Keynes and the Market Part 7

-Keynes to his mother, September 2, 1922 During his interview for a director ' s seat at National Mutual, Keynes ventured the opinion that " the right investment policy for [the Society] would be to hold one security only and change it every week at the board meeting." This rather hyperbolic remark was, no doubt, designed to dislodge the old guard from their stubborn attachment to a pa.s.sive and property - oriented investment style. But although it was an ambit claim - intended to startle the frock - coated gents out of their comfortable complacency - it did re.ect, to a large extent, Keynes ' faith in " focus investing."

However, for all his enthusiasm for a compact portfolio, even Keynes conceded that the principle of concentration " ought not to be carried too far." Keynes accepted that the maintenance of " a balanced investment position " justi.ed a certain degree of diversi.cation within any stock holding. He de. ned a " balanced position " as one in which there were: . . . a variety of risks in spite of individual holdings being large, and if possible opposed risks (e.g. a holding of gold shares amongst other equities, since they are likely to move in opposite directions when there are general . uctuations).

A portfolio of stocks with opposed risk characteristics - to take another example, oil producers and airline companies - will serve to offset, at least in part, the effect of unforeseen and unpredictable shocks to any particular security.

Additionally, investors may obtain some of the bene. ts of diversi.cation, while still maintaining a focused portfolio, by spreading their capital between different a.s.set cla.s.ses - by holding not only stocks but also, for example, investments in property or bonds. Although Keynes ' wealth was particularly concentrated in the stock market - he never owned a house or any other form of real property, and by the time of his death his securities portfolio represented over 90 percent of his total a.s.sets - most other investors display a preference for considerably less reliance on just one a.s.set cla.s.s. " Sell down to your sleeping point," the American .nancier J. Pierpont Morgan reportedly advised a friend whose slumber was being compromised due to worries about his stock portfolio. Similarly, most value investors may elect to adopt a slightly more wide - ranging investment approach than that of Keynes.

Loading Up To suppose that safety - .rst consists in having a small gamble in a large number of different directions . . ., as compared with a substantial stake in a company where one ' s information is adequate, strikes me as a travesty of investment policy.

-Keynes to the Chairman of Provincial Insurance Company, February 6, 1942 Value investment emphasizes the quality of stocks rather than the quant.i.ty of stocks. For those investors who believe they know something of the market, or at least certain sectors within the market, it makes sense to focus on what Keynes called the " ultra - favourites." This handful of stocks - Keynes never prescribed an exact number, Buffett in one communiqu e suggested " .ve to ten sensibly - priced companies " - will absorb the bulk of investible funds. Intelligent investors - because they know the companies they are a.n.a.lyzing and because their comfort levels will need to be high to justify such relatively large outlays - will satisfy themselves, after diligent a.n.a.lysis, that the investment is not too risky.They will not merely cast their money on a wide range of stocks about which they know very little, relying on a belief in the ef.ciency of markets to absolve them from any need to carefully a.n.a.lyze the underlying companies.

Focus investing, then, refers not just to the maintenance of a targeted portfolio of stocks, but also to the limited pool of stocks evaluated (those within an investor ' s " circle of competence " ), and the laser - like intensity with which those stocks are a.s.sessed.The intelligent investor will not re.exively spread his or her funds across the universe of investment opportunities, for, as Keynes noted: To carry one ' s eggs in a great number of baskets, without having time or opportunity to discover how many have holes in the bottom, is the surest way of increasing risk and loss.

Contrary to conventional .nancial wisdom, Keynes argues that a focused portfolio should be less risky than a diversi.ed portfolio, as investors will restrict their a.n.a.lysis to those stocks within their circle of competence and will also demand a wide margin of comfort prior to allocating a substantial proportion of total funds to a single stock.

