So if the stock market Santa is late, does the efficient markets hypothesis still apply?

21 Jan

Santa Efficient Markets

So there I was, working away in H M Treasury in the last Great Recession (1980-84 from memory), when one of my colleagues piped up – “so I suppose evidence of seasonality in stock market prices would be prima facie evidence against them being efficient?”

It was a rhetorical question, as the answer was obviously yes – if stock prices exhibited seasonality, say rising in the spring and falling in winter, you could trade to beat the market. So markets were not, in some sense, “efficient” – they did not price in all of the available information (in this case, the seasons). And if you had information they did not appear to have (in this case, whether it was spring or winter) you could do what Margaret Thatcher advised you could never do – buck the market.

“Oh come on”, I can hear you say, “can’t you find a better and less trivial example?” Well, how about this? As David Schwartz pointed out in an FT article on 30th November, in 19 of the previous 21 years since 1989, the stock market had risen in December. 2012 proved no exception, with a rise in the FT 100 (and FT All Share) – but by only 0.5%. However, the end of December was mired by worries about the US fiscal cliff, so had you hung on till the markets opened on the second of January, you would have done much better – a gain of over 2.5%. Hence the argument about Santa being delayed.

Evidence that perhaps markets are not as efficient as all that also comes from a more academic source, where Pontiff & McLean have published a paper on whether published academic research destroys stock return predictability – a paper also picked up by the FT. “Not completely” appears to be the short answer, although publication of a “profitable” trading strategy (ie buy before December) does then reduce the returns you can expect significantly – especially for large, easy to trade stocks.

Bit of a mystery, though, we still see the Santa effect in stock markets – after all, it must now count as a published strategy. Transactions costs? End of year trading constraints? Or are the arbitrageurs too busy at their Christmas parties?

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