December’s real-time test of market efficiency.

We have this month both a test of and an immediate HBS case study in market efficiency. A highly innovative electronic vehicle company is about to enter the major market index. Is that a problem for the many investors in the index funds and ETFs based on the S&P 500 Index, or are things as they should be in an efficient market?

Market efficiency is presumed to be greatest in large-cap, liquid, well-researched companies. The EV company clears all three thresholds easily, with a market cap of over a half trillion (!) dollars, plenty of trading volume, and 36 separate brokerage firms providing research and recommendations on the stock.

So what’s the problem? Well, the stock of said company trades with a forward (2021) GAAP P/E of 221 times. Non-GAAP forward P/E is a mere 163. The market multiples are, well, a matter of debate but somewhere in the 20s. The new company will come in at a 1% weight—one of the largest in the total index—and, alas, no dividend. The market’s already low yield will fall by roughly another 1.6 basis points.

While some index funds and ETFs may have found a way to buy ahead of the newcomer’s most recent spike in price, index fund managers and investors are still going to pay up for the privilege of having this fancy in their products and portfolios. According to an orthodox interpretation of the EMH, that is no mispricing. Such highly focused and liquid assets are “correctly priced” based on what the community of investors knows at the time. So we’ll see. Stay tuned.