Is the Efficient Market Hypothesis True?

The famed efficient market hypothesis, or EMH, is widely accepted by academics and modern investors. The hypothesis states that stock prices reflect all available information at any given time, making it impossible for investors to beat the market with any consistency.

Why, then, are there myriad examples of excess returns that should not exist if the EMH is true? To name three examples of results that seem to counter the theory: Returns vary widely across different days of the week, premarket and after-hours trading periods display mysterious return profiles, and even weather patterns strongly correlate with up and down days on Wall Street.

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Here’s a look at the evidence of enduring inefficiencies in the stock market that seem to fly in the face of the vaunted efficient market hypothesis, and how everyday investors can better understand the theory:

— Large gains in after-hours trading.

— Sunny-day surges.

— TGIF on Wall Street.

— The consistent outperformance of gurus.

— What meme stocks say about the efficient market hypothesis.

— Implications of the efficient market hypothesis’s shortcomings.

Large Gains in After-hours Trading

Given that the stock market generally goes up over long periods as the economy grows and companies become more profitable, it’s perfectly natural to expect that stocks would, on an average day, close at levels higher than where they opened.

But no. Astonishingly, stocks tend to lose ground during the trading day, which runs from 9:30 a.m. to 4 p.m. Eastern time. The magic tends to happen outside normal trading hours.

Examining returns for the popular SPDR S&P 500 ETF (ticker: SPY), Bespoke Investment Group found that since 1993, buying at the market close and selling at the market open the next day would have returned 850%. Buying at the open and selling at the close would net you a 10% loss over the same period.

But why? Theories abound.

“This, to me, is a liquidity issue,” says David Yu, a professor of practice in finance at New York University Shanghai.

“At that point, there’s no liquidity, there’s no trading — or very little, because it’s after the markets close,” Yu says. After all, it’s unconventional to engage in after-hours or premarket trading, and retail investors might not know it exists or have access to it.

To Yu, it may also be an information-gap issue. “Maybe someone’s heard something, and it hasn’t been broadly disseminated because it’s the middle of the night — everyone’s asleep,” Yu says.

For others, the broad discrepancy in returns isn’t a mystery at all — and actually enforces the efficient market hypothesis.

“Announcements come out at 4 p.m. Company results are more often good than bad. That is an argument for the EMH — that it’s bid up right at 4 p.m., when announcements come out,” says Brian Huckstep, chief investment officer of Advyzon Investment Management.

In other words, markets instantly incorporate new information like earnings announcements as they come out. On the other hand, why should return discrepancies between the day and night be so dramatic, predictable and exploitable? There should not be, the EMH tells us, easily copied market-beating strategies that work — especially over long periods.

Sunny-Day Surges

A 2003 study published in the Journal of Finance pointed to another stock market quirk. The study examined “the relationship between morning sunshine in the city of a country’s leading stock exchange and daily market index returns” in 26 countries between 1982 and 1997. “Sunshine is strongly significantly correlated with stock returns,” it reads, noting that sunny weather is associated with positive moods.

Authors David Hirshleifer and Tyler Shumway note that using weather-based strategies was “optimal for a trader with very low transaction costs” but that frequent trading and the associated costs would likely eliminate the gains. The abstract concludes with a dryly humorous understatement: “These findings are difficult to reconcile with fully rational price setting.”

While the data are a bit old in 2022, the conclusion is inescapable: For at least a 15-year period, the valuation of companies all across the world benefited when weather was good and, presumably, traders were in better moods.

Moreover, the benefit of using weather-based strategies may have been outweighed by trading costs in 2003, but virtually all mainstream brokers now have commission-free trades, making such strategies far more feasible in the 2020s.

TGIF on Wall Street

This theme of returns being predictably lopsided during certain periods continues in what is sometimes called the “weekend effect” in the stock market. One would expect the value of companies to be entirely independent of which day of the week it is, but in fact, Mondays are significantly worse for returns than Fridays.

The phenomenon goes all the way back to 1953, the first year the market was always closed on Saturdays. A 1973 research paper showed that between 1953 and 1970, the S&P 500 rose 62% of the time on Fridays and a miserable 39.5% of the time on Mondays.

Fast forwarding to 2018, and this discrepancy was still happening: That year, Fridays were the best day of the week for the S&P 500, returning an average of 0.14%. Mondays saw declines of 0.02%.

Huckstep, again, is unfazed. “It’s because people spend money on the weekend,” he says.

