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*In this series, I’d like to explore some of the most popular investment cliches. These are the phrases we hear constantly in investing circles, and are considered “secrets” to success in the markets.*
*Why, do you ask? To pass along my vast knowledge and help my fellow regards make money? Hell no. That’s cringy af, bro. Nah, this is for fun. If anything, I’m here to roast all the Ausfinance nerds for being try-hards. So, let’s not let our dreams be dreams, and instead make them memes.*
# The Dream
***“It's priced in.”***
It's not clear where this cliche originated from, but the general idea has been around for quite some time. Indeed, the concept is a key aspect of the [Efficient Market Hypothesis](https://en.wikipedia.org/wiki/Efficient-market_hypothesis), a theory that [Eugene Fama](https://en.wikipedia.org/wiki/Eugene_Fama) is often credited as developing in the mid 1960s, and which won him a noble prize. The theory has become prominent in the investment community since then. Central to the theory is that the market factors in all information available to rationally price things. It runs parrallel to the [wisdom of the crowd](https://en.wikipedia.org/wiki/Wisdom_of_the_crowd), which observes that while individuals can be quite error prone, their judgements in aggregate are surprisingly accurate.
An interesting example of "priced in" is the dynamics of the treasury inflation-protected securities ([TIPS](https://www.investopedia.com/terms/t/tips.asp)) market. The simple idea behind these specialised bonds is that the yield should reflect the current inflation rate (CPI). Sounds straight forward, but it isn't quite that simple in practice. Once these are on the market, other things are factored in to the price, like inflation rate expectations and relative yields (spreads) between other assets (e.g. normal treasuries). So ultimately, the yield that is achievable by buying TIPS is not necessarily the same as what the CPI would imply it should be.
There are other cliches that also overlap with the notion of the market pricing everythign in. A notable one is "Buy the rumour, sell the news." While there used to be a time when knowing something about a company or industry could provide an edge, in this day and age, with the internet and 24/7 news, there is barely any gap between the news and the markets pricing it in. Instos using trading algorithms can scan press releases and instantly react. Stonks rerate in a matter of minutes. The average regard is not fast enough to capitalise on these things. If they hope to benefit from some anticipated news, it requires speculation on the results beforehand. In other words, buying the rumour.
If all information about a stonk or industry is already reflected in the market price, simply knowing a particular industry or company is doing good will generally not be enough to produce excess returns. It can actually get a bit more complicated than this when considering the dynamics of game theory ([which I explored in a post years ago](https://www.reddit.com/r/ASX_Bets/comments/qf6viv/what_level_of_investor_am_i/)), but sufficed to say that ultimately, what is already known should be factored in, and in a meaningful way. Or so we're lead to believe from the Efficient Market bros...
# Slap the Ask
The "priced in" quote, and those like it, are not as much cringe as they are hilarious. Like when Haute Crapper enthusiasts, predicting the next announcement on their shitco will launch it to the moon, are quite puzzled when the "pleased to announce" press release causes the stonk to go down. Like, what the heck, man? But mate, you missed page 2. It’s priced in, bro. Or when gold goes up and the goldies goes down, that’s priced… actually, no, that’s just fucked. But we digress.
[But what about my lambo?](https://preview.redd.it/urursf0eo0bg1.png?width=828&format=png&auto=webp&s=868375ace196767119a0c5ec5146b3c39f3de0f4)
There is a more subtle point here about stonk prices that needs to be appreciated. As we considered in the previous [Time in the Market](https://www.reddit.com/r/ASX_Bets/comments/1pr1cof/scam_dreams_time_in_the_market/) post, there are a few levers of price appreciation. A company being a quality business that is profitable and is growing is only part of the equation. The market essentially assesses these facts and assigns a valuation from the aggregate decisions of individual regards' buy and sell orders.