It is ironic that in the high temple of capitalism,Adam Smith ' s commandment to specialize has been so comprehensively ignored. Dismissing the dogma of diversi.cation, Keynes noted in a letter to the Chairman of the Provincial Insurance Company that: As time goes on I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes. It is a mistake to think that one limits one ' s risk by spreading too much between enterprises about which one knows little and has no reason for special con. dence.

The level of investment risk in respect of a particular stock, Keynes emphasized, was commensurate with the level of ignorance and uncertainty surrounding that security.Value investing inverts the risk - return trade - off suggested in orthodox texts - those stocks offering the greatest apparent margin of safety, and therefore by de.nition the least downside risk, also potentially offer the greatest returns. By " loading up " only in respect of " stunners ," as Keynes suggested, investors should both reduce the riskiness of their portfolio and give themselves the best chance of outperformance relative to the broader market.

Chapter 13

A Sense of Proportion

The Stock Market Stoic Of all existing things some are in our power, and others are not in our power . . . Let him then who wishes to be free not wish for any-thing or avoid anything that depends on others; or else he is bound to be a slave.

-Epictetus, THE HANDBOOK Maynard Keynes granted only conditional a.s.sent to Saint Timothy ' s belief that the love of money was the root of all evil.True, he had lit-tle time for the " strenuous purposeful moneymakers " motivated by " the love of money as a possession," but he also agreed with Samuel Johnson that there are few ways in which a man can be more inno-cently employed than in getting money. Keynes observed in The General Theory that: . . . dangerous human proclivities can be ca.n.a.lized into comparatively harmless channels by the existence of opportunities for money -making and private wealth, which, if they cannot be satis.ed in this

way, may .nd their outlet in cruelty, the reckless pursuit of personal power and authority, and other forms of self - aggrandizement. It is better that a man should tyrannize over his bank balance than over his fellow - citizens . . .

In any case, those touched with " the moneymaking pa.s.sion " were, as Keynes conceded, a necessary evil - it would be in the wake of these men, impelled by their striving after pro.t, that the rest of mankind would be dragged to the promised land of " economic bliss " and mate-rial abundance.

Keynes, in contrast to the energetic wors.h.i.+ppers of Mammon, pro-fessed a much more utilitarian conception of money. As he coolly com-mented to his friend Duncan Grant, who was " very much enraged " to have received mere cash as a birthday gift, " The thing is good as a means and absolutely unimportant in itself." Later, in A Tract on Monetary Reform, he would return to the theme of money as a simple expedient: It is not easy, it seems, for men to apprehend that their money is a mere intermediary, without signi.cance in itself, which . ows from one hand to another, is received and is dispensed, and disappears when its work is done from the sum of a nation ' s wealth.

Moneymaking, Keynes thought, should be accorded its proper place - as an amus.e.m.e.nt, an intellectual game, a means to secure the good things in life.

Keynes ' pragmatic att.i.tude conferred on him a hardy resistance to the a.s.saults of animal spirits, and engendered a more clear - sighted approach to stock market investing. After the false starts of his early investment career, Keynes realized that enduring success in the stock market accrued to those who exploited mob behavior rather than those who partic.i.p.ated in it, and that a businesslike approach to invest-ment decisions was in.nitely preferable to blindly following the crowd. Keynes ' lesson from the 1920s was that .nancial exchanges were inher-ently unpredictable, at least in the short term. Intelligent investors, then, accept that they cannot control the market ' s behavior and instead focus on controlling their own behavior - what is required, as Warren Buffett would later af. rm, is " a sound intellectual framework for making deci-sions and the ability to keep emotions from corroding that framework."

Don ' t Just Do Something, Stand There . . .

Investing should be more like watching paint dry or watching gra.s.s grow. If you want excitement, take $ 800 and go to Las Vegas.

