Market Rules

Keynes’s famous beauty contest was one of the great market insights because it shifted the question from “What is true?” to “What will others believe others will believe?” From this perspective, investors are not trying to identify intrinsic value in some pure, detached, ivory tower/pipe-puffing/CFA way. Rather, they are trying to anticipate the beliefs, fears, preferences, constraints, and forced actions of other investors.

That makes markets not merely discounting mechanisms, but belief mechanisms. Price reflects not only expected cash flows, but expected expectations. Sounds like fun?

While you’re wrapping your head around that concept, allow me to add another, more mind-twisting one: What happens when being wrong becomes being right? Say a market narrative starts out false, incomplete, or exaggerated. In other words, it is wrong. But if enough capital acts on that wrong idea for long enough, the wrong idea can begin to shape reality. Like a broken clock, it may hang around long enough to be declared right. Not because it was insightful at the start, but because the market helped drag reality in its direction.

Now let’s bring this into the realm of real consequences. Let’s say the “wrong crowd” depresses the price of a stock. That selling pressure can raise the cost of capital. A higher cost of capital can make financing harder. Harder financing can delay execution. Delayed execution can then appear to confirm the original concern.

The same can work in reverse. The “right crowd,” or at least the crowd with the money and the momentum, can inflate the price of a stock. That buying pressure can lower the cost of capital. A lower cost of capital can make financing easier. Easier financing can accelerate execution. Accelerated execution can then appear to confirm the original enthusiasm.

And there it is. Puff! The market’s magic trick, a/k/a the “wisdom” of the market.

The belief may have been wrong at the start, but through price, liquidity, confidence, financing, and enough time, it can become right enough to matter.

And the beauty of it all is that in a market driven by expected expectations, you never quite know when being wrong will turn out to be right.