Overwhelmed by Noise
Cliff Asness on the Less-Efficient-Market Hypothesis, the impact of Inelastic Markets, and why it pays to be a Shark.
Spend anytime in the financial markets and a standard narrative of market efficiency emerges - it goes something like this:
As technology advances, information becomes ubiquitous. As information travels faster, it is incorporated into prices more quickly. Therefore, over time, markets must become more efficient.
The logic is seductive. In 1990, a research report might have traveled by physical mail. Today, an earnings release instantly hits a terminal in New York, a server in London, and a smartphone in Tokyo simultaneously. Costs have collapsed. Spreads have tightened. Friction has been eliminated.
But what if the narrative is wrong? What if the very tools we assumed would perfect the weighing machine have instead broken the scale?
We often assume that the market is a collective intelligence—a wisdom of crowds that compensates individual errors. However Clifford Asness of AQR Capital Management suggests that this collective intelligence is suffering from a cognitive degeneration.
He calls it the “Less-Efficient-Market Hypothesis” (LEMH).
It posits that despite our supercomputers and our fiber-optic cables, the stock market has become worse at its primary job: assigning accurate prices to businesses. For the long-term compounder, this is not just an academic curiosity. It is a fundamental shift in how we think about the landscape of risk and reward.
Speed is Not Truth
To understand Asness’s point, we must first decouple two concepts that are often conflated: operational efficiency and informational efficiency.
Operational efficiency is about speed and cost. On this front, we have achieved miracles. You can trade for free, instantly, from your pocket. The rails of the financial system are near frictionless.
But informational efficiency is about truth. It is the market’s ability to digest information and calculate a rational price that reflects the discounted value of future cash flows. Asness argues that while the market has become faster, it has also become less accurate. Said another way, we have a market that can execute a mistake in a nanosecond.
The core of the LEMH is that the noise in the system is overwhelming the signal. The mechanism of arbitrage—where rational investors (the sharks) correct the errors of emotional investors (the minnows)—is being jammed.
The Four Horsemen of Inefficiency
Why is it jamming? Asness proposes four drivers, with one standing out as the primary villain.
1. The Indexing Singularity
The first suspect is the rise of passive investing. For decades investors have been told that they likely cannot beat the market and should just buy the index.
…what if everyone invested only in the capitalization-weighted index?” Nobody has a great answer to this. It’s kind of the finance equivalent of a singularity. How can prices be set if nobody is actually looking at anything?
Markets rely on active, informed traders to set prices. Capitalization weighted index funds are “price takers”—they buy more of a position as it gets bigger (higher capitalization). Further, as the sharks (active managers) leave the pool - either because they are allocated less capital, or they closet index themselves - to become indexers, the minnows (emotional traders) are left to set the prices. Think about Michael Burry closing down his fund at the end of 2025 - there’s one less shark to hunt the minnows.
Recent academic work on the Inelastic Markets Hypothesis suggests that as active capital shrinks - more sits on the market sidelines in passive funds that in aggregate don’t do any trading - prices become more volatile. A small amount of buying or selling pressure can then dramatically move prices because there is no one left to take the other side.
The big implication here is that order flow is a primary driver of price fluctuations, challenging the belief that markets are perfectly rational or efficient at all times.
2. Volatility Laundering
As public markets have become a volatile casino, institutional capital has fled to the perceived safety of private markets (Private Equity, Private Credit, Real Estate). He posits it as a consequence of LEMH although it too further contributes to public market inefficiency.
Asness offers a scathing critique of this trend, coining the term “Volatility Laundering.”
In public markets, prices are marked-to-market every second. You see the volatility. You feel the pain. In private markets, assets are often marked quarterly, using models that smooth out the bumps. Is the private asset truly safer? Unlikely. The manager simply hasn’t updated the price tag.
Institutions have begun to view illiquidity not as a risk, but as a benefit. They are paying high fees for the privilege of being lied to about the volatility of their portfolio. They are trading real risk for fake smoothness. Pulling money from public markets contributing further to public market inelasticity.
3. The Distortion of Free Money
The third suspect is the long era of Zero Interest Rate Policy (ZIRP). When the cost of capital is zero, the discipline of valuation evaporates. Investors chase “moonshots” because the hurdle rate is nonexistent. Asness calls this the “going cray-cray” factor.
I don’t think super-low rates are a necessary or certainly sufficient condition for relative value within the stock market to go mad (after all, again, this explanation went one for two, getting 1999–2000 wrong but 2019–2020 right). But it certainly feels like it could be a serious contributing factor among other conditions in making investors lose their minds (a more colloquial definition of a bubble)
However, Asness notes that the 1999 bubble happened when yields were 6%. Low rates are like pouring gasoline on a fire, but they aren’t the spark.
4. The Technologization of Behavioural Bias
This is the most compelling argument, and it strikes at the heart of the human condition.
The “Wisdom of Crowds” works only under one specific condition: Independence. If we ask a thousand people to guess the number of jellybeans in a jar, the average is usually eerily accurate. However it only works if they can’t see each other’s guesses.
