News & Analysis

Can the market ever be wrong?

9 December 2022 By Adam Kahlberg


The capital markets are complex, volatile, and dynamic. A collection of buyers, sellers, market makers and many other participants all working together to facilitate the transfer of assets between different parties. However, can the market ever be wrong

What is ‘Getting it wrong?’

 It is often one of the first lessons a market participant learns. This is that the market is never wrong. No matter what the price of an asset the constant message is that the market can never be wrong. Whilst this may be true, a different perspective may look at the scale of the market being wrong, as a measure of how large the difference between an asset’s price vs its fundamental value. An opposing argument may believe that the fundamental value is just the price at which someone is willing to pay. Many longer terms investors value their assets based on some long-term fundamentals such as revenue, profit, and net income. Other shorter-term traders try and value an asset on a short-term news catalyst such as shifts in government policies, tax incentives and other measures. Exploring these ideas and some examples of exceptional mispricing’s will form the basis for the analysis below.



The Efficient Market Hypothesis


One reason that the market is never wrong or that it is not wrong for very long is because of the ‘efficient market’ theory. This is one of the fundamental principles of the capital markets and is the idea that market prices for assets reflect all the information available whether it be privately held or publicly disseminated. This can include things like financial statement from companies, economic data for a country’s GDP and everything in between. In theory this means that it is impossible to consistently beat the market. Therefore, in theory, over time the market will always price assets correctly. Or will they? Based on this theory, institutional and retail participants must price assets pricing the assets correctly.


When the Market got it wrong


2009 Global Financial Crisis


One example of when the market got it very wrong, on a large scale was the 2009 Global Financial Crisis. It has been well discussed and researched but the credit crunch and housing crisis caused by large investment banks manipulating dodgy securities that were inaccurately pricing mortgage bonds and other related derivatives. Whilst the details of the causes are complex, the main issue for of this analysis is that the broader market was unable to correctly price these risky assets for whatever reason. Even though all the information was available, the pricing was not accurate. The housing bubble burst and prices crashed. The consequences of which caused an economic meltdown. Why did the market fail to correctly price these derivatives and how did the market get it so wrong. In the years since the GFC it has come out that not only was the pricing inaccurate, but the management of these assets was fraudulent at worst, and negligent at best. The contracts and derivatives became so overly complex that perhaps no one could be bothered to understand the structure of the contracts. This brings up another point, if fraud and criminal activity are taken out of the equation can, can the market be wrong.



Asset Bubbles


Another example of which the market can be wrong and very wrong is in the matter of asset bubbles. Asset bubbles are when assets see a rapid increase in price that becomes disproportionate to the fundamental value. Once the bubble gets too inflated, it inevitably bursts, and the asset sees a rapid decline in price closer to its fundamental level. The point is that in this instance the market has mostly been blinded by emotions such as greed and fear and is not thinking rationally. Therefore, in these situations the market gets the pricing wrong. When this occurs, it can be difficult for investors and traders to remain composed in their management of their portfolio or their trading account. Bubbles can occur in any assets class and a recent example include the Bitcoin bubble of which the price peaked at nearly $70,000 last year before falling more than $50,000.

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Ultimately, it has been established that the market can gravely misprice assets and that these mispricing’s can wreak havoc on the local and global economies. However, whether these constitute the market being wrong at the end of the day is a matter of opinion and definition. It doesn’t really matter if the market can be wrong or not as it is just a matter of semantics. What does matter however, is that the pricing can have a massive discrepancy to the underlying intrinsic value of the asset. Traders and investors should be aware that prices are not always as they seem. Whilst they are accurate most of the time there are instances where they can be incorrect, and traders and investors should be aware of this.




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Disclaimer: Articles are from GO Markets analysts and contributors and are based on their independent analysis or personal experiences. Views, opinions or trading styles expressed are their own, and should not be taken as either representative of or shared by GO Markets. Advice, if any, is of a ‘general’ nature and not based on your personal objectives, financial situation or needs. Consider how appropriate the advice, if any, is to your objectives, financial situation and needs, before acting on the advice. If the advice relates to acquiring a particular financial product, you should obtain and consider the Product Disclosure Statement (PDS) and Financial Services Guide (FSG) for that product before making any decisions.