The assumptions under the efficient market hypothesis ultimately relies on "rational" behaviour. The economic events of 2007 have increased the exposure of behavioural economics and many other groups (such as the austrian school of economics) which have argued for a long time that humans in general can be "irrational" or only partly "rational".

People can tend to be over confident, overzealous and inadequately informed and can drive stock prices to insane levels (if the stock is still rising why should I sell? Maybe I should just sit back and coast) and likewise cause them to dive into the abyss (the market is in deep water right now, nobody should purchase anything, its a slaughterhouse!). Hardly coincides with the age old saying of "buy low, sell high".

During the epicenter of the great depression there were numerous opportunities available where the stock price was lower than net current assets per stock (basically the liquidation value was higher than the stock price). As Benjamin Graham once said, the stock market can be a popularity contest at times and rationality can completely vapourise in an instant because lets be honest, humans are emotional.

So is the efficient market hypothesis completely wrong? Probably not. There is a lot of evidence suggesting efficient market behaviour esp in weak and semi strong form, but likewise there are a lot of empirical and theoretical evidence to dispute this claim. Generally however I think there are some inefficiencies in the market where mispriced securities can remain that way for relatively long periods of time.

In response to kahmeng: Like you mentioned there is no clear cut answer, we must remember that whatever market efficiency/inefficiency one believes in there are copious amounts of evidence to dispute/support it.

For example: weak form efficiency argues that there is no autocorrelation in stock prices however some "technical analysts" have performed relatively well in the medium term consistently which testifies the existence of seasonal trends. However the majority of empirical evidence argues against the effectiveness of technical analysis.

A lot of value investors (warren buffet being an easy example) have shown to amass great levels of wealth by consistently beating the market over the long term which disputes the semi-strong form EMH.

I think we can all agree that the conditions of strong form efficiency are a bit ludacris and best left for the textbook.

To quote: Harvard financial economist Michael Jensen writes “there is no other proposition in economics which has more solid empirical evidence supporting it than the Efficient Market Hypothesis,” while investment guru Peter Lynch (another Graham inspired value investor) claims “Efficient markets? That’s a bunch of junk, crazy stuff”.

Personally I believe is market is either weak form efficient or inefficient. Inefficiencies and mispricings in the short run are sometimes unseen for quite some periods of time (because its easy to understand price but hard to recognize value) and there's always a worrying level of respect for the market (common to believe in the fair pricing of assets) when over/under reactions are never in the realm of impossible.

If stock prices were simply the result of the total sum of all information about the companies and their stocks, then stock bubbles shouldn’t happen but they do happen.

In response to James Hayden: In a semi-strong efficient market the public's valuation of the intrinsic value is exactly equal to market price. Assuming the 14k figure is settled and in equilibrium then I think investors would be indifferent in buying or selling more shares, all positions would be on hold until more "news" is announced. Basically it is arguing that more than half of the market's intrinsic value evaporated during the period.

Refer you guys to a book on this:

Lo and MacKinlay (1999): http://press.princeton.edu/chapters/i6558.html

Read the chapter 1, which is also on the website.

Lets answer this in the semi-strong from context which is arguably the most relevant to the case presented. The answer to the question really depends on the information set publicly available to investors (or what you are ready to believe is). If the information set as at October 9 2007 supports the 14,165 points valuation and that information set changes such that it supports the 6,457 point level on March 9 2009, then it is certainly safe to presume that markets are semi-strong form efficient. If, however, the information set as at October 9 2007 actually points to a much lower valuation then the market is obviously inefficient.

In short, the answer to the question is really dependent on what you are ready to believe is the information that is available to the public and what valuation level it supports. And as all things finance, there is no clear cut answer.