“I was an advisor for two years. You get most of your calls from people taking money out on Monday. So people sell on Monday because they spend the money on Saturday and Sunday,” Huckstep says.

The Consistent Outperformance of Gurus

“The only one I have more difficulty with is people like [Warren] Buffett who, year-in, year-out, do beat the market,” Huckstep says. “So I would suggest there are certain people with a really, really high IQ who are potentially able to identify some winning ideas.”

Buffett is certainly the most prominent individual example of someone who’s been able to fly in the face of the EMH for decades on end. With Buffett at the helm, financial holding company Berkshire Hathaway Inc. (BRK.A, BRK.B) has trounced the market. From 1964 to 2021, Berkshire shares returned 3,641,613%. The S&P 500 returned 30,209% over the same period.

An arguably more remarkable market walloping has been dealt out by Renaissance Technologies’ Medallion fund. The quantitative hedge fund, which employs high-frequency strategies and reportedly uses a vast trove of historical data — including variables such as weather — boasted an average annual return before fees of 66.07% between 1988 and 2018.

The fund is no longer open to outside investors — only employees at Renaissance can participate in the fund, which has performed like a money-printing machine.

“If you really, truly believed in the efficient market hypothesis, there would be no hedge funds or no single stock picker outperforming the markets, but that’s obviously not true,” Yu says.

What Meme Stocks Say About the Efficient Market Hypothesis

A further example of what might be considered a chink in the EMH’s armor arises from the very recent phenomenon of so-called meme stocks — companies whose share prices are sometimes driven by swarms of retail investors. Mostly short-term oriented, these investor groups often target stocks with high short interest in order to trigger a “short squeeze” that is supposed to teach a lesson to demonized hedge funds that are betting against the stock.

These meme stock rallies are prime examples of the EMH’s shortcomings, says Siddharth Singhai, chief investment officer of Ironhold Capital, a value-based hedge fund. One need look no further than the price activity of Bed Bath & Beyond Inc. (BBBY) in recent months to find issues with the theory, Singhai says. “It’s a dying retailer with no profitability and no substantial asset value.”

Despite that, shares rallied from less than $5 to $23 per share, then plunged back to the $6 range, all within a few months, as retail investor hysteria catalyzed wild swings in the stock price.

Over this time, “there was no substantial change in the fundamental value of the business,” Singhai notes.

More amusing examples of glaring human error in recent years also cast doubt on the narrative of rigorous efficiency in markets. During the onset of the pandemic in the early days of 2020, shares of China’s Zoom Technologies Inc. (ZOOM) more than doubled in a few days. Traders had mistaken it for Zoom Video Communications Inc. (ZM), the rapidly growing video-conferencing software that went into hypergrowth mode with the rapid onset of the work-from-home economy.

Implications of the Efficient Market Hypothesis’s Shortcomings

As many examples as there are of return dynamics that ostensibly shouldn’t exist if the efficient market hypothesis is true, taking advantage of these as an average investor is another story.

Most of the aforementioned market anomalies would require trading in and out of the market on extremely short time frames, requiring an enormous level of discipline and large amounts of time. In addition, gains from such trades would incur the far more onerous short-term capital gains tax and frequently run afoul of the wash-sale rule, which states that investments sold at a loss and repurchased within 30 days can’t be written off for tax purposes.

For Yu, he’s a broad believer in the EMH, but with some qualifiers. “It’s really for liquid markets,” Yu says, and in particular the U.S. stock market, which is the most liquid and highly analyzed. Going further, Yu says the EMH is best understood as a long-term rule. “If it’s one minute, of course you could outperform if you got lucky,” Yu says. “From my perspective, there’s sort of a reversion to the mean [toward efficient markets] over long periods of time.”

For most individual investors, attempting to seize on the exceptions to the EMH, at least when it comes to U.S. stocks, is often more trouble than it’s worth. On the reward-to-effort scale, few methods compare to buying low-cost index funds and sitting on your hands over the long run.

More sophisticated investors might look to take advantage of weaknesses in the efficient market hypothesis by trading micro-caps or foreign markets, which tend to be less liquid and have less analyst coverage and more information asymmetry between buyers and sellers. Of course, these strategies also carry higher risk. Other asset classes altogether — real estate, for example — arguably offer more opportunities for folks seeking to exploit inefficiencies.

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Is the Efficient Market Hypothesis True? originally appeared on

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