ChaoticMarket 49(bouncing around) in price changes in contrast to remarkable
smoothness in the cash stream.
Shiller and his colleague John Campbell recognize that some of
the price changes are due to changes in fundamental information
and to uncertainty about the future trends of cash flows. But taking
account of these factors, Shiller and Campbell estimated that only
27% of the annual return volatility in U.S. stoc kmar kets is justified
in terms of fundamental information. Campbell followed up this re-
search with John Ammer by using more recent data and reduced the
estimate to only 15%.^11
Markets may be relatively efficient only on some days but not on
all days or may be relatively efficient for some stocks but not for
others. Even if we are more generous than the 15 to 27% suggested
by these studies and say EMT is 80% correct, it is a grave mistake
to use market efficiency as the basis of a managerial or investor game
plan. Buffett sums it up: “Observing correctly that the market was
frequentlyefficient,” EMT devotees “went on to conclude incorrectly
that it wasalwaysefficient. The difference between these proposi-
tions is night and day.”^12 That difference between night and day is
all that Graham and Buffett need to recognize. Neither is enthused
by mathematical accounts of markets, except to agree that EMT does
not explain all of market behavior.
Buffett quotes one of Charlie Munger’s favorite sayings to de-
scribe the modern economist’s penchant for building EMT and re-
lated mathematical models of stoc kmar kets: “To a man with a ham-
mer, every problem looks like a nail.”^13 Graham quotes Aristotle: “It
is the mar kof an educated mind to expect that amount of exactness
which the nature of the particular subject admits. It is equally un-
reasonable to accept merely probable conclusions from a mathe-
matician and to demand strict demonstration from an orator.”^14
Graham concludes that “the wor kof a financial analyst falls
somewhere in the middle between that of a mathematician and an
orator.”^15 The vanguard theorists of behavioral finance stand a better
chance of finding that middle road than do the devotees of EMT,
but they admit they still have a long way to go in understanding
investors and markets, a task that is likely to get harder rather than
easier, as the next chapter explains.