The Fallacy of Passive Investing

Market Efficiency - Efficient market proponents espouse that markets are perfectly priced and reflect fair value at all times. If markets are truly perfect, financial bubbles could not exist. By definition, a bubble occurs when prices deviate significantly from true fair value resulting in spectacular market corrections. Efficient Marketers believe that today’s price reflects all known information. Shiller disproved this by taking the known dividends with the benefit of hindsight and the known discount rates and reverse engineering efficient market fair value. This is plotted against actual market value. If markets were truly efficient they would overlap. These short term deviations from market efficiency lead to longer term opportunities.

Source: Market Volatility, R. Shiller, MIT Press, 1989, and Irrational Exuberance, Princeton 2005

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