-Paul Samuelson (attributed) Keynes was not unaware of the tribute exacted by stock trading. In one biographical sketch, he described the German representatives at the Paris Peace Conference as a " sad lot . . . with drawn, dejected faces and tired staring eyes, like men who had been hammered on the Stock Exchange." At .rst blush, this seems a curiously inappropriate simile - comparing the representatives of a vanquished nation to victims of a mere . nancial defeat - but the memoir was written in the summer of 1931, in the trough of the Great Depression and with the death of a former student still fresh in Keynes ' mind. Sidney Russell Cooke, a fellow director at National Mutual and a " brilliant and engaging per-sonality " in Keynes ' estimation, took his own life the previous year as a result of losses on the stock exchange. Reversals in the world of money could, as Keynes discovered, claim a heavy toll on those weakened by the contagion of animal spirits.

In the subsequent calm, after he had restored his fortune on the back of value investing principles, Keynes concluded that the intelli-gent investor needed " as much equanimity and patience " as possible to withstand the periodic incursions of animal spirits and the distractions of .uctuating prices. Market liquidity and its concomitant, constant price quotation, is a double - edged sword - it enables investors to easily enter and exit the market, and thereby makes them " much more will-ing to run a risk," as Keynes noted, but minute - by- minute changes in stock prices can also foster a short - term mindset among stock market players. Keynes cautioned that: One must not allow one ' s att.i.tude to securities which have a daily market quotation to be disturbed by this fact or lose one ' s sense of proportion. Some Bursars will buy without a tremor unquoted and unmarketable investments in real estate which, if they had a selling quotation for immediate cash available at each Audit, would turn their hair gray.

The intelligent investor, Keynes a.s.serted, maintains " a sense of pro-portion " by accepting that for sustained periods a stock ' s price may split from its underlying value. The investor is not overwhelmed by constant price quotation, by Mr. Market ' s ceaseless urgings to buy or sell. Rather, the disciplined investor applies his or her own a.n.a.lysis in identifying mispriced stocks and adheres to a long - term time horizon, con.dent that the stock market will eventually revert to its professed role as a machine for crystallizing expected future cash .ows and, ulti-mately, will reward those businesses with a sustainable earnings pro. le. The value investor must, as a colleague noted of Keynes ' own tem-perament, maintain a " robust faith in the ultimate rightness of a policy based on reason and common sense."

Do - It - Yourself For my own part, I can certainly claim to be a Buddhist investor, in the sense of depending wholly on my own meditations.

-Keynes to a fellow stock investor, March 28, 1945 As Ben Graham observed, " Buying a neglected and therefore under-valued issue for pro.t generally proves a protracted and patience - trying experience," and the value investor must resist strong social forces that encourage conformism and a short - term mindset. Not only can con-stant price quotation distract undisciplined investors from the long -term merits of an investment, but stock market partic.i.p.ants must also battle against an inst.i.tutional apparatus geared to high turnover. Brokers and investment managers have a vested interest in promoting active markets, and even orthodox .nancial theory conspires with the specu-lator to a.s.sert the pre - eminence of short - term price movements over long - term income .ow by de. ning " risk " as volatility in prices rather than volatility of earnings.

Value investors are not swayed by these factors. Rather, they rec-ognize that the stock market is there to serve investors, not to instruct them. In the dark days of the early 1930s, after the stock market had suffered another of its sinking spells, Keynes remarked de. antly that: . . . I do not draw from this the conclusion that a responsible investing body should every week cast panic glances over its list of securities to . nd one more victim to .ing to the bears.

Value investors like Keynes rely on their own independent a.n.a.lysis rather than seeking guidance from the crowd.They practice, as Keynes did, " a certain continuity of policy " - a strategy that limits trading activity to those occasions when price departs widely from underlying value.

Stock market prices are only relevant to the value investor as a benchmark against a.s.sessed intrinsic value, to determine whether a suf-.cient margin of safety exists. It is a potential entry or exit point for the investor, but past price patterns should not in.uence the investment decision.As Keynes said: . . . it seems to me to be most important not to be upset out of one ' s permanent holdings by being too attentive to market movements . . . Of course, it would be silly to ignore such things, but one ' s whole tendency is to be too much in.uenced by them.