Whether a stonk is a good investment depends upon not only the quality of the company, but the price paid for it. In other words, if the market knows a company is growing, and expects similar growth in the future, the multiple will likely include a premium over what might be considered a base rate. The legendary [Peter Lynch](https://en.wikipedia.org/wiki/Peter_Lynch) expressed this idea with his [PEG Ratio](https://www.investopedia.com/terms/p/pegratio.asp), which was a modified P/E ratio that factored in expected growth. For example, if a company is priced at 30x P/E and is likely to grow 100% in the next year, buying it now is essentially buying it at 15x P/E to its future earnings. So it is probably fair value at 30x, if that growth comes to fruition.
In addition to expectations of growth, other considerations like the risk of loss, term premium, and other probabilities can be influencing factors in this pricing mechanism. You can think of the market being like a bookie setting the odds. In theory, all prices within the market should align to a similar overall expected return when all is said and done. Similar to how bonds adjust pricing to align with the prevailing yield in the market so that all bonds within a class align, regardless of the [coupon](https://www.investopedia.com/terms/c/coupon.asp) they were originally issued with.
As our unfortunate Haute Crapper stonk enjoyers often discover, even if a company does well and grows, if it fails to live up to the market's expectations, then it could lose some of it's value. Basically, stonks that fail to deliver end up rerating to revised expectations and as such, different market premiums or discounts. This makes sense, because those expectations are directly linked with the possible returns of the company. Less return means less valuable stonk. Unless it's just an insto tree-shake, of course. In that case, better back up the truck and scoop up those cheap shares.
# Is Not It Scam Dream?
Those who have been here long enough will remember of our [Nepalese fren's bewildering question to the sub](https://www.reddit.com/r/ASX_Bets/comments/m6rtgu/dumb_question_invest_in_secondary_sharemarket_and/). Our foreign fren was sceptical about the gains possible in speculative shitcos. They posited that if diversified mutual funds cannot produce 2x or 3x returns in a single year, how is it that we expect our shitcos to do it? Maybe they had a point too. In aggregate, all those ASX shitcos likely balance out to a total return not too far off the going rate for the market overall. For every 100x bagger moon shot, there are 99 others that go to zero.
[Good question.](https://preview.redd.it/tpq4joylo0bg1.png?width=868&format=png&auto=webp&s=956e661f600b5385d263517f8050b46822114ee8)
All this leads us to the question that Efficient Market bros raise. If the market is simply setting the odds on all our stonks, doesn't it make sense to just go with the diversified index and dollar cost average as you go? No point in timing. No point in stonk picking. Moonshots are a matter of luck. If you want to gamble to get the moonshot, you may as well just buy lotto tickets.
Though, I cannot help but feel as though there is a bit of discrepancy with this theory when compared to observable market behaviour. If the market has priced everything in, and in aggregate the market is very accurate, why is it that we still get big earnings beats and misses? It's not as though this is exclusive to the realm of microcap shitcos and speccie miners. Even the largest stonks on the NYSE, extensively covered by the best analists in the world, have beats and misses to such a degree that they move 10-20% in a single day. Surely the market could not be wrong that often and to that degree for the notion of "priced in" to be meaningful, right?
[NVDA % change daily L3Y](https://preview.redd.it/vs3sloaoo0bg1.png?width=1627&format=png&auto=webp&s=a3332fe48afacf592482f3f29b9120c821aec00b)
If there's room for a stonk to move so dramatically on an announcement, then it follows that the market hasn't *fully* priced in expectations. So, what is actually priced in prior to that point? It would seem there's a certain amount of probability built in to the market pricing mechanism, since there is still uncertainty among market participants on what the news will be. Individuals are making bets on different possibilities, but as we see, quite often the "wisdom of the crowd" isn't worth much.
Don't get me wrong, the Efficient Market bros do make a good point. It is quite evident that stonks do tend to factor in known facts and the markets are interrelated. Relative returns between stonks and industries tend to balance out over time. Certain spreads between different assets classes seem to be reliable over long periods. However, it seems to me there are a number of issues, which the bros gloss over when coming to the conclusion that everyone should just DCA into the index. The very idea that we can "buy the rumour" implies that market pricing mechanisms have some serious blind spots when looking towards the future.
