the only way to organise things. All it is in fact saying is that markets are efficient at processing information.
More specifically, that markets are efficient at processing the information about what prices should be in a market. It also comes in three flavors, weak, semi-strong and strong. Roughly speaking the weak says that all generally known information is already in prices, the semi-strong that all public information is, the strong that all information is. Generally speaking all economists would sign up to the weak and a few to the strong.
As to how useful the EMH is really the major point being made is that it's extremely unlikely that you'll be able to beat the market. For any piece of information you've got is already in stock prices: thus a low- or no-load index fund is the place to save for your retirement.
And now we can test the EMH against this revelation from Carl Icahn that he's bought a decent piece of Apple stock:
Shares of Apple immediately spiked following Icahn’s comments. The stock rose 3.8% to $485.03 in early afternoon trading.
That's new information being presented to the market, it gets incorporated into the stock price pretty quickly, yes, I think we probably can say that markets are efficient at processing information. And do recall, that's all the EMH is trying to aver: not that markets are necessarily the most efficient way of doing things, not that we absolutely must have a market economy, only that markets are efficient at processing the information about what prices should be in a market. A test they seem to have passed yesterday afternoon.