It is a market truism that in times of crisis money moves from weak hands to strong hands - the disciplined investor must therefore culti-vate, as Charlie Munger advises, a " disposition to own stocks without fretting."

Going for It A nimble sixpence is better than a slow s.h.i.+lling.

-English proverb One of the .rst trading ventures established by Keynes and " Foxy" Falk was the P.R. Finance Company, founded in early 1923 and engaged mainly in commodities speculation. The initials of the company - an allusion to the ancient Greek aphorism Panta rei, ouden menei ( " All things .ow, nothing abides " ) - were perhaps a subtle salute to the mercurial nature of the commodities market. In the stock market, too, all is in a state of . ux - prices jump about and the intrinsic value of a stock alters as conditions affecting the underlying business change. Value investors, therefore, cannot let their professed bias toward a long - term investment horizon acquit them of the duty to always remain vigilant, to be alert to changes in the value of stocks relative to their price.

A philosophy of " being quiet " - of trading only when a substantial gap is identi.ed between a stock ' s intrinsic value and its quoted price - in no way implies a complacent or pa.s.sive investment style. In his role as chairman of National Mutual, Keynes repeatedly emphasized that investors cannot adopt a " set and forget " investment policy: The inactive investor who takes up an obstinate att.i.tude about his holdings and refuses to change his opinion merely because facts and circ.u.mstances have changed is one who in the long run comes to grievous loss.

Value investors must, Keynes a.s.serted, exercise " constant vigilance, con-stant revision of preconceived ideas, constant reaction to changes in the external situation." In stock market investing, he implied, the price of success is eternal vigilance.

The intelligent investor, by focusing only on those stocks within his or her circle of competence, will in fact be far more attuned to s.h.i.+fts in their relative value than market partic.i.p.ants monitoring a much wider universe of securities. And by concentrating on a smaller pool of stocks, the value investor is in a better position to make a judg-ment on the merits of a particular security and act decisively. One observer of Keynes ' methods with the King ' s College Chest Fund noted that: The great point about King ' s has been that when a good opportu nity is pointed out to them, they " go for it." The swiftness of decision which marked their policy is due to Mr. Keynes.

Nicholas Davenport, a fellow board member at National Mutual, agreed that Keynes ' stock market success was due to " beating the other fellow to the gun," adding that " I have never known a man so quick off the mark in the stock exchange race." Value investing, conducted prop-erly, is not unlike Keynes ' beloved cricket - vast longueurs occasionally punctuated by episodes of intense activity.

Debt - Defying Creditors are a superst.i.tious sect, great observers of set days and times.

-Benjamin Franklin, POOR RICHARD'S ALMANACK During the effervescent days of the late 1920s - when Keynes still clung to the tenets of momentum investing, attempting to antic.i.p.ate the antic.i.p.ations of others, .itting in and out of the market - well over half of his investment portfolio was underwritten by borrowings. The idea was that he could leverage his bets on the . nancial exchanges - by borrowing money to speculate on the currency, commodity, and stock markets, Keynes would multiply his capital gains if his hunches were correct. Although he enjoyed intermittent success during these years, Keynes found that - like Irving Fisher, Ben Graham, and millions of others operating on credit during the Great Boom - leverage also works in reverse.

To take an extreme example, an investor buying a security on a 10 percent margin - that is, 90 percent of the purchase price is sup-ported by borrowings - requires just a 10 percent increase in stock price to double his or her money. But with this greater potential reward comes a commensurate increase in risk - a 10 percent decline in price will effectively wipe out all the investor ' s capital contribution. Leverage works when markets are rising but can be catastrophic when they are falling. Margin loans and other forms of credit are an essential adjunct to many speculators ' tool kits - they often work on . ne margins, and borrowing funds allows them to raise the stakes on their stock mar-ket wagers.The power of leverage gives these game players the chance to potentially magnify capital pro. ts, while " market liquidity " confers the illusion that there exists a . re escape should things get too hot.

