Dr. Ben Hunt: How Sentiment and Narratives Shape the Crowd
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Cris Sheridan, Senior Editor of Financial Sense, sits in for Jim to welcome Dr. Ben Hunt, author of the popular newsletter Epsilon Theory, to discuss the role and dynamics of sentiment, particularly through the structure of narratives, in shaping the investment crowd. Dr. Hunt explains how the influential economist John Maynard Keynes was able to generate significant returns by anticipating crowd behavior in the market and why narratives are so powerful in influencing investor decision-making. Lastly, Cris and Dr. Hunt touch upon the role of big data and high frequency trading.
Cris Sheridan: Dr. Ben Hunt is the Chief Risk Officer of Salient Partners. He's also the author of the popular newsletter, Epsilon Theory. You write that the "strategic interaction of all investors trying to figure out how all other investors feel about a stock, each of whom knows that everyone else is going through the same decision process is sentiment." And then that leads to the game playing. You kind of touched upon that a little bit with how Keynes played this game. Do you mind going through the Keynesian Beauty Contest and what that means?
Dr. Hunt: No, no, not at all. What Keynes was writing about when he described the newspaper beauty contest, and is what modern game theory calls the common knowledge game--what Keynes was referring to was really the social media of the day. I mean, remember he's writing in the 1930s so this is the heyday of Atlantic City, bathing beauty contests and the like. This was when the Miss America pageant gets its start. And one of the common things that newspapers did in the day is that they would print pictures of 10-15 pretty girls and then they would invite readers to write in with a ballot to vote for who the readers thought was the prettiest girl. And if you voted for the girl that got the most votes then you'd be entered into a sweepstakes, some sort of prize and your name would be drawn from a hat to win some sort of prize. And what Keynes was saying is investing in markets--and this is true regardless of the time you live in--is like the newspaper beauty contest. It's like voting for who you think is the prettiest girl, but you're voting for whom you think is the prettiest company...