Before you start to think this all sounds too far-fetched, let’s connect some of these concepts back to one of the most famous descriptions of the market: a beauty contest.
The Keynesian beauty contest is the view that much of investment is driven by expectations about what other investors think, rather than expectations about the fundamental profitability of a particular investment. John Maynard Keynes, the most influential economist of the 20th century, believed that investment is volatile because investment is determined by the herd-like “animal spirits” of investors. Keynes observed that investment strategies resembled a contest in a London newspaper of his day that featured pictures of a hundred or so young women. The winner of the contest was the newspaper reader who submitted a list of the top five women that most clearly matched the consensus of all other contest entries. A naïve strategy for an entrant would be to rely on his or her own concepts of beauty to establish rankings. Consequently, each contest entrant would try to second guess the other entrants’ reactions, and then sophisticated entrants would attempt to second guess the other entrants’ second guessing. And so on. Instead of judging the beauty of people, substitute alternative investments. Each potential entrant (investor) now ignores fundamental value (i.e., expected profitability based on expected revenues and costs), instead trying to predict “what the market will do.” [eg, news, charts, etc.] The results are (a) that investment is extremely volatile because fundamental value becomes irrelevant, and (b) that the most successful investors are either lucky or masters at understanding mob psychology
Sci-Finance: The Great Cybernetic Experiment, Part 2
Peak Prosperity: Daily Digest 1/5