One of the most obvious blind spots for Efficient Markets bros is the idea of [Black Swans](https://www.investopedia.com/terms/b/blackswan.asp). Even if the market is pricing the past, present, and future expectations perfectly, what it cannot price is what cannot be predicted. The market may be able to handle the known-knowns and the known-unknowns, but how can it possibly factor in unknown-unknowns? The essential nature of a black swan is that noone (or very few) expected it, or it otherwise could not have been predicted.
There is also the issue of the market's tendency to be manic depressive, as we explored in the first post of this series about [Buying the Dip](https://www.reddit.com/r/ASX_Bets/comments/1pl6kdg/scam_dreams_be_greedy_when_others_are_fearful/). If there's a tendency for the market to overshoot on expectations, both to the upside and downside, doesn't that also mean that there are opportunities to buy or sell a stonk when pricing goes far beyond what we reasonably can expect to happen? Indeed, how can we qualify an overshoot as the "crowd's wisdom", when by its very nature, it’s a mispricing of the underlying company due to the irrational feedback loops generated by crowds? How do Efficient Market bros explain how markets are pricing in something far better or worse, just because we’re collectively getting a bit emotional?
[Rationally priced? lol](https://preview.redd.it/f5pjuwsgz0bg1.png?width=1098&format=png&auto=webp&s=cfd66a02b3268348240ecadffbd2c6b2790b0161)
It is important also to mention how the market can become irrationally exuberant, especially when it comes to new and hyped technologies or industries. The [South Sea Company](https://en.wikipedia.org/wiki/South_Sea_Company) of the 18th century, [Railway Mania](https://en.wikipedia.org/wiki/Railway_Mania) of the 19th century, and the [Dot Com Bubble](https://en.wikipedia.org/wiki/Dot-com_bubble) with the subsequent [Telecom Crash](https://en.wikipedia.org/wiki/Telecoms_crash) more recently, are all great examples of ideas that changed the world, and yet ended up losing investors a ton of money. How do Efficient Market bros disentangle the contraction between the notion that markets are prudently pricing-in future returns with the fact that markets have repeatedly and foolishly over-invested on the basis of hype?
But perhaps the most critical flaw to efficient market bros’ idea is that it hinges upon the assumption that [price discovery](https://www.investopedia.com/terms/p/pricediscovery.asp) is even working properly in the first place. The wisdom of the crowd requires a certain critical mass of participants in order to function. If there are too few buyers and sellers for a particular stonk, then how can we expect that pricing will properly reflect all the information present? It would seem that the fewer the market participants, the more random and unreliable the pricing of a stonk.
For many low liquidity stonks, it is self-evident that the level of price discovery at work is rudimentary at best. Under these circumstances, it is more accurate to say that the stonk reflects only the predilections of a small number of people. Taking this one step further, we must remember that the broader market itself is just an aggregate of individual stonks, each with its own varying level of liquidity and price discovery in action. For the Efficient Market bros to have any hope of their idea being meaningful, they need most of the market’s constituents to be trading with some minimum level of participants and liquidity. But is that really the case in the markets today?
# Capital for the Life Span
When [Vanguard](https://en.wikipedia.org/wiki/The_Vanguard_Group) was founded in 1975 by the legendary [Jack Bogle](https://en.wikipedia.org/wiki/John_C._Bogle), the idea of passive indexing was almost unheard of outside of academic studies. Vanguard’s first fund, proposing to replicate the S&P500, was derisively called "Bogle's Folly."
Indexing proposed to solve a significant problem with stonk picking. With [very few stonks making most of the market’s returns](https://wpcarey.asu.edu/department-finance/faculty-research/do-stocks-outperform-treasury-bills), trying to find one of the truely great ones was difficult. The solution was to invest in a diversified group of carefully picked stonks. That way, a portfolio is more likely to hold at least one big winner. Even then, there is risk to underperform the broader market. If regards instead hold the index itself, their portfolio will hold all of the winners, and indeed, be guaranteed the market’s return. One of Mr. Bogle’s iconic quotes summed this up, “Don’t look for the needle in the haystack. Just buy the haystack!”