The problem with .re escapes, however, is that they do not work particularly well when everyone is rus.h.i.+ng the door at the same time. Those who believe that they can divine the tides of sentiment are often caught short when the market suddenly turns. Empirical evidence has, broadly speaking, failed to identify any single news factor that could explain some of the great " corrections " of the last century: the Crash of October 1929, " Black Monday " in 1987, the bursting of the dot - com bubble in March 2000. Those investors with leveraged positions - where market exposure far exceeded real capital resources - found themselves with .nancial obligations they simply could not meet.As Warren Buffett dryly comments," You only .nd out who is swimming naked when the tide goes out."

Value investors - those who buy a stock on the expectation that, in the longer term, its quoted price will rise to meet intrinsic value - are particularly circ.u.mscribed when it comes to borrowings. Keynes observed that the market can stay irrational longer than game players can stay solvent - Alan Greenspan, after all, made his famous " irrational exuberance " remark a full three years before the dot - com bubble . nally burst.The value investor must therefore be prepared to wait potentially considerable periods before the stock market weighing machine usurps the voting machine. Keynes consequently concluded that: . . . an investor who proposes to ignore near - term market . uctuations needs greater resources for safety and must not operate on so large a scale, if at all, with borrowed money . . .

Something of a debt junkie in the 1920s and early 1930s, Keynes con-siderably reduced his borrowings in the latter part of his investment career, with loans const.i.tuting around 10 percent of his a.s.sets in the last years of his life.This .nancial conservatism is repeated in the prac-tices of Berks.h.i.+re Hathaway, which, as Charlie Munger comments, is " chicken about buying stocks on margin." As Munger suggests, " The ideal is to borrow in a way no temporary thing can disturb you."

Mind Control I still suffer incurably from attributing an unreal rationality to other people ' s feelings and behavior . . .

-Keynes, MY EARLY BELIEFS Value investors require a dispa.s.sionate framework for investment decision - making, one that screens them from the insidious effects of animal spirits and short - termism.As Warren Buffett comments: Investing is not a game where the guy with the 160 IQ beats the guy with the 130 IQ . . . Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing.

Cultivating the correct temperament - one that couples, in Buffett ' s words," good business judgment with an ability to insulate . . . thoughts and behavior from the super - contagious emotions that swirl about the marketplace " - requires the investor to focus on just two variables, the price and the intrinsic value of a stock.

The intelligent investor, although skeptical of the stock mar-ket ' s ability to always price securities correctly, nevertheless maintains an appropriately humble outlook. The investor not only accepts that on many - if not most - occasions the market is approximately ef. -cient in terms of pricing, but also remains .rmly within his or her circle of competence. Similarly, the investor does not succ.u.mb to the trait of overcon.dence.Adam Smith, in his seminal work The Wealth of Nations, wryly remarked on: The overweening conceit which the greater part of men have of their own abilities . . . and . . . their absurd presumption in their own good fortune . . . There is no man living, who, when in tolerable health and spirits, has not some share of it.The chance of gain is by every man more or less overvalued, and the chance of loss is by most men undervalued . . .

Empirical evidence supports Smith ' s insight - individuals typically exag-gerate their skills (to take an everyday example, considerably more than half of survey respondents believe they are much better drivers than the average motorist), and harbor overly optimistic views in respect of future events (research has shown, for instance, that game show contest-ants ma.s.sively overestimate their chances of success).

Guilt - Edged Securities . . . in the stock market the facts of any situation come to us through a curtain of human emotions.

-Bernard Baruch, MY OWN STORY In addition to the traits of overcon.dence and overoptimism, there are other cognitive biases that may affect investor behavior. Most impor-tant, perhaps, is the " endowment effect " - the tendency for people to apply an " owners.h.i.+p premium " to their possessions. A simple experi-ment conducted by the economist Richard Thaler - which showed that the average asking price of an object already owned by a person, in this case a coffee mug, was more than double the offer price of an equivalent object they did not yet own - ill.u.s.trates the general princi-ple that an individual will typically demand signi.cantly more to give up something they already hold than they would be willing to pay to acquire the very same object.

