Great Expectations part II

The previous post introduced the concept of elasticity of expectations as developed by Ludwig M. Lachmann and applies it to the stock market. Lachmann added that the velocity of price change is important as well as the practical range and break outs from the range: 

“‘Explosive’ price change is seen to be the main cause of elastic expectations, both in the sense of violent change, and in that it destroys the existing basis of expectations, the sense of normality, which provided a criterion of distinction between the more probable, the less probable, and the highly improbable. It does so by demonstrating that the highly improbable, which had been excluded from our range, is possible after all. Now, as we saw, a price will pass the limits of the range with difficulty. As it approaches them it encounters increasing pressure from inelastic expectations resulting in sales at the upper and purchases at the lower limit. To overcome the pressure of these stabilizing market forces the price movement will most probably have to be carried by a strong ‘exogenous’ force, i.e. one originating outside the market, unknown to it and therefore not taken into account when expectations were formed.”[1]

Great Expectations – an Austrian economist lends support to technical analysis (part 1)

Does technical analysis of the stock and commodity markets have any validity, or is it the financial equivalent of reading tea leaves? Technical analysis encompasses a wide variety of methods, so a workable definition might be any method that uses historical prices and volume to predict future ones. Of course, the efficient market hypothesis denies that is possible. The alternative to technical analysis is fundamental analysis, which looks at earnings, dividends, management, sales growth, etc. to predict prices. 

 Technical analysts search charts for patterns such as head-and-shoulders, hammers, shooting stars, flags, pennants, double tops or bottoms, cups-and-handles, and many others. They employ multiple moving averages, relative strength indices, Bollinger Bands, Dow Theory and many other methods of analyzing price pattern and volume of trading. 

A few financial economists have tried to assess the validity of technical analysis methods with mixed results. Economists typically ridicule technical analysis, but a late great Austrian economist, Ludwig Lachmann, who championed the importance of the stock market more than any economist, provided support for technical analysis in his concept of the “elasticity of expectations.” He applied the concept to all kinds of prices, not just to the stock market, but it fits the stock market exceptionally well.

Is the stock market a casino?

The media often portrays the stock market as a casino. That attitude first gained academic cover with J. M. Keynes. Ludwig Lachmann wrote, “Thus, seeing the importance of expectations in asset markets, and disliking the implications of what he saw, he launched his famous diatribe on the Stock Exchange as a ‘casino.’”[1] Here are excerpts from Lachmann’s defense of the stock market against Keynes’ assault:

“Furthermore, in his Chapter 12 on ‘The State of Long-Term Expectation,’ the famous diatribe against the Stock Exchange, it becomes painfully evident that Keynes failed to grasp the nature of the problem posed by the existence of inconsistent expectations. Instead of studying the process by which men in a market exchange knowledge with each other and thus gradually reduce the degree of inconsistency by their actions, he roundly condemned the most sensitive institution for the exchange of knowledge the market economy has ever produced! [2]

“The Stock Exchange is a market in ‘continuous futures’. It has therefore always been regarded by economists as the central market of the economic system and a most valuable economic barometer, a market, that is, which in its relative valuation of the various yield streams reflects, in a suitably  objectified’ form, the articulate expectations of all those who wish to express them. All this may sound rather platitudinous and might hardly be worth mentioning were it not for the fact that it differs from the Keynesian theory of the Stock Exchange which is now so much en vogue.