If the crowd is not independent—if they are all looking at the same FinTok influencer, the same Reddit wallstreetbets thread, or the same Crypto Discord, - then the errors don’t cancel out. They correlate. They compound.
Social media and gamified trading apps have destroyed independence. They have turned the market into a synchronized mob. Platforms are designed to amplify extreme views because outrage and euphoria drive engagement.
Instantaneous, gamified, cheap, 24-hour now including “one-day funds” (Greifeld 2024)56 on your smartphone after getting all your biases reinforced by exhortations on social media from randos and grifters with vaguely not-safe-for-work (NSFW) pseudonyms filtered and delivered to you by those companies’ algorithms that famously push people to further and further extremes. What could possibly go wrong?
Technology hasn’t made us smarter - it has caused us to outsource our critical thinking, created echo-chambers for pre-existing beliefs, and has made biases more contagious. It has weaponized our worst human instincts.
Overwhelmed by the Noise
If the market were efficient, the gap between the valuation of “cheap” stocks (value) and “expensive” stocks (growth) should stay within a reasonable band. Sure, growth companies should trade at a premium, but that premium should be tethered to economic reality.
For forty years (1950–1990), this was largely true. The “Value Spread” was mean-reverting. When the rubber band stretched too far, arbitrageurs stepped in, sold the expensive stuff, bought the cheap stuff, and snapped the market back to sanity.
Then came the Dot-com bubble of 1999-2000. We all know that story. The rubber band didn’t just stretch; it snapped. The spread between growth and value hit levels that defied mathematics. It was a “three-sigma” event—a statistical impossibility. It was supposed to be a once-in-a-life-time event.
Starting around 2018 and accelerating through the pandemic, the Value Spread blew out again. By some metrics, the dislocation in 2020-2021 exceeded the insanity of the Tech Bubble. And unlike the Dot-com era, which was driven by junk companies with no revenue (Pets.com).
Yes, today’s company is superior to the company from even just ten years ago. However the spreads imply that the expensive companies will outgrow the cheap companies by margins that have never occurred in the history of capitalism. Is this likely? Or, is the weighing machine overwhelmed by all the noise?
The Burden of Conviction
What does this mean for us?
If the LEMH is true, the opportunity for rational, active capital allocation is actually larger than it has been in decades. If the mob is pricing assets emotionally, the potential “alpha” for the disciplined investor is huge.
If prices are inelastic, and there are more minnows, then it pays to be a shark.
But there is a catch. The price of that alpha is pain.
In a less efficient market, asset prices can detach from reality for longer periods. The “insanity” is more durable. Asness updates Keynes’s famous quote:
The market can remain irrational longer than you can keep your clients.
To survive this, you need Implicit Conviction. You cannot rely on a spreadsheet alone.
When you are underperforming for three years because you refuse to buy a bankrupt company trading at 50x sales, you will feel immense social pressure to capitulate.
The “Career Risk” for active managers has never been higher. For individual investors who can capture this Horizon Premium the opportunity has never been higher.
How to Compound in a Broken Market
So, how do we navigate a market that is increasingly a voting machine rather than a weighing machine?
1. Embrace The Pain: We must be willing to hold assets that the mob hates.
2. Reject Volatility Laundering: Embrace the volatility of public markets as the price of liquidity and honesty - if you want high returns, you must endure the drawdowns.
3. Extend Your Time Horizon: The only arbitrage left is Time Arbitrage. The market has become short-term obsessed and structurally impatient.
The Verdict
Cliff Asness’ Less-Efficient-Market Hypothesis strips away the comforting illusion that the market is always right. It reveals a reality where technology has amplified and accelerated human error rather than correcting it.
Market inelasticity creates more volatility, which then increases the chances of emotional decision making.
For the true student of compounding, this is good news. Efficiency is the enemy of opportunity. If the market were perfect, there would be no bargains. The fact that the market is “losing its mind” and that weighing machine is broken means that sanity and rationality are scarce assets. Scarce assets are valuable.
We must be willing to look foolish in the short term to be right in the long term. We must have the conviction to stand apart from the mob when the feed is screaming that we are wrong.
We assumed technology would clarify the signal of the weighing machine. Instead, it has amplified the noise of the voting machine. Let the minnows chase the short term thrill of the noise. The shark can tune out the deafening static of the mob and find the true signal.
Be a shark - there is more opportunity than ever.
The Pursuit of Compounding 📈
Disclaimer: We are private investors and not financial advisors. This post is for educational purposes only and does not constitute financial advice. Always conduct your own due diligence before making any investment decisions.
This how the weight machine works:
https://open.substack.com/pub/absolutetoal/p/simplified-seven-levels-of-implied?utm_source=share&utm_medium=android&r=5g11d4
For more on this topic, I would recommend Chapter 1 of Daniel Gladiš' book — Hidden Investment Treasures. He makes the compelling case for active investing in a world dominated by passive flows.