NOTE: Every week or two I write a Client Note for my clients. For a limited time, I am allowing non-clients to sign up and receive it at the same time as my clients. You can sign up at the top right hand corner of the website. I will also be posting the notes on my blog with a time delay from time to time.
Originally sent to clients March 20.
When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done.
– John Maynard Keynes, The General Theory of Employment, Interest and Money
, Chapter 12
In Chapter 12 section 5 of his The General Theory, Keynes penned one of the best critiques of Wall Street ever written. Given the current market environment, I think this is an excellent time to review his arguments.
Wall Street does a poor job valuing investments for a number of reasons Keynes argued. First, the level of fundamental knowledge among professional investors is low. With so many stocks in the investment universe, it is rare for a professional investor to know many in any great depth. In contrast to a business owner who knows every detail of his business, most professional investors have a superficial knowledge of a large number of stocks.
Second, Wall Street is incorrigibly short term oriented: “day-to-day fluctuations….. have an altogether excessive, and even an absurd, influence on the market.”
Third, valuations determined by an ignorant and short term oriented crowd are subject to mass psychology. Since conviction lacks strong roots, “the market will be subject to waves of optimistic and pessimistic sentiment, which are unreasoning….”
This is even more true now with many investors having sworn off fundamental analysis and trading on the basis of technical analysis only. These traders are primarily trend followers, buying or selling based not on any fundamental or economic analysis but on the trend of the market itself. This significant market constituency accentuates market swings in both directions.
Fourth, the market is dominated by professional investors judged by a fickle clientele over short periods of time. As a result, professional investors don’t have the luxury of waiting for an out of favor investment or thesis to come to fruition. They have to perform now or they will lose their clients: “They are concerned, not with what an investment is really worth to a man who buys it ‘for keeps’, but with what the market will value it at, under the influence of mass psychology, three months or a year hence.”*
Fifth, I would add that the market suffers from a bullish bias. Since the great 1982-2000 bull market, professional investors have been conditioned that every selloff is a buying opportunity because at some point the market always recovers and makes new highs. It was during this period that Stocks For The Long Run and buy and hold became the conventional wisdom.
The market’s incredible resiliency is to a large extent the result of an obsequious government that can be counted on for bailouts and stimulus in the event of any stormy weather. The decisive event in this context may be Alan Greenspan’s Federal Reserve Statement before the market opened on the morning of Tuesday October 20, 1987 – the day after Black Monday – which read: “The Federal Reserve, consistent with its responsibilities as the Nation’s central bank, affirmed today its readiness to serve as a source of liquidity to support the economic and financial system.” From that point on, the great bull market never looked back. Bernanke has done everything possible to maintain confidence in The Greenspan Put.
* Keynes notes only that this is how professionals actually invest. The sociological explanation is mine.
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