Keynes, the State of Long Term Expectations and Technology Markets
When I write about product cycles, leadership teams, decision making pace and the culture of a company, I am doing so thinking about how it is correlated with valuation. On a constant basis companies are calculating the state of their long term expectations. Some companies have control over this expectation and some companies do not. The ebb and flow of this control is how positive and negative product cycles are formed. Investors and analysts are calculating this control on daily basis. If you are an interested party: employee, investor, analyst then you are affecting the state of long term expectations and you are doing this negatively or positively. Companies are in positive or negative product cycles. Leadership teams positively or negatively affect companies. The formation of investor expectation as to the state of long term expectations does affect equity pricing.
In 1936, John Maynard Keynes published his manuscript for economists entitled The General Theory of Employment, Interest, and Money. Beginning with Margret Thatcher and the privatization of BT we find evidence of the retreat from economic policies labeled “Keynesian,” that began in the late 1970s in Britain, to economic policies of free markets or the Chicago School of economics was a macro enabler of the computer, telecom and internet markets. Although the retreat from state ownership of the commanding heights of the economy through privatization and deregulation would become an important driver of technology and telecom investment in the 1990s, there is another Keynes contribution that is often overlooked and that is the state of long term expectations. This contribution is applicable from a historical perspective to technology markets and the capital invested in the new economy, but it is the potential influence that this Keynes thesis will have in union with the information revolution, which is being enabled by technology and the successful proofs from these technology markets that is of interest over the long term.
Keynes defines the state of long term expectation as the basis upon which decisions are made. The level of confidence in the forecast or model of long term expectations for a company is how the value of the company is derived. “The state of long-term expectation, upon which our decisions are based, does not solely depend, therefore, on the most probable forecast we can make. It also depends on the confidence with which we make this forecast — on how highly we rate the likelihood of our best forecast turning out quite wrong. If we expect large changes but are very uncertain as to what precise form these changes will take, then our confidence will be weak. The state of confidence, as they term it, is a matter to which practical men always pay the closest and most anxious attention,” [see Keynes, page 148]. The level of confidence in the long-term expectation for a company is derived from assessing all the knowledge that concerns the company, including the macro state of the market or markets in which the company is involved. “We are assuming, in effect, that the existing market valuation, however arrived at, is uniquely correct in relation to our existing knowledge of the facts which will influence the yield of the investment, and that it will only change in proportion to changes in this knowledge; though, philosophically speaking, it cannot be uniquely correct, since our existing knowledge does not provide a sufficient basis for a calculated mathematical expectation,” [see Keynes, page 152].
Complicating the determination of value based upon long term expectations is the fleeting nature of the facts and data points used to determine valuation. Data is rarely current or real time. It is best classified as lagging indicators that are historical in nature.
If you take the time to read pages 40-43 in Nassim Taleb’s book Black Swan, you will find a very interesting two paragraphs for those people who produce charts that often show a slope rising from the bottom left to the upper right. “Consider a turkey that is feed every day. Every single feeding will firm up the bird’s belief that it is the general rule of life to be fed every day by friendly members of the human race ‘looking out for its best interests,” as a politician would say. On the afternoon of the Wednesday before Thanksgiving, something unexpected will happen to the turkey. It will incur a revision of belief…how can we know the future, given knowledge of the past; or, more generally, how can we figure out properties of the (infinite) unknown based on the finite known? Think of the feeding again. What can a turkey learn about what is in store for it tomorrow from the events of yesterday? A lot, perhaps, but certainly a little less that it thinks, and it is just that ‘little less’ that may make all the difference.”
If companies take weeks or months to report quarterly results, how is that an indication of how their present day business is succeeding? Most leadership teams within public companies are worried about meeting objectives in the current quarter – not reviewing the past. Predicting the future is not a precise function. In stable market conditions in which companies possess market share that has minimal fluctuation due to competitive forces, we would expect fewer dynamic changes to the conventional valuation of company. In conditions in which market share is dynamic, we would expect the state of long term expectations to change frequently; which is why corporate leaders are often reluctant to provide forward looking guidance. “A conventional valuation which is established as the outcome of the mass psychology of a large number of ignorant individuals 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,” [see Keynes, page 154].
If you want to simply define what professional equity portfolio managers (PMs) do on a daily basis is they make bets against the state of long term expectations. For example, if the stock of Company X is approaching a 52 week or multi-year high and Company X is going to report their quarterly results in a few days, how do you want to play the affect that Company X’s results will have on the long term state of expectations? Your choices are: (1) no position, thus neutral, (2) long thus assuming that the majority of investors will be encouraged by the results and continue to value the company highly post the newest report of lagging data points or (3) short thus assuming that Company X will disappoint thus negatively affecting the state of long term expectations.
Keynes adds another important element to his thesis which was derived from his observation of markets and investing. He made the assertion that a stock market is the equivalent to a casino and he reached this conclusion after observing the stock market in the U.S. and determining that the brightest minds were not concerned with building long-term value, building companies, or assessing the state of long term expectations – but rather with making money. This is where he defined a conflict of interest between various parties investing capital in a financial market. “It happens, however that the energies and skill of the professional investor and speculator are mainly occupied otherwise. For most of these persons are, in fact, largely concerned, not with making superior long-term forecasts of the probable yield of an investment over its whole life, but with foreseeing changes in the conventional basis of valuation a short time ahead of the general public. They are concerned, not with what an investment is really worth to a man who buys it ‘for keeps’, but with what the market will value it at, under the influence of mass psychology, three months or a year hence,” [see Keynes, page 155]. If price is not derived from the state of long term expectations, then it must be valued by some other set of metrics. Keynes described this metric as the assessment of price based upon the determination of average opinion of all investors using all available information and anticipating change. “Thus the professional investor if forced to concern himself with the anticipation of impending changes, in the news of or in the atmosphere, of the kind by which experience shows that the mass psychology of the market is most influenced,” [see Keynes, page 155].
Keynes went further in his essay and provided a metaphor to describe how markets determine price. In hindsight to the telecom and internet bubbles and the run up of the stock markets in late 1990s, this metaphor seems accurate. “Or, to change the metaphor slightly, professional investment may be likened to those newspaper competitions in which the competitors have to pick out the six prettiest faces from a hundred photographs, the prize being awarded to the competitor whose choice most nearly corresponds to the average preferences of the competitors as a whole; so that each competitor has to pick, not those faces which he himself finds prettiest, but those which he thinks likeliest to catch the fancy of the other competitors, all of whom are looking at the problem from the same point of view. It is not a case of choosing those which, to the best of one’s judgment, are really the prettiest, nor even those which average opinion genuinely thinks the prettiest. We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be. And there are some, I believe, who practise the fourth, fifth and higher degrees,” [see Keynes, page 156]. If we think through the IPO process (Linkedin comes to mind) that thousands technology and telecom companies engaged in during the 1990s, we see the function of pricing the initial public offering as a function of average opinion. Facts, projections, models, trends et hoc genus omne were a function of creating opinion and driving the determination of the average opinion of the mass of investors, higher.
When I look at a number of companies who have recently fallen into negative product cycles, it is because they became too focused on trying to determine the prettiest face that their customers would pick as the prettiest face. What they should have been doing was spending less time trying to determine the most likely selection and more time affecting the market with solutions that stand out. Some people would phrase this as if you do not cannibalize your installed base someone will do it for you – but I prefer to think of it as you want to be the agent of momentum and change or the agent of the past. When product development falters and then market share momentum slows, it is a sign of negative product cycle developing and the state of long term expectations is slipping out of control for the management team.
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