The Hardly Efficient Market

I got my first iPod (a Press loaner from Apple) the first week they came out. It was a transcendant experience, and I pounded the table to nearly everyone I knew that this was a huge winner. It made Apple stock, trading then at a pre-split price of $18, with $13 in cash, absurdly cheap. Yet AAPL traded essentially flat from that late 2001 intro until its breakout in 2004. In late ’02/early ’03, the stock was $15.

For those who believe in the efficient market thesis — an increasingly discredited theory that states markets (nearly) instantaneously reflect all available data — kindly explain this chart to us:

click for larger chart

graphic courtesy of the NYT

I told practically everyone I knew. From my mom to my co-workers to various fund managers, I went over the Apple iPod story til I was blue in the face (I eventauly came to be bored to tears with it).

The response? I heard every excuse as to why Apple was now irrelevant, the stock was "dead money," why the company couldn’t make money, and why Dell was going to put them out of business. Then came the ubiquitous statement that it was impossible to compete with Microsoft. Some of Wall Street’s dead fish analysts even suggested that Apple put out a Windows box based on an Intel CPU. (Can you imagine?)

My favorite comment came from someone who told me that since the market had valued Apple at a low price, it sees the reason that I don’t (What are you, smarter than the entire market?). Apple’s stock price, according to this perspective, was a fait accompli. There’s an old Econ joke on the subject:

Two economists are walking down the street. One sees a $20 dollar bill lying on the sidewalk, and says so.

"Obviously not," says the other. "If there were, someone would have picked it up!" 

That’s a perfect example of bad theory costing you money.

As we stated previously in The kinda-eventually-sorta-mostly-almost Efficient Market Theory, markets do usually get there — not always, but most of the time, and not right away, but eventually.

Incidentally, the Efficient Market theory is the prime motivator behind indexing, which has been a losing propostion over the past few years (but I think thats more a function of market cap weighting than inefficient markets).

Expect to hear about this theory’s decline in the coming years . . .

To Cut Online Chatter, Apple Goes to Court
NYT, March 21, 2005

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What's been said:

Discussions found on the web:
  1. Rajesh commented on Mar 23

    Fred Wilson brings up something called “we company/they company” with respect to Apple (According to Fred, Apple is turning from “we” to “they”): But based on recent actions I feel Apple is actually beginning to bet against iPod sales. For similarity consider Microsoft/record studios/telcos/cable monopoly tactics: lock a customer in and squeeze every last penny before dying an ugly death (hopefully). The new “iPod tax” and streaming restrictions seems to suggest that Apple is interested in drawing every dollar into its kitty early (instead of confidentally allowing third-party iPod accessories and wide-range legal music sharing) since the long term prospects of iPod/iTMS domination isn’t clear? Or maybe I am just reading too much into it.

  2. Ben W. commented on Mar 23

    I did something similar after getting acquainted with a friend’s Powerbook & iPod a few years ago. Tipped off several people, including the CIO of an Austin tech company (another friend’s father). No one bit.

    Eventually, on Christmas 2003, the only gift I asked of my parents was lend me money to invest, with promises that I would be keeping only the earnings, and would reimburse the losses. They did not bite either.

    Finally, I took an internship (Spring ’04), earned some money, opened an online trading account, and bought a hundred shares or so, which have doubled over several times since them. As a “gotcha” gift, I bought my parents, long-time PC users, an iMac G5 with a portion of the earnings. I also got my GF an iPod mini, and will be getting myself my very own Powerbook, when the need arises.

    The problem with the efficient market hypothesis is that it assumes perfect information, and a balanced, rational assesment of all available facts. This clearly was not the case with investor’s views on Apple in 2002. Due to its historicly cold relationship with business-types, who make up the better part of the active trading population, and all the bad press Apple had been getting in the pre-iPod-boom days “beleaguered,” was an oft-used adjective), it’s understandable to me that a good number of investors, particularly the “me-too” types, would not take a “balanced, rational assesment,” of all currently-available information.

    The good news is that people who do approximate the assumptions in the efficent market theory are those who make the most money, so there is an incentive for improvement. And as the cost of information declines, barriers to market entry are lowered and we, hopefully, continue improving in other ways, the market will better approximate the efficient markets theory.

  3. Andy Nardone commented on Mar 23

    While I never fully explored the iPod, I suffered from AOLitis. What’s that you ask? Many years ago I would ask rhetorically why anyone would use AOL when they could just jump on the net and use best of breed sites for whatever particular interest – cars (Edmunds), sports (take your pick), finance etc. My thesis was right, but timing way off. In fact, in the time it took for my view to play out AOL went to the moon and back.

    With the iPod/iTunes I asked, rhetorically once again, why anyone would want to be locked into the Apple platform/hardware for all their music. Well, in the interim Apple has gone to the moon. But guess what, it will come back too, just like AOL. Technology today will not allow any one player to enjoy this type of dominance for too long. Sure, many will be locked in with their existing investments in their library. But the future users will see the benefit of being allowed choice. It’s the American way. Apple is the AOL of the 20 aught decade.

    But that’s why I use TA, to force myself to see how silly my ideas are until they aren’t. And to avoid the dogma of fundamental analysis, the greatest perpetuator of market inefficiency.

    I don’t see markets getting any more or less efficient as we evolve. Because at their core markets are us. And try as we might, people never change. Fear and greed baby. That you take to that bank.

  4. seamus commented on Mar 23

    Barry, I think you really identify the ass-backwards way that people approach companies based on their stock price, not vice-versa.

    Every year, Fortune does its “Most Admired Companies,” and often they point out that “admired” companies’ stocks outperform the market as proof that being “admired” leads to a better stock price. Of course, the opposite is true — companies are admired because of their stock price. Why is Berkshire Hathaway always one of Fortune’s most “admired companies”? They’re more am exquisitely managed mutual fund than a real company.

    That chart tells so much. One year ago, when I was interviewing MBA students for our summer internship program, none of them was talking about Apple. This year, they’re all talking about Apple in hindsight. I don’t blame them.

  5. Mapping Strategy commented on Mar 24

    Prediction Market Common Sense

    As I commented last fall, the accuracy of Efficient Market Theory (or a lack thereof) has obvious bearing on how much effort it’s worth investing in prediction markets, where they can be applied, how they should be structured and overseen, who ought to…

  6. Mapping Strategy commented on Mar 24

    Prediction Market Common Sense

    As I commented last fall, the accuracy of Efficient Market Theory (or lack thereof) bears on how much effort it’s worth investing in prediction markets, where they can be applied, how they should be structured and overseen, who ought to participate, an…

  7. Investing Intelligently commented on Feb 9

    Non-Market Cap Weighted Indexes: The Next Big Thing

    I predict that within the next 10 years we will see a wave of new index ETFs and index/passive mutual funds. Almost all indexes currently available (and the ETFs and mutual funds that track them) are market-cap weighted. The technique that is usually u…

  8. iPod commented on Apr 6

    Awesome read. Really handy info.

  9. James Snedaker commented on Oct 11

    Yeah, EMH does have an explanation for why this happened. According to some of the more lax versions of the hypothesis, investors can value information differently. All of your family members and friends took more value from the info given by “proffesionals” than you. If some big wig says that Dell will put Apple in the red, it is going to take someone with more authority to convince mom otherwise. What happened over time is that more and more people learned to value the info that you already knew, causing the lag. and FYI the price set by EMH is based on the PROBABILITY of future outcomes.

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