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Speculation has always been a part of the market and always will be.

It was the spring of 1976. Investors were still licking their wounds from the severe bear market of 1973-74. Donaldson, Lufkin & Jenrette, an investment bank, was hosting a conference that matched two investing legends onstage at the same time — Ben Graham and Charles Ellis.

Ellis, moderating a Q&A, asked Graham why the mid-1970s were such a disaster in the stock market for most investors. Graham replied that, “most investment professionals, although possessing above average intelligence, lacked an overall understanding of common stocks.”

As told by Robert Hagstrom in his book Latticework: The New Investing, here’s where Ellis and Graham picked up after the conference:

After the seminar, Graham and Ellis spent some time together, and the conversation continued. The problem with our industry, Graham insisted, is not speculation per se; speculation has always been a part of the market and always will be. Our failure as professionals, he went on, is our continuing inability to distinguish between investment and speculation. If professionals can’t make that distinction, how can individuals investors? The greatest danger investors face, Graham warned, is acquiring speculative habits without realizing they have done so. Then they will end up with a speculator’s return — not a wise move for someone’s life savings. (more…)

The greater the story, the greater the bubble

The greater fool theory explains almost every bubble

Some things have an intrinsic value. The most-obvious example is a stock with a dividend. The absolute floor for an equity is its dividend and so long as their is a profitable business behind it, the value is a multiple of that dividend.

Other things don’t have an intrinsic value. This includes virtually everything that doesn’t produce a yield. Oftentimes, prices of those things rise and fall based on future expectations of what profits or yield might be. In other cases, there is an estimation of utility. Oil, for instance, can be refined into gasoline which can be used to move things or for dozens of other uses.

Oftentimes there is a dispute about utility or a dispute about future profitability, which can lead to a dispute about prices. One way to resolve this is a model but oftentimes that’s so fraught with assumptions that it’s useless.

So how do you establish prices? Obviously, via the market.

This is when storytelling, which is another way of saying a sales job, takes over.

Cryptocurrencies are an obvious example. A Bitcoin has no yield but it has some utility. To some, that utility is replacing the US dollar as a global transparent currency. To others, it’s a way to facilitate transactions. And for others still, it’s a handy tool for criminal transactions. How you price it then, depends on how you view the future utility.

Or does it? (more…)