In a similar manner, many stock market players appear to invest more than just dollars into their securities - a well - performed stock may garner positive emotional a.s.sociations, and consequently the stockholder may be reluctant to sell his or her " pet " even when the quoted price far exceeds a.s.sessed intrinsic value. Conversely, an underperforming stock - whatever its future prospects - may be sold by the rash investor, rather in the man-ner of a guilty party anxious to dispose of incriminating evidence. Perhaps a more likely scenario - in light of .ndings by behavioral economists that .nancial losses exacted more than twice the emotional impact of an equivalent gain - is that some stockholders may be reluctant to sell under-performing securities, even those unlikely to return to favor, because to do so would crystallize a loss and con. rm their original investment error.

The intelligent investor does not lapse into these episodes of trans-ference, and remembers that, as Warren Buffett puts it rather poignantly, " The stock doesn ' t know you own it." Value investors focus on the perceived value of a stock based on expected future cash .ows, and do not .xate on the original acquisition price. If investors are to anchor themselves to any particular number, it should be to antic.i.p.ated future earnings rather than historical prices.The decision to buy, sell, or hold a security should be determined by reference to " a policy based on reason," one free from the taint of animal spirits and emotional baggage. Value investors concentrate unwaveringly on the economics of the underlying business-they are security a.n.a.lysts rather than insecurity a.n.a.lysts.

Pride Goeth before Destruction . . .

. . . while enthusiasm may be necessary for great accomplishments elsewhere, on Wall Street it almost invariably leads to disaster.

-Ben Graham, THE INTELLIGENT INVESTOR Aware of these psychological quirks, value investors work diligently within their circle of competence, practicing what Buffett terms " emo-tional discipline " and dealing only in stocks displaying a wide mar-gin of safety. In an early press interview, Buffett compared investing to being in " a great big casino . . . [where] everyone else is boozing." He suggested that if the intelligent investor can stick to Pepsi (or, given his subsequent acquisitions, c.o.ke), then that individual will do . ne. Charlie Munger made the same point in a letter to shareholders of Wesco Financial Corporation, a Berks.h.i.+re Hathaway subsidiary: It is remarkable how much long - term advantage people like us have gotten by trying to be consistently not stupid, instead of trying to be very intelligent.There must be some wisdom in the folk saying, " It ' s the strong swimmers who drown."

It was once remarked of Foxy Falk and his hyperintelligent mer-chant banking colleagues that " their brains make them dangerous, for they arrive at their errors more rapidly." Mere intelligence is not suf-.cient for stock market success - the disciplined investor must possess a robust and objective framework for investment decision - making, and a temperament that, as Keynes suggested, exhibits " much patience and courage." In a similar vein, Ben Graham noted that " the investor ' s chief problem - and even his worst enemy - is likely to be himself," and suggested that the successful stock market partic.i.p.ant requires not only intelligence and an understanding of value investing principles, but also - and most importantly - " . rmness of character."

Forewarned, Forearmed . . . the modern organization of the capital market requires for the holder of quoted equities much more nerve, patience, and fort.i.tude than from the holder of wealth in other forms.

-Keynes to the King ' s College Estates Committee, May 8, 1938 The man who con.rmed the primacy of money in economic theory thought very little of it in practice.To Keynes it was nothing more than a means to an end, a pa.s.sport to the possibilities of life. It was this equiv-ocal, utilitarian att.i.tude to moneymaking that bestowed the sangfroid required for a businesslike att.i.tude to stock market investing. Keynes realized that successful stock market players could not be distracted by constant price quotations, which were driven, by de.nition, by the greediest buyers and most jittery sellers. Rather, investors needed to cul-tivate " a sense of proportion " - the con.dence that, despite short - term gyrations, in the longer term the market would recognize and reward those stocks with sustainable earnings.

