No. of Recommendations: 20
When puzzling about the market, I often think back to Keynes 1935 observations. CoPilot AI provides this nice summation:
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In Chapter 12 of his book, Keynes introduced the concept of the Keynesian beauty contest. He described an imaginary newspaper contest where participants are asked to choose the six most attractive faces from a hundred photographs.
The twist is that the prize goes to those who pick the faces that most participants would find beautiful, not necessarily the ones they personally find most attractive.
Investment Analogy:
Keynes believed that investors in the stock market behave similarly to participants in this beauty contest.
Instead of choosing stocks based on their fundamental value or personal preferences, investors try to predict what other investors will choose. The goal is not to pick the stocks they think are best but to anticipate what the average opinion of other investors will be.
Higher-Order Thinking:
Keynes went further, suggesting that this process can extend to higher-order reasoning. Investors may not only consider what they think others believe but also what others believe others believe, and so on. It becomes a complex game of predicting market behavior based on the reasoning of other rational agents1.
Implications for Investing:
In financial markets, this means that stock prices are influenced not only by fundamental value but also by collective expectations. Investors may buy stocks not because they believe in their intrinsic worth but because they expect others to buy them, driving up prices.
The market becomes a self-referential system where perception matters more than reality.
In summary, the Keynesian beauty contest analogy highlights the importance of understanding investor psychology, market sentiment, and the impact of collective expectations on stock prices.
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Over the years, unfortunately, I've learned that I'm poor at picking beauty contests. But often that's the only explanation of what's happening.
