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 :::::::::: OVERVIEW ::::::::::
   

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          In his General Theory (1936) John Maynard Keynes offered a description of investor behavior that many, including Nobel laureate James Tobin, deem to be one of the most incisive commentaries on the stock market ever written. Meanwhile Bertrand Russell, considered by many to be the greatest logician since Aristotle, once observed, “Maynard Keynes' intellect was the sharpest and clearest that I have ever known. When I argued with him, I felt that I took my life in my hands, and I seldom emerged without feeling something of a fool.”  

         Here, then, are a few remarks from Keynes' remarkable essay that address the consequences of investors’ woefully inadequate forecasting ability:  

A conventional valuation which is established as the outcome of mass psychology...is liable to 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, since there will be no strong roots of conviction to hold it steady. The market will be subject to waves of optimistic and pessimistic sentiment, which are unreasoning and yet in a sense legitimate where no solid basis exists for a reasonable calculation.  Investment based on genuine long-term expectation is so difficult today as to be scarcely practicable.

          If Russell and Tobin are correct in their assessment of Keynes intellect (and Keynes’ in turn is right about the market) then Modern Capital Market Theory (MPT, EMH and the CAPM) is mistaken about many things.

          Thus, if the Efficient Market/Random Walk Hypothesis appears to be valid, it may simply be because short-term security price changes are set hundreds of times each day under the chaotic conditions that Keynes was describing.            

           Likewise, while it may be possible to prove theoretically that “properly anticipated” security prices fluctuate randomly” it only requires a few years experience to realize that improperly anticipated prices can fluctuate randomly too.  

          Moreover, the Capital Asset Pricing Model assumes everyone strives to earn superior returns in the manner that Markowitz prescribed in Modern Portfolio Theory. In an efficient market (which the CAPM also embraces) this causes stock returns to be proportional to the risks they embody relative to an efficiently (“correctly”) priced market index.   

          In such a dream world, it is unnecessary for anyone in particular to practice security analysis or to behave as Markowitz admonished them to. With the CAPM’s cannons squarely turned on fundamental security analysis, moreover, all an investor needs to do is select stocks (or portfolios) that reflect his tolerance for risk. Moreover, we are left with the paradox that an ordinary chimpanzee tossing 30 darts at the stock pages cannot be beaten (for the coming year, say) by the best trained and/or most highly paid professional manager who also selects 30 stocks.

          Finally, if the chimp owned a brokerage firm and did not have to pay trading commissions (or if he chose to buy the 30 stock DJIA index fund) he would actually beat the professional. Needless to say, this metaphor assumes that the portfolio returns of all contestants would be risk-adjusted according to CAPM’s tried-and-suspect scientific methods. Such, then, are the type of investment conundrums we will address in the sections that follow.

 

  
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