The Financial Philosopher: Financial Blogs: The Making of Efficient Markets

Ghandithe_financial_philosopher

"The more efficient a force is, the more silent and more subtle it is." Mahatma Gandhi (1869-1948)

The financial markets community and its participants have given much time and consideration as to the validity and degree of usefulness of the Efficient Market Hypothesis (EMH). The hypothesis says that all known information about securities traded in the financial markets is reflected in the respective prices of those traded securities, thereby making financial markets "informationally efficient." Arguably, this hypothesis gains in viability as the abundance of information increases and as that information is made readily available and consumed...

Without a doubt, the Internet has profoundly impacted the way we exchange information, especially with regard to its velocity and abundance. More recently, the advent of weblogs or "blogs" have made even more information available for consumption and have exponentially increased, not only the velocity and abundance of information available on the Internet, but it has, in my humble view, increased its quality as well. I believe that the power and proliferation of financial blogs have especially made an impact on financial markets and I now suspect that a significant portion of that impact can be found in the increased efficiency of the markets...

Before moving forward to share my financial blogging observations with you, please endure a few more essentials for understanding EMH:

It is not possible to consistently outperform the market averages, especially over long periods of time, by using any information that the market already knows, except through luck; therefore, competitive advantage through skill diminishes as market efficiency increases.
EMH implies that markets become more efficient where information is more abundant and readily available; therefore, the opposite would be true: If information is less available, the market is less efficient.
Market participants will have rational expectations but EMH does not require them to be rational . When faced with new information (news), some investors will over-react and others will under-react.
Personally, I believe, and many others that are smarter than I would concur, that certain areas of the market, such as large-capitalization stocks, are more efficient than other areas of the market; therefore, passively-managed investments, such as index funds, are prudent investment vehicles for efficient markets.
Applications of such uses of EMH can be found here, as well as here and here).
Within five minutes, I could teach my six-year old son how to look up Wal-Mart on Yahoo Finance and determine if it's stock is a "good buy" or not. That's what I call efficient...

Now take a look at this chart from Technorati, a resource for all things related to the blogosphere, to introduce and illustrate my observations of the explosive growth of weblogs over the past five years and how they may be making the markets more efficient. The graphic speaks for itself:

Growth_of_blogstechnoriati2007

Here are more points to ponder from Technorati's most recent "state of the blogosphere" report:

Nearly 75,000,000 (that's million) weblogs are being tracked!
The blogosphere grew from 35 million to 75 million blogs in 320 days.
About 120,000 new blogs are being created every day or roughly one new blog every 1.4 seconds.
1.5 million blog entries are posted every day or 17 posts per second.

As a point of reference, would you be surprised if I told you that financial blogs may be more prevalent on the Internet than, say, politics or even more than mindless pop culture? Check this out: Prior to posting this blog entry, I "Googled" the words "financial blogs" and the search engine returned 113 million results; then I did the same for "George W Bush" (109 million), "Paris Hilton" (95.9 million), and "American Idol" (24.9 million). The winner? Financial blogs...

In the true spirit of a blogger (and financial philosopher) here are my personal observations that contribute further to the case for financial blogs making the markets more efficient:

Increasingly over the past few years, the equity markets (stocks) appear to be "rationally exuberant:" Investors seem to retreat from market highs just as sentiment begins to become overly optimistic (judging by the small corrections on February 27 and the first week of June 2007).
The upward trajectory for stocks in this Bull market is broad and is absent any large single-day gains or losses, making this Bull run unusually orderly, which nurtured a recent record run for the Dow Jones Industrial Average not seen in nearly 80 years.
Investors appear to be cognizant (and capable) of balancing the "good news" (positive economic growth, historically low interest rates, reasonable valuations, or P/E ratios, for stocks) and the "bad news" (inflationary pressures, high fuel prices, a deteriorating housing economy).

In summary, we should take note of how information has formed and transformed our society, especially in terms of making the world a "smaller place;" however, regarding financial markets and citing EMH, human behavior is not expected to remain "rational" in perpetuity. While there are likely other factors, such as a clear memory of the recent technology boom and bust, that are momentarily preventing investors from losing touch with rationality, the logic of history tells us that human nature will eventually overcome rationality and some "trigger event(s)" will begin the end of this "orderly" Bull market, regardless of (or because of) how readily available information has become. Efficient markets still behave randomly. There is no way of knowing precisely what event(s) will bring the market back down, when it will occur, or how much higher the market will go before that happens...

Until that day (and the day after), at least you'll know where to find the information you need to make an informed decision (or not)... Financial Blogs...

View this blog post and others like it at the Carnival of Personal Finance...

TFPAuthor, Kent Thune, is the President and Owner of Atlantic Capital Investments, LLC (ACI), a fee-only, registered investment adviser based in Mount Pleasant, SC, near Charleston. ACI specializes in retirement, investments, and financial planning.

Comments

I once saw an entry on Wikipedia that said, ""A number of researchers have investigated motivation in virtual communities. Studies show that over the long term
users gain a greater insight into the material that is being discussed and a sense of connection to the world at large." I certainly have increased my knowledge by reading all sorts of blogs and financial information sources on the internet.

Posted by: InvestEveryMonth.com | June 26, 2007 at 12:09 PM

I firmly believe that, at a minimum, a "weak form" of efficiency exists in the markets that is increasingly minimizing the competitive edge of traders. I find it difficult to argue that the mass aggregation of information by bloggers are not contributing to that efficiency.

Thanks for the comment...

Posted by: The Financial Philosopher | June 26, 2007 at 05:40 PM

While blogger’s and operators of the web 2.0 have the power to emerge as the leader in the dissemination of financial information, my anecdotal evidence suggests the web 2.0 has just barely begun to lend any increased efficiency to the financial markets. Search on Wikipedia for some Financial Information and then a topic like Search Engine Optimization, your will see the later is much more developed.
The reality is that with the exception of some niche academic circles, the web 2.0 despite is democratic nature, is being steered by those with the most economic incentive. Google and other have only compounded this problem by favoring older, larger sites and monetizing poor quality sites with there adsence program.

Posted by: Michael D | July 08, 2007 at 08:38 PM