Efficient market hysterics

The past several months have shown that the naive assumption of capital market efficiency is the road to ruin. You could also add the blind faith in diversification, so beloved of ill-trained and lazy financial advisers, to the mix.

Several people have challenged me to justify these beliefs. I've been in the business long enough to see that human nature is wondrous but fallible. It is easy to be seduced by the elegant simplicity of a straightforward "academic" solution to the investment puzzle. I've learnt at my own personal cost that relying on those sirens is lethal.

The chief villains are the "efficient market" and "diversification" mantras. I'm not saying that they haven't got some limited truth (some of the time). The problem is that they were so easy to pump into an Excel model: any idiot could churn out a reasonably literate asset allocation. Experience and judgement became a distraction - the canned solution was much less tiring.

The better (but more difficult) route is to base these allocation decisions on liquidity and risk. Sure, diversifying is common sense, but don't let it override your judgement on current market price trends. And although most vanilla news is priced in fairly well, in these uncertain times people are trading in a messy herd, clouding pricing.

Of course, some optimists are calling a turnaround with some handy data mining. Take the latest examples in this article. The thesis (if you can call it that) is that investors are not getting "gloomier", so we've reached the bottom.

My advice is to take that statement with extreme caution. First, there is far more bad corporate news to come in the new year, as central banks run out of ammunition. Second, the people coming out with this facile reasoning are long-only shops. Talking up their books, no doubt.