The Factors that Affect Expectations

Below are some of the factors which accentuate this precariousness.

1. The gradual increase in the share of persons who do not manage and have no special knowledge of the business.

This leads to a serious decline in the real knowledge in the valuation of investments by their owners or potential owners.

2. Day-to-day fluctuations in the profits of existing investments tend to excessively and absurdly influence the market

These fluctuations are obviously of an ephemeral and non-significant character.

For example:

• the shares of American companies which manufacture ice tend to sell at a higher price in summer when their profits are seasonally high than in winter when no one wants ice.
• the recurrence of a bank-holiday may raise the market valuation of the British railway system by several million pounds.

3. A conventional valuation which is established ignorant mass psychology can change violently as the result of a sudden fluctuation of opinion due to factors which do not really make much difference to the prospective yield.

This is because there will be no strong roots of conviction to hold it steady.

In abnormal times, the hypothesis of an indefinite continuance of the existing state of affairs is less plausible than usual even if there are no express grounds to anticipate a definite change.

In such times, the market will be subject to waves of optimistic and pessimistic sentiment, which are legitimate where no solid basis exists for a reasonable calculation.

But there is one feature in particular which deserves our attention.

People think that the competition between expert investors would correct the vagaries of the ignorant individual investor.

But these professional investors and speculators are mainly occupied otherwise.

This is because they are largely concerned with foreseeing changes in the conventional basis of valuation a short time ahead of the general public.

They are not concerned with making superior long-term forecasts of the probable yield of an investment over its whole life.

They are concerned not with the real worth of an investment “for keeps”, but with what the market will value it at, under the influence of mass psychology, 3-12 months from now.

This behaviour is an inevitable result of an investment market organised along the lines described.

It doesn’t make sense to pay 25 for an investment which will have a prospective yield of only 30 if you also believe that the market will value it at 20 three months hence.

Thus, the professional investor is forced to concern himself with the anticipation of impending changes most influenced by mass psychology.

This is the inevitable result of investment markets organised with a view to so-called “liquidity”. *

Of the maxims of orthodox finance, the fetish of liquidity is the most anti-social.

It is the doctrine that it is good for investment institutions to concentrate their resources on the holding of “liquid” securities.

It forgets that there is no such thing as liquidity of investment for the community as a whole.

The social object of skilled investment should be to defeat the dark forces of time and ignorance* which envelop our future.

The actual, private object of the most skilled investment today is to:

• outwit the crowd
• pass the bad or depreciating half-crown to the other fellow.

This battle of wits to anticipate the basis of conventional valuation a few months from now, instead of the prospective yield of an investment over many years:

• can be played by professionals amongst themselves
• does not require anyone to keep his simple faith in the conventional basis of valuation having any genuine long-term validity.

It is a game of Snap, of Old Maid, of Musical Chairs.

It is a pastime the winner:

• says Snap neither too soon nor too late
• passes the Old Maid to his neighbour before the game is over
• secures a chair for himself when the music stops

These games can be played with zest and enjoyment. Though all the players know that:

• it is the Old Maid which is circulating
• when the music stops some of the players will find themselves unseated.

Professional investment may be likened to those newspaper competitions where the competitors have to pick out the 6 prettiest faces from 100 photographs.

The winner being the one whose choice most nearly corresponds to the average preferences of the competitors as a whole.

In this way, each competitor picks, not those faces which he himself finds prettiest, but those which he thinks likeliest to catch the fancy of the other competitors. All of them are looking at the problem from the same point of view.