Lots of investing news coming in today! The Fed is probably going to renege their indication towards continuing rate increases throughout 2016, which does provide a comfort to investors concerned about a reversal of monetary stimulus. Earnings season is in full swing and the results have been generally higher than expected, further feeding the rally in US equity markets.
There is a concept in modern finance: the efficient market hypothesis. It roughly states that stock prices should accurately reflect all known information. Given the broad strokes of the economy and investing climate are positive, and rationally so. You could make an argument that the markets are rationally absorbing positive information about earnings and likely interest rates and appropriately adjusting their estimates upward, sparking the current rally. So, the broad market direction provides evidence for rational investment and the efficient market hypothesis.
But I love counter-examples! Here’s a fun one (originally reported on CNBC.com). In your real life outside of the office, have you noticed all the Millennials wandering around playing Pokémon Go on their smart-phones over the past few weeks? Pokémon is such a tremendous hit that Nintendo stock skyrocketed about 80% in the past month or so. Just one problem: Nintendo didn’t make Pokémon. Yes, they have partial ownership of the franchise (32% according to CNBC), but all the earnings from this runaway hit aren’t flowing directly into Nintendo’s coffers. This is all readily available public information. But global investors – thousands of people making literal bets with their own money – seem to have ignored that fact until Nintendo released a statement this Friday reminding investors of that fact. Big shock – Nintendo lost the maximum allowable amount (17% per day on the Tokyo stock exchange). Did anybody do their homework?
So here’s what Pokémon teaches us: the efficient market hypothesis is a theory that doesn’t always work out. It might be generally true in aggregate and over the long term, but there are exceptions to every rule.