Markets are very efficient
The standard Efficient Market Hypothesis has been widely mocked lately. If it was true how could anyone beat the market long enough to rule out luck, or avoid a loss by leaving an overpriced market? In fact, why not go buy some gold today since all those people bidding it up must know what they’re doing? While I don’t believe that markets are efficient in the sense that it’s impossible to get any sense of their future direction, maybe that’s looking at it the wrong way.
The standard efficient market hypothesis is that all known information, such as declining future profits, is priced in already so it has no advantage to anyone else. You can in fact get information which gives you an advantage (that’s exactly what it is when you decide a market is too expensive), although it’s never guaranteed.
But markets are very efficient at pricing emotions. For example, in March 2009 when the market hit the bottom it was pricing in the fact that we had reached the maximum expectations that the market would fully collapse. Since that possibility was priced in those who bought got a great price and protection from that very event as confidence started to rise. Rather than having the market collapse we found out the price associated with the lowest expectations of its survival.
This provides a boost and a margin of safety for contrarians. However it’s no simple signal that tells you what to do since everything is relative. March 2009 simply marked the lowest point of opinion that we reached in the last 5 years and had no absolute significance to indicate it was the bottom. The mistake many investors make is thinking that negative emotions mean prices will fall in the future, when in reality the market is so efficient that the foreseen disaster is already in today’s prices. Only future emotions will affect future prices. And the best part is that this information is actually easy to access. Almost anyone will tell you exactly why you’re an idiot for not investing like them and the media loves it too. Let’s support our efficient markets and profit from them!