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When we don't learn

Investors don't always learn from experience, which means that markets can remain inefficient
When we don't learn

Have investors wised up, causing stock markets to become more efficient? This is the question posed by the fact that two of the best-attested deviations from the textbook idea of market efficiency have stopped working: in the past 12 months many momentum and defensive stocks have underperformed the market.

In theory, this is what should happen. Investors should not leave money on the table by ignoring stocks or strategies that beat the market. As they learn about such opportunities they should pile into them. As they do so, they drive their prices up to levels from which subsequent returns are average – which of course means suffering occasional big losses. In this way, markets should become more efficient over time.

And there’s some evidence that they have done so. John Cotter and Niall McGeever at University College Dublin studied the performance of nine anomalies (deviations from market efficiency) in the UK market from 1990 to 2013 and found that most diminished over time. “Recent years have seen an improvement in market efficiency” they conclude. This is also the message of research in the US by David McLean and Jeffrey Pontiff. In this sense, the rising popularity of index tracker funds has a good evidence base.

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