[S&P500 1955-1995 Inflation Adjusted](https://preview.redd.it/gusml1i0p0bg1.png?width=1250&format=png&auto=webp&s=e7823a027fda6e5a5a0b10345971b21c91ee4982)
There is some irony in the instos casting shade at Boge’s fund at the time, as they were essentially closet indexers already. The big mutual funds of the 1960s were ground zero for the creation of the [Nifty Fifty](https://en.wikipedia.org/wiki/Nifty_Fifty) bubble.
Funds prominently featuring these 50x biggest and best blue-chip US stonks were pitched as being a sure thing. These funds had huge inflows in the 50s and 60s. As more money piled in, valuations grew. As valuations grew, so did their relative weight in the index. The whole thing was massive positive feedback loop, with money increasingly allocated to just a few select names. The momentum itself served to draw in more money, and insofar seemingly reinforce them as the best stonks to be invested in.
The Nifty Fifty's average P/E reached over 40x by the early 1970s. The largest 5 constituents accounted for over 20% of the S&P500. However, by the early 1980s, these companies had collectively lost about 90% of their value inflation adjusted. It wasn't because the companies suddenly became bad. What made these otherwise good companies such bad investments was the very fact that they were seen as a sure thing. As a result, valuations were largely ignored, until they couldn't be.
In one of his books, *A Brief History of Financial Euphoria*, the prominent 20^(th) century economist [John Kenneth Galbraith](https://en.wikipedia.org/wiki/John_Kenneth_Galbraith) observed that every 20 years or so the market seems to forget all the lessons it learned from the last big crisis. As a result, it blissfully wanders its way into making the same mistakes all over again. I cannot help but feel as though Efficient Market bros would have us believe that by passively indexing, we don't need to worry about market movements and valuations. But can the past mistakes of active management truly be ignored when going passive? Market concentration is not a feature exclusive to active funds.
[Current Holdings of Vanguard International ex AU \(VGS\)](https://preview.redd.it/a0fkvfc6p0bg1.png?width=1432&format=png&auto=webp&s=a29f476802ea2c10c0fdaae2f3b5cca0aea79b78)
As I write this, the [Magnificent Seven](https://www.investopedia.com/magnificent-seven-stocks-8402262), the largest companies in the US, account for over 35% of the S&P500. More broadly, the US stonk market accounts for over 70% of the MSCI world index. Their average P/E is over 70x (35x if you exclude Tesla). That means AusFin nerds, thinking they are “diversified" buying MSCI world index funds like VGS, are in reality putting 30% of their money into only 10 stonks, which very well may be overvalued.
Being such a large portion of the worldwide market, these stonks' valuations must offer a compelling return on investment, right? Passive indexers seem to think so, given how much we hear about safe and reliable 10%+ returns you can get simply just piling into the index, as though it's a sure thing. After all, it's priced in.
[Passive vs Active Funds \(chart from morningstar.com\)](https://preview.redd.it/i2iq63jfp0bg1.png?width=2132&format=png&auto=webp&s=aba47af7b703ef0f73f3c730088c97e4512720d1)
50 years after Mr. Bogle launched his first fund, there has been a massive [shift away from active management in favour of passive indexing](https://www.morningstar.com/funds/recovery-us-fund-flows-was-weak-2023). By some estimates, the market has gone from less than 10% passive in the 1990s to more than half of it today. Why pay an insto two and twenty to lose money in a closet index fund, when us regards can lose it just fine making the same mistakes on our own?
For the few large and active instos that could help serve as price discovery for the market, most would be limited toward the top end of the market in terms of market caps due to liquidity requirements. This means that much of the price discovery that could be occurring is wasted on mega-cap stonks, with funds riding the momentum of passive flows. As for the retail crowd, a significant portion of active regards are tied up with meme stonks, [0dte options](https://www.investopedia.com/zero-days-to-expiration-0dte-options-and-how-do-they-work-6753832), technical analysis, and the other ~~amusements~~ investments that the ~~casino~~ market offers.
