Didier Le Menestrel

Determining Market Price?

With moments of irritation behind us and resigned to waiting patiently to fill up our fuel tanks, queuing at French petrol stations has provided us the time and the material to philosophise over stockmarket behaviour.

While the petrol shortage in France stemmed from haphazard supplies to service stations, it was above all created by a sudden peak in demand. Drivers fearing a lack of fuel flocked to service stations and in so doing, effectively caused the much-feared shortage to materialise. The queues at petrol pumps provided a visual illustration of what is known as a self-fulfilling prophecy.

This phenomenon has existed for years. Indeed, Shakespeare provided a magnificent analysis in the play Macbeth where the king’s behaviour is directly influenced by the prophecies he is told.

In terms of market behaviour, learned financier John Meynard Keynes was one of the first to identify the phenomenon: we cannot ignore the role of mimetic behaviour and the weight of general opinion. Very early on, he understood that “[…] the assessment of fundamental value essentially has the dimension of an opinion”.

This idea was provocative at the time since in historical terms, economic models used individual rationality as a starting point. Léon Walras1 and numerous economists that succeeded him also attempted to explain the creation of prices based on the “rational individual behaviour of optimisation”. Only recently have players sought to modelise mimetic behaviour with sometimes spectacular stockmarket effects.

Work reported by André Orléan2 in an essay on understanding speculative crowds placed mimetic behaviour into three categories:

– Informational mimicry: “I imitate Goldman Sachs because I believe it is the best informed”.

– Self-referring mimicry: “I imitate my neighbours because I believe they are right collectively”. This is self-fulfilling prophecy at its best!

– Normative mimicry: “I know that the community is wrong but I stick with their opinion because it is too hard to be right alone”. This is what a number of researchers call “conventional wisdom”, like that which could prompt an investor to buy technological stocks in 2000 when deep down he considered the price exorbitant.

Sometimes mimetic behaviour takes over to the extent that it is the only parameter explaining the formation of a price. The daily news and headlines on the streets is a good example.

How can we maintain that fundamental value remains the only objective measure of an asset when faced with the opinion of the masses and its short-term excesses? This is a subject that concerns us and that we have discussed for some years now. With our 20 years experience, we have noted that fundamental value on the one hand and opinion on the other are permanently at work in the formation of an asset price.

While opinion can take over for a while and influence the market, we remain convinced that sooner or later the rights of fundamental value end up being restored and we continue to avoid mimetic behaviour and favour fundamental value that creates performance over the long term.

Didier Le Menestrel

1 Léon Walras, French economist (1834-1910

2 André Orléan, French economist, author of De l’euphorie à la panique: Penser la crise financière (2009)