Keynes cautioned that the intelligent investor must think independ-ently, unaffected by the views of the pack.The disciplined stock - picker cannot be seduced by the siren calls of continuous price quotation, and must negotiate a course between excessive activity and an unresponsive pa.s.sivity.The market is no respecter of the debt - servicing timetables of creditors, the expiry dates of derivatives, or the margin requirements of brokers - the intelligent investor does not, therefore, give hostages to fortune by borrowing excessively or relying on options.

Investing, in the style of Keynes and Buffett, may seem an easy game, but this simplicity of approach is deceptive. The investor must remain unin.uenced by the bipolar tendencies of the market and ensure that he or she is not tainted by the pathogen of animal spirits.As Keynes remarked to a colleague, successful investing may in fact require " more temperament than logic " - the ability to invest with one ' s head rather than one ' s glands, to paraphrase a Buffett observation.The intelli-gent investor - armed with the knowledge of concepts such as intrinsic value and safety .rst, and aware of the stock market ' s dual personal-ity as a voting machine and a weighing machine - will be much better placed to cultivate the right temperament for successful investing.

Chapter 14

Post Mortem

The Establishment Rebel I agree with everything in this if not is put in front of every statement.

-Keynes ' verdict on a government memorandum There is a story that toward the end of Maynard Keynes ' life, when he had once again returned to the warm and secure embrace of the Establishment, he was gently reproved for becoming orthodox in his old age. Keynes gave short shrift to such a foolish charge - " Orthodoxy has at last caught up with me," he replied with customary aplomb.After innumerable battles with what he mockingly called " sound . nance," Keynes was justi.ed in claiming, .nally, to be on the right side of con-ventional wisdom.The central conclusions of The General Theory- that .nancial markets can misbehave, that disturbances in the world of money can blight the real economy, and that government intervention is required to remedy these dislocations - were accepted with the same cert.i.tude that cla.s.sical dogma had been accorded only a few years ear-lier, and the " Keynesian consensus " ruled the developed world for the next three decades.

It has taken far longer for Keynes ' views on stock market invest-ing to move into the mainstream. Orthodox . nancial theorists, until recently, have doggedly maintained that modern . nancial exchanges are ef.cient mechanisms for pricing securities, that one share is as good a bet as another, and that diversi.cation is indeed the most pru-dent policy for stock market investors. The emergence of " behavioral . nance " - integrating psychological insights with economics - has at last overturned the .awless fairytale world of cla.s.sical economics, in which all men are not only unfailingly rational, but also invested with a divine omnipotence. Once again, The General Theory has proved the harbinger for an intellectual revolution.

As Keynes would no doubt have a.s.serted, however, a set of prin-ciples are only as good as their practical ef.cacy. Keynes himself was prepared to change his mind when the facts warranted such a move - like his sometimes sparring partner, sometimes ally,Winston Churchill, Keynes never developed indigestion from eating his words. Ever the pragmatist, each year he applied the blowtorch of a.n.a.lysis to his invest-ment performance, " partly with a view to comparing our [stock mar-ket] experiences with those of other investors and partly to discover what lessons were to be learnt." These " post mortems " , as he termed them, were valuable not only in determining " whence the satisfactory results came," but also - and perhaps more importantly - in identifying where performance was susceptible to improvement.

The .nal part of our investigation into Keynes ' stock market expe-riences will, in due homage to the man, therefore comprise an over-view of his unorthodox investment tenets and an appraisal of his stock market performance.

Every Crowd Has a Silver Lining If G.o.d didn ' t want them sheared, he would not have made them sheep.

-The bandit - leader Calvera, THE MAGNIFICENT SEVEN Ben Graham applied a measure of anthropomorphic sleight of hand to beget that embodiment of an irrational stock exchange, Mr. Market.