As such, I wonder at what point does "priced in" actually make no sense at all. Where is the price discovery in all of these passive index funds increasingly funnelling all their cash into a handful of US tech stonks? Less and less of each investment dollar these days finds its way into the other 50,000+ stonks that are listed on the world markets. Where does that leave the poor stonk picking regards and their neglected microcap shitcos?
[Who does the market smile upon?](https://preview.redd.it/9qto9nzxp0bg1.png?width=1422&format=png&auto=webp&s=2505a4b066bcbe6125c999dc42557a1d68aa2f50)
Pondering this led me to the interesting account of a man named [Tatsuro Kiyohara](https://ja-wikipedia-org.translate.goog/wiki/%E6%B8%85%E5%8E%9F%E9%81%94%E9%83%8E?_x_tr_sl=ja&_x_tr_tl=en&_x_tr_hl=en-US&_x_tr_pto=wapp). From what I can figure out, he is a bit of a legend in Japanese investment circles. He ran an investment fund during Japan's lost decades, and during is 25-year run achieved a 20% average return per annum (even more impressive in light of the fact that the index returned only 3% pa over the same period). Kiyohara-san's gains were so good in 2004, he was recognised as [the biggest taxpayer in Japan for that year](https://www.nbcnews.com/id/wbna7876361), which was the only time a 'salaryman' had topped the list.
There is no english translation of his book *Our Investing Strategy; who does the market smile upon?* but I managed to find a fellow regard otaku that had summarised it ([Part 1](https://madeinjapan.substack.com/p/book-summary-our-investing-strategy), [Part 2](https://madeinjapan.substack.com/p/book-summary-part-2-our-investing)) in english (as a side note, checkout the story of Zensho Holdings in part 1 if you want to have a laugh). In the book, Kiyohara-san recounts that after graduating from Tokyo U, he wanted to avoid competing with all those students he met whom he thought were smarter than him. So, he pursued a career investing in Japanese micro-caps, where he reckoned he'd be able to go up against 'dumb competition.'
[Or maybe just the baghodlers now...](https://preview.redd.it/txp4p551q0bg1.png?width=1078&format=png&auto=webp&s=203696ec1abcb0fb850b2b79cacb8ebfe4137050)
His strategy was to identify stonks before any of the big money found out about them. The fact was that active instos didn't know or even care about microcap stonks, which meant there was little to no price discovery at work at that level of the market. Kiyohara-san reckoned the risk reward in these stonks as a result was skewed to the upside. Typically no growth was priced in, so if the business did nothing, it didn't matter. But for the businesses that did do well, the returns were astronomical. I'm not sure if there's a lesson to be learned from Woren Buffetto here, but it's a cool story, bro.
# TL;DR
Regards new to investing are often surprised when their genius idea to invest in the latest hype industry doesn’t leave them with massive gains to match their massive brains. In many cases, the markets had already "priced in" those gains. Indeed, there are countless examples in history when hyped new technologies were world changingly good, but ultimately bad investments. So hyped were the stonks, that even great returns at the company level did not offset the valuation premiums.
Does that mean we should listen to Efficient Market bros, who claim that the market already knows everything that there is to know, and all the gains are already priced in? Shall we just resign ourselves to dollar cost averaging into index ETFs like an AusFin nerd? Should we do as legend Jack Bogle suggested and "Don't look for the needle in the haystack. Just buy the haystack!" Maybe... We’ll certainly get the market return doing that.
And yet, when we consider that today's markets are increasingly concentrated due to growing passive investment flows, it seemingly leaves a huge swath of stonks neglected. With fewer and fewer active regards discovering these stonks, it potentially leads to market pricing that may not truely reflect the opportunities they present. With all these potential hidden gems out there, it seems to me, the haystack is increasingly becoming a bunch of needles with no one looking for them.
*Thanks for attending my Bread Talk. If you think this is advice, then you are truly regarded. So please, DYOR, GLTAH, NFA, and since you asked…. DLC.*