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At this point, the efficient markets hypothesis makes for an easy rhetorical target. Precious few economists and financial professionals are willing to stand up in public anymore and assert that financial markets produce the best estimate of fundamental asset values. A series of enormous bubbles, plus decades of outsized profits for hedge funds like Renaissance Technologies, has turned the efficient markets hypothesis (EMH) into a bit of a joke.

Meanwhile, finding ways to beat the market has become a parlor game in the world of financial economics. Hundreds of papers have been published claiming to have found new ways to predict returns. Defenders of the EMH counter that many of these so-called “anomalies” are probably false alarms, much of it due to what’s known as publication bias. As economists Campbell Harvey, Yan Liu and Caroline Zhu pointed out in a famous 2013 paper, the statistical hurdles that researchers demand that anomalies pass are probably not high enough. That leads to a sort of “monkeys on typewriters” effect -- if enough finance professors sift through the data for long enough, they’ll find a bunch of apparent EMH violations that are exciting enough to get published, but which evaporate upon further scrutiny. That concern seems to be supported by the fact that most anomalies disappear over time.

This finding allows efficient market theory’s defenders to raise the suspicion that most of the violations of their theory are fake. But this proves to be only a small respite. First of all, just because anomalies are fleeting doesn’t mean they weren’t real to begin with. A recent paper by David McLean and Jeffrey Pontiff found that anomalies often hold up even after they’re discovered, but then disappear only after finance professors publish papers about them. That implies that market flaws are real, but traders learn about them by reading academic papers, then trade against the mispricings until they fade. A follow-up paper by Heiko Jacobs and Sebastian Muller found that in most countries, markets are even less efficient than in the U.S. and the anomalies discovered by finance professors persist for a much longer time.

Now Andrew Chen and Tom Zimmermann have a paper claiming that publication bias is much more subdued than previously believed. They reason that if an anomaly comes from data mining, it will probably just barely be statistically significant. But many anomalies show up with extremely strong signals in the data -- much stronger than would be required to claim significance. That implies that many are real, and can be used to beat the market -- at least, until enough traders catch on that the mispricing gets traded away.

Efficient market theory’s defenders have a second tactic to deal with challenges. If an anomaly survives scrutiny and replication, and persists for a long time, the EMH’s remaining adherents will generally try to classify it as a “risk factor,” claiming that the extra return compensates investors for taking extra risk that can’t be diversified away. For some economists, it’s almost an article of faith that changes in the prices of stocks come from changes in investors’ risk preferences, rather than from swings of irrational sentiment or the market’s failure to take important information into account. Eugene Fama, who won the Nobel Prize for his formulation of the EMH, has by now expanded his preferred set of “risk factors” to five, while others identify many more.

A new paper by business school professors Lars Lochstoer and Paul Tetlock investigates whether risk-based stories hold up. The researchers develop a new statistical procedure for separating changes in a company’s expected cash flows from changes in investors’ risk preferences, combining information about differences between companies at a given point in time with information about changes in stock values over long periods of time. They find that most of the excess returns that investors can get from factor investing -- or, if you prefer, from trading against anomalies -- come not from changes in risk preferences, but from changes in the long-term path of companies’ cash flows. Furthermore, they find that when overall risk tolerance in the market goes up, tolerance to the specific risks represented by the popular risk factors tends to go down, a strange phenomenon for which there’s no explanation as yet.

Lochstoer and Tetlock’s result implies that anomalies probably don’t come from variations in investors’ preferences. That doesn’t prove that risk isn’t the culprit -- a company that suffers some change that causes it to make less money over the long term also probably becomes riskier. But the authors’ evidence is also consistent with another story -- the idea that when a stock does badly, investors irrationally expect it to keep doing badly.

In other words, efficient markets theory isn’t dead yet. There are still loopholes its defenders can thread, that allow them to claim that nobody really beats the market, and that all excess returns are just compensation for taking on extra risk. But as more anomalies persist, and more risk-based theories are found wanting, the window for the EMH grows smaller and smaller.

Eventually, it seems likely that a new consensus will replace the EMH -- that the market is a complex ecosystem of hundreds or thousands of imperfections, offering clever investors plenty of opportunities to make money in the short term, but that these mispricings are constantly shifting, appearing and disappearing as investors chase them and trade them away.

--Noah Smith is a Bloomberg View columnist.

This is the Globe Investor newsletter, published three times each week. If someone has forwarded this e-mail newsletter to you, you can sign up for Globe Investor and all Globe newsletters here.

Stocks to ponder

TransCanada Corp. (TRP-T). Pipeline stocks might seem like the last place investors should be parking new money, with the combination of rising bond yields and growing environmental and political opposition posing major challenges to the industry. TransCanada’s dividend yield, which moves in the opposite direction to its price, is now at about 5 per cent. John Heinzl considers that attractive, given that the company – which has raised its dividend for 18 consecutive years – is aiming to continue growing its payout at an annualized rate of 8 per cent to 10 per cent through 2021, supported by about $23-billion of small- and medium-sized projects. John Heinzl explains why he is adding more TransCanada to his Yield Hog Dividend Growth Portfolio.

FairFax Financial Holdings Ltd. (FFH-T). After Toronto-based Fairfax Financial Holdings Ltd. prevailed with its $300-million bid for the Canadian subsidiary of Toys “R” Us Ltd. on Monday, you may have wondered if this was a deal to applaud or question. Welcome to Fairfax, a property- and casualty-insurance holding company that is better known for its substantial investment portfolio − and its head-scratching bets. David Berman reports (for subscribers).