Warren Buffett, Graham ' s most renowned disciple, provides a concise character sketch of this creation: [Mr. Market] has incurable emotional problems. At times he feels euphoric and can see only the favorable factors affecting the business. When in that mood, he names a very high buy sell price because he fears that you will snap up his interest and rob him of imminent gains. At other times he is depressed and can see nothing but trouble ahead for both the business and the world. On these occasions he will name a very low price, since he is terri.ed that you will unload your interest on him.

Mr. Market is riddled with a complex array of character pathologies. Af.icted by periodic " waves of irrational psychology," he can suffer from alternate bouts of mania and depression. Mr. Market can meta-morphose into Mr. Magoo - an extremely myopic character, congeni-tally unable to take the long view. And he can also be psychosomatic, with disturbances in his state of mind impacting not only the stock market but also the real economy.

In contract law, agreements with individuals of an unsound mind are generally unenforceable. In the dog - eat - dog world of the stock market, however, investors are free to exploit the periodic madness of others. Rather than being in. uenced by short - term price . uctuations - by Mr. Market ' s interminable yammerings - intelligent investors instead concentrate on the underlying value of a business. The phrase " value investing " , then, is something of a tautology, for all true investing - as opposed to speculation - involves an a.s.sessment of intrinsic value. The value investor - realizing that a stock price is transitory, a snapshot of jostling views and emotions - views Mr. Market ' s prices as nothing more than a possible entry or exit point on to the market.

Price trends and market fas.h.i.+ons are of no concern to the disci-plined stock - picker - instead, the investor applies his or her own inde-pendent a.n.a.lysis to the investment decision - making process. Intelligent investors buy for value reasons and capitalize on the mistakes of those who do not. Stocks, for these individuals, are not mere tracings on a chart but real ent.i.ties producing real goods and services. At Berks.h.i.+re Hathaway' s annual meetings, Buffett emphasizes the ultimate con-creteness of his stock holdings by gulping c.o.ke, offering discounts to Berks.h.i.+re - owned jewelry stores, and promoting the company ' s candy shops.Value investors focus on the attributes of the business- particularly future earnings - and when Mr. Market casts aside his accountant ' s eye-shade and dons his party hat, or a.s.sumes dark robes of mourning, they search carefully for the radically mispriced bet.

Stock Market Jujitsu . . . the way is to avoid what is strong and to strike at what is weak.

-Sun Tzu, THE ART OF WAR Keynes ' experiences on the stock market read like some sort of morality play - an ambitious young man, laboring under the ancient sin of hubris, loses almost everything in his furious pursuit of wealth; suitably humbled, our protagonist, now wiser for the experience, applies his considerable intellect to the situation and discovers what he believes to be the one true path to stock market success. Somewhat ironically for a man who remarked that " in the long run we are all dead," Keynes - in his new guise as value investor - became particularly scornful of the stock market ' s insistence on taking the short view. In his later incarnation, Keynes looked beyond short -term price trends and events, instead focusing on the long - term earnings potential of a stock and adopting a steadfast holding of his " pets."

The practice of value investing involves identifying those stocks displaying a wide gap between quoted prices and a reasonable estimate of future income potential, and often requires the investor to battle against the prevailing currents of crowd sentiment. The value investor favors a long - term investment horizon, and is content to wait for the ephemera of constantly quoted prices to eventually reconcile with the reality of earnings. Keynes ' additional gloss to the value investing canon is a policy of portfolio concentration - of putting one ' s eggs in only a handful of baskets - a strategy practiced by Buffett, but not by some other notable value investors, such as Ben Graham.

In a memorandum written for the King ' s College Estates Com-mittee in 1938, Keynes set out the most concise summary of his stock market investment philosophy: I believe now that successful investment depends on three principles: (1) a careful selection of a few investments (or a few types of invest-ment) having regard to their cheapness in relation to their probable actual and potential intrinsic value over a period of years ahead and in relation to alternative investments at the time;