Keynes and the Beauty Contest

John Maynard Keynes, the famous economist, was also a very active and, by the end of his life, a successful stock-picking investor. After loosing large amounts of money in the 1920s, he changed the way he invested. He used to invest according to macroeconomic insights (a top-down approach), but as he admitted:

We have not proved able to take much advantage of a general systematic movement out of and into ordinary shares …at different phases of the trade cycle

That led him to reconsider his investment philosophy and the way financial markets work. In a memorable passage of The General Theory, he compared the behaviour of participants in financial markets to the behaviour displayed by participants in newspapers beauty contests:

It is not a case of choosing those [faces] that, to the best of one’s judgment, are really the prettiest, nor even those that 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 practice the fourth, fifth and higher degrees