If markets were 100% efficient there would not be any trading. When new information was made available to the market, everybody would simply adjust their price expectations. Since trading happens, markets are not efficient.
The efficient market hypothesis can, therefore, easily be shown to be wrong. Yet it is still a good approximation which makes portfolio theory sufficiently mathematically tractable to write papers about it and win Nobel prizes, say.
Insofar efficient market theory is a close approximation of reality, the best trading strategy is not to trade at all (see paragraph 1). However, the more popular this becomes, the more difficult it becomes to estimate asset prices. Buy&Hold on a large scale, therefore, makes asset prices more volatile.
The more popular buy&hold becomes, the closer index returns will be to GDP growth, that is, around 3% in real growth. Any growth beyond this is rightfully attributed to investing becoming more popular, hence it is only possible to get the historic 10% returns, if you are actually part of the history where fewer people were equity investors.
When everybody becomes equity investors as part of their retirement strategy, buying and selling will not depend on whether business conditions are good (the prioritizing based on the individual merits of a business having already been destroyed by blindly investing in indexing) but on whether people are retiring(*). Hence, if large numbers of people are retiring, expect the markets to drop. If large numbers of people are entering the work force, expect the markets to rise. It would seem that retiring baby boomers can keep markets depressed for quite some time.
(*) This attitude is dangerous towards business conditions. Hopefully, professionals will keep trying to reward good companies insofar that they have the money to do so with more money being invested solely based on the stock price or current capitalization.
Originally posted 2009-11-02 07:17:13.