Larry Swedroe, nationally acclaimed author and principal at Buckingham Asset Management, on his blog at moneywatch.com, recently addressed the growing controversy over market efficiencies, and more specifically, the validity of the “efficient market hypothesis.”

Efficient Markets

Over the past few weeks there have been some prominent articles discussing the “efficiency of markets,” especially in light of the past eighteen months, when many global stock market indices declined by 50 percent or more.

Yale’s Robert Shiller and Jeremy Grantham of GMO, two individuals who have garnered widespread credibility with their work on the forces behind irrational markets, have been at the forefront of criticizing the efficient market theory.

Does Volatility Explain Efficiency?

The reasoning goes something like this . . . “How can markets be efficient if the Dow Jones Industrial Average trades at 14,000 one year, and twelve months later is below 7000? That is proof enough that there are major inefficiencies in the stock market.”

In my opinion, the authors of these articles, and prominent figures like Shiller and Grantham, misuse the word “efficient,” with “rational.”

I don’t think anyone would argue that markets aren’t highly irrational at times. Whether it was the tulip bulb craze of many centuries ago, or the dot com bubble of ten years ago, the emotions of investors, not wanting to miss out on a good deal, can drive “fair valuations” of assets to seemingly absurd levels.

Trying to Win in a Non-Efficient Market

Two points . . . First, from a market efficiency standpoint, even when markets are highly irrational, it is still difficult, if not impossible, for professional stock traders to take advantage of this irrational investing climate, which indicates that markets remain fairly efficient during these time periods as well.

Second, as Mr. Swedroe points out in his blog, even those who are critical of market efficiencies have not been able to exploit it through their management of money.

How do you weigh in on this debate? Do you try to take advantage of potential inefficiencies in the marketplace? Have you been able to successfully navigate irrational markets with your investment decisions?