The Investment Scientist

How I Reconcile the Differences Between Eugene Fama and Robert Shiller

Posted on: November 3, 2013


One very very sharp reader of my blog sent an email to me, and here is what it said:

Aren’t these 2 philosophies opposites of each other? If the market prices correctly based on all available information, how can the stock price be different from the expected dividend? Aren’t these 2 prize winning economists speaking in opposites?

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Indeed Eugene Fama’s Nobel Prize winning research is contradictory to Robert Shiller’s, so much so that Robert Shiller refers to Eugene Fama as “my good friend who believes in a different religion.”

I am very aware of their differences, but I never let them stop me from applying their best insights.

How do I reconcile their differences in my investment practice?

I believe the market is informationally efficient, but not emotionally efficient. In other words, I believe in a competitive market. Investors on aggregate will use all available information to their advantage – therefore Eugene Fama is right, the market is informationally efficient. So, one can not use information such as that on Jim Cramer’s Mad Money and in Harry Dent’s books to outperform the market!

On the other hand, Robert Shiller does document that mispricing in fact occurs and when it does, it is because of investor emotions not omission of certain information.

I’d like to argue it is possible to beat the market. I did so here during the recent financial crisis. But the only way to do so is by supreme emotional intelligence: being very aware of your own and the market’s emotional states, and having the willpower to go against your gut feeling. Thus Warren Buffet’s famous “Be greedy when others are fearful; be fearful when others are greedy.” and “Go where the blood is flowing.”

These things are more easily said than done since humans tend toward a mob mentality. Evolution has conditioned us to  go along with the herd. Those ancestors of ours who could not read the terror on the faces of their fellows and subsequently opted not to run away with them to safety have long since been eliminated from the gene pool by the proverbial lion. This is also why despite Robert Shiller’s research, few people are actually able to beat the market.  

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1 Response to "How I Reconcile the Differences Between Eugene Fama and Robert Shiller"

A way to reconcile the two views is that financial markets in particular (and capitalism in general) tend to be acutely efficient and chronically inefficient. This way the market creates bubbles but few can profitably trade around them.

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Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC.

Twitter: @mzhuang

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