Why might the efficient market hypothesis be less likely to hold when fundamentalssuggest stocks should be at a lower level?

The Efficient Market Hypothesis (EMH) is a theory that suggests that financial markets are always perfectly efficient, meaning that it is impossible to consistently achieve higher than average returns because stock prices already incorporate and reflect all relevant information. However, there are several reasons why the EMH might be less likely to hold when fundamentals suggest stocks should be at a lower level:

1. Investor Irrationality: The EMH assumes that all investors are rational and always make optimal decisions based on available information. However, in reality, investors can be influenced by cognitive biases and emotions, leading to irrational decisions. For example, during a market bubble, investors may continue to buy overpriced stocks due to greed or FOMO (Fear of Missing Out), even when fundamentals suggest that these stocks are overvalued.

2. Market Manipulation: The EMH assumes that markets are free from manipulation. However, in reality, large investors or institutions can sometimes manipulate stock prices through high-volume trading or spreading false information, causing stock prices to deviate from their fundamental values.

3. Information Asymmetry: The EMH assumes that all relevant information is publicly available and reflected in stock prices. However, in reality, there can be information asymmetry, where some investors have access to private or insider information that is not yet reflected in stock prices. This can cause stock prices to deviate from their fundamental values.

4. Transaction Costs: The EMH assumes that there are no transaction costs. However, in reality, transaction costs (such as brokerage fees) can prevent investors from immediately correcting mispriced stocks, causing stock prices to deviate from their fundamental values.

5. Market Inefficiencies: The EMH assumes that markets are always efficient. However, in reality, markets can sometimes be inefficient due to various factors such as liquidity constraints, regulatory restrictions, and technological limitations. These market inefficiencies can cause stock prices to deviate from their fundamental values.

In conclusion, while the EMH provides a useful theoretical framework for understanding financial markets, it may not always hold in reality, especially when fundamentals suggest that stocks should be at a lower level.