The Rundown

Where to hide amid rising bond yields

Investors always obsess over whatever number is supposed to hold the key to the market’s future. Right now, that magic figure is the yield on the 10-year U.S. Treasury bond. For the first time in four years, the payoff from the benchmark bond ticked over 3 per cent on Tuesday. Its climb may portend a shift in investor psychology, one that could endanger this long-running bull market. Ian McGugan reports (for subscribers).

This index suggests things are about to get real nasty for U.S. stocks

For investors worried that equity markets have been supported by overzealous monetary stimulus, and are set for sharp declines as central banks remove the punch bowl, there’s an index for that. What’s more, and even though there are significant caveats, this index suggests a significant correction ahead for the S&P 500. The Federal Reserve Bank of Chicago’s National Financial Conditions Index attempts to measure the state of credit markets, including the ease with which corporations and investors have access to funds, with a weighted gauge of 105 indicators grouped in to three categories: risk, credit and leverage. Scott Barlow reports (for subscribers).

Why this week’s bump in interest rates is so concerning

Well, it finally happened. After all the watching and waiting, the yield on the 10-year T-note has broken above 3 per cent and is now heading into overshoot terrain, notes economist David Rosenberg. The problem for the equity market is that this is not about rates rising because the economy is doing so well. This last leg up in bond yields since mid-March has been driven by inflation expectations, not by real rates, and that is a problem for the stock market since the latter would at least symbolize rising real economic growth. Only the most obtuse cannot see we are into a mild form of stagflation, and this is very rarely beneficial for financial assets writ large. Read Rosenberg’s view (for subscribers).

As rates rise, these are some of the best bond funds to consider

Gordon Pape takes a look at some solidly performing bond funds that are worth a look. The options include First Asset Investment Grade Bond ETF and PIMCO Monthly Income Fund. (for subscribers).

Top options for RRSP investors who want to hold cash

The average one-year return for Canadian money market funds is 0.4 per cent, which means you’re losing money on an after-inflation basis if you use this old favourite of a parking spot for cash. But there are better alternatives such as an investment savings account for your Registered Retirement Savings Plan. Rob Carrick explains (for subscribers).

Innovation ETFs seek to sate investor appetite for the next big thing

Investment funds tracking companies described as innovative and disruptive are attracting dollars both in the United States and Canada, but investors need to check out what’s under the hood, as these products can include a broad range of companies. Evolve ETFs is set to begin trading the Evolve Innovation Index ETF on the Toronto Stock Exchange on May 2. Under the ticker EDGE and with a 0.40-per-cent management fee, the ETF will give Canadian investors access to a portfolio of global companies involved in six main categories: big data and cloud computing, robotics and automation, genomics, future cars, cybersecurity and social media. Clare O’Hara reports.

Top Links (for subscribers)

Caterpillar’s ‘high water mark’ is what investors were warned about

‘Mission accomplished for OPEC’ as global oil industry [ex-Canada] enjoys boom

Others (for subscribers)

Thursday’s analyst upgrades and downgrades

Thursday’s Insider Report: Companies insiders are buying and selling

Wednesday’s Insider Report: Companies insiders are buying and selling

Wednesday’s analyst upgrades and downgrades

Others (for everyone)

TSX earnings scorecard: How first-quarter results have fared so far

Bears to lose steam with Canada yields at 7-year high

Forget Caterpillar freakout, S&P 500 profit picture looks rosy

Twitter is no longer a disaster, but don’t celebrate yet

Bond bears rule as U.S. treasuries breaking above 3% find little love

U.S. energy shares outperform as companies begin to report

Peak or pause? Global economy’s hesitation unnerves markets

Number Crunchers (for subscribers)

A portfolio of stocks built on steady earnings, Street revisions

Ask Globe Investor

Question: I have some U.S. dollars in a money market fund in an RRSP and a RRIF. Does it make good investing sense to purchase interlisted Canadian stocks, such as Pembina Pipeline or Canadian National, on the New York exchange? My reason for wanting to do this is because I don’t have any Canadian cash available in these accounts and I want to increase my holdings of Canadian blue chips. Will this strategy still give me currency gains if the Canadian dollar falls? Thanks very much for your past (and present) advice.

Answer: All transactions in an RRSP or RRIF are valued in Canadian dollars, regardless of the currency of the investment or the market where purchased.

For greater certainty, I put this question to a broker. Here is his reply.

“Many people have a USD side of their accounts as well as a CAD side. To answer the question, let’s look at the shares of RBC (RY-T, RY-N). As of the time of writing, RY on the TSX was trading at $99.80 and is down 2.7 per cent year to date. RY bought on the NYSE was trading at US$76.96 and is down 5.7 per cent for the year. The extra 3-per-cent drop reflects the Canadian dollar decline versus the U.S. dollar.

“The value of the RY shares in the RRSP and RRIF are the same – as expressed in Canadian dollars. The dividend is the same in both situations.

“The only advantage the reader has is avoidance of foreign exchange costs. The disadvantage is the increased complexity of understanding a stock’s performance relative to the currency of reference (i.e. Canadian dollars).”

--Gordon Pape

Do you have a question for Globe Investor? Send it our way via this form. Questions and answers will be edited for length.

What’s up in the days ahead

Get ready: The Report on Business Magazine Friday is out with the Top 1000 stocks annual edition. It provides a bevy of facts and figures on each company and includes a star system that ranks the largest firms on their attractiveness as potential investments. A select group of 20 stocks with the best prospects make it to the very top and into this year’s megastar team. Last year, the megastar team produced returns of more than 16 per cent, easily beating the TSX Composite.

Click here to see the Globe Investor earnings and economic news calendar.

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