Except, we've learned via a robust body of research over the last 5 decades that the market is largely efficient.
Therefore, a change in share price over time (not measured in quarters, but over 3+ year periods...as was done in this study) is an excellent proxy for change in fundamentals.
> Except, we've learned via a robust body of research over the last 5 decades that the market is largely efficient.
Oh? Care to cite some of that research? And let me preempt a few common citations which don't actually work:
1. Warren Buffett's hedge fund bet does not prove this. Among other reasons, he made a bet concerning the performance of a fund of funds, not any particular outlier.
2. Eugene Fama's research on the Efficient Market Hypothesis (EMH) does not prove this (while we're at it, Fama would disagree with you that the market is efficient). His work applies the EMH as a means of studying efficiency, not asserting efficiency. One of the most common misconceptions of Fama's work is that it's descriptive instead of prescriptive.
3. When you actually do the math, the number of hedge funds that has ever existed is nowhere near what you'd need to explain the outliers like RenTech or Baupost. So the common coin flipping analogy actually doesn't prove it either.
I can save you a trip to look for citations - the "robust" body of research you're talking about doesn't exist. There is no such consensus. The efficient market is a model which only approximates real world conditions - it do so imperfectly, and in the best case it only works locally.
Here is an article [1] written by Cliff Asness on the topic of the EMH which might be educational. Asness earned his PhD under Fama and founded AQR, one of the more successful hedge funds. He also regularly comments on, and published, research. There remains a great feal of inefficiency at the macro level, even on horizons measured in years.
As I stated, the market is largely efficient. I did not say it is completely efficient.
Also throwing out Rentech as an example just further proves my point.
The inefficiencies that Medallion fund is exploiting are extremely capital constrained (ie. They are very tiny). This is why they don’t accept outside investor money and even limit the amounts employees can have in the fund. The fund is limited to roughly $3 billion, because the inefficiency they are exploiting is that small.
An inefficiency of $3 billion in capital markets of roughly $100 trillion dollars is tiny.
All of Rentech’s larger funds for outside investors have not shown the same ability to beat the market.
Also, I’m amazed that you use Asness as a counterpoint, because if you’ve ever heard him speak, he would agree that the market is “largely efficient.” I’ve literally heard him say those words in person.
Asness’s entire hedge fund is based on Fama’s factor models. He literally makes his money by making the market even more efficient. He has admitted long-short factor funds like his have likely reduced (and will continue to reduce) factor alpha, hence why they need to apply leverage to make these returns significant.
The market is going to price in expected change in fundamentals due to the new CEO. They're going to price it in immediately - before the fundamentals actually change. The market does not proxy change in fundamentals. It proxies change in expected future fundamentals. These are different things.
We could be arguing semantics here, but my point is; the market will of course price in prevailing sentiment at the time, but this will be corrected over the next 3 year of earnings releases whether prospects for future fundamentals have actually improved (hence why the study used 3-6 year time periods).
The price at year 1 will be based on the prospect of future earnings. The price at year 3 will still be based on the prospect of future earnings...but with 12 quarters of hard data allowing you to more accurately price in the new CEOs specific strategy and its effects on growth prospects.
Right. But any of that future price movement that was predictable based on the known attributes of the CEO at the time will be priced into the initial move. If it were not, then you would have a profitable trading strategy that say, went long Harvard CEOs and short Princeton CEOs (strictly a hypothetical example).
Therefore, a change in share price over time (not measured in quarters, but over 3+ year periods...as was done in this study) is an excellent proxy for change in fundamentals.