Way back in 1925, John Maynard Keynes provided a wonderful insight on the role of speculation in shaping stock returns. Observing the predilection of investors to implicitly assume that the future will resemble the past, Keynes warned: “It is dangerous to apply to the future inductive arguments based on past experience unless we can distinguish the broad reasons for what it [the past] was.” A decade later, in 1936, in his classic The General Theory of Employment, Interest, and Money, Keynes focused on the two broad reasons that explain the returns on stocks. The first was what he called enterprise—“forecasting the prospective yield of an asset over its entire life.”1 The second was speculation—“forecasting the psychology of the market.” Together, it is these two factors that explain “The State of Long-Term Expectation” for stocks, the title of Chapter 12 of The General Theory. From his vantage point in London, Keynes observed that “in one of the greatest investment markets in the world, namely, New York, the influence of speculation is enormous . . . It is rare for an American to ‘invest for income,’ and he will not readily purchase an investment except in the hope of capital appreciation. This is only another way of saying that he is attaching his hopes to a favorable change in the conventional basis of valuation, i.e., that he is a speculator.” Today, 75 years after Keynes wrote those words, the same counterproductive situation prevails, only far more powerfully.
Lord Keynes’s confidence that speculation would crowd out enterprise came at a time when individual investors dominated stock ownership. Since “the crowd” was largely ignorant of business operations and valuations, Keynes argued, excessive—even absurd—short-term market fluctuations would occur, reflecting events of an ephemeral and insignificant character. Short-term fluctuations in the earnings of existing investments, he correctly argued, would lead to unreasoning waves of optimistic and pessimistic sentiment. Competition between expert professionals, possessing judgment and knowledge beyond that of the average private investor, Keynes added, should correct the vagaries caused by ignorant individuals. But he expected such competition to do the reverse. The energies and skill of the professional investor would come to be largely concerned, not with making superior long-term forecasts of the probable yield of an investment over its whole life, but with foreseeing changes in the conventional basis of valuation a short time ahead of the general public. Keynes described the market as “a battle of wits to anticipate the basis of conventional valuation a few months hence rather than the prospective yield of an investment over a long term of years.”
Source : marketstechno
Please follow and like us: