Come INTO the LIGHT!<G>
June 17, 2001
Strategies: Forget About Efficient Markets. Let the Sun Shine In
By MARK HULBERT
Strategies: Forget About Efficient Markets. Let the Sun Shine In (June 17, 2001)
Strategies: Tales of Summer in the Stock Market (June 3, 2001)
Strategies: Beneath the Stock-Market Rebound, Hints of Trouble (May 20, 2001)
If you still believe in efficient markets, consider this: City by city, according to a new study, stock markets rise more often on days when the sun shines in the morning than when skies are overcast. And, the study concludes, the New York Stock Exchange is among the most weather-influenced markets in the world.
These findings are devastating for people who advocate the efficient-market hypothesis, at least in its strongest form. The hypothesis holds that the market so efficiently assimilates all new information as it sets stock prices that no one can outperform it consistently. But if something as obviously irrelevant as the weather can change market performance, such efficiency cannot exist.
The study, "Good Day Sunshine: Stock Returns and the Weather," by two finance professors, David Hirshleifer of Ohio State University and Tyler Shumway of the University of Michigan, is available at www.cob.ohio-state.edu/fin/dice/papers/ 2001/2001-3.pdf.
For example, on a day when Paris is sunny and Brussels is cloudy, French investors tend to interpret that day's news more optimistically than Belgian investors — even though the two exchanges trade many of the same companies and are affected by the same economic developments.
The professors arrived at their conclusions by studying 26 stock exchanges worldwide between 1982 and 1997. They found that sunshine's positive effect is not confined to one country, or to a few emerging markets. In fact, they found it in virtually every market they studied. Furthermore, American investors will be humbled to learn that, notwithstanding their self-image as technologically sophisticated, the Big Board is among a cluster of stock exchanges that are most influenced by the weather. Others in that group are markets in Brussels, Paris, Vienna and Helsinki, Finland.
All of this may be fascinating, but how can the study make you a better investor? Its greatest lesson is not how to day-trade the world's stock markets according to the weather — though if you were so inclined, the key would be to have low transaction costs, like those that apply to stock index futures. In that event, according to the professors' calculations, you might make money by going long in markets whose cities start the day in sunshine and going short in markets whose cities are under clouds.
More important, the study shows that our moods can have powerful effects on our interpretation of economic developments. When the sun is shining, the study concludes, people tend to put a more optimistic spin on the day's news developments. The process is subtle; indeed, most of us are unaware of how our moods contaminate our objectivity. But if the weather can change our opinion about a stock, imagine the impact of our other daily mood swings.
The main point, of course, is that objectivity is rare among investors. We may think that we are being objective as we assess an earnings report, for example, but we most likely are not.
To have any chance of beating the market, we need to be ruthlessly objective. Although we have conclusive evidence that the market is not completely efficient, it would be a mistake to conclude that it is totally inefficient, and thus easy to beat. To the contrary, despite frequent anomalies, financial markets remain predominantly efficient and difficult, though not impossible, to beat.
To immunize yourself from your moods, use a mechanical investment strategy that dictates how to react in all possible circumstances — eliminating the need to make judgments in the face of new developments. And try to be disciplined enough to stick with the strategy, even in the face of inevitable emotional pulls to second-guess it.
If you follow this advice, I predict that your long-term performance will be more than enough to cheer you on even the cloudiest of days.
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