Why you should invest like Keynes

The markets are on a tear.

The G20 meeting at the weekend included vague promises that countries wouldn't embark on "competitive devaluations". But you need only take one look at the market reaction to see what everyone thought of that promise.

The dollar continued to slide, as investors realised that the talks merely gave both China and the US the fig leaves they need to excuse their own anti-competitive behaviour. So both countries get to save face while pursuing their existing policies.

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And as my colleague Dominic Frisby has pointed out in the past, a weaker dollar means everything else rises.

So what are investors to do? Just piling into stocks in the hope that the dollar keeps falling is one option. But there are smarter ways to invest that won't cost you as many sleepless nights

Second-guessing the market is not investing

The markets are currently being driven by investors trying to second-guess government policies. The rally is based largely on the assumption that next week, the Federal Reserve will announce plans to pump a load more money into the global economy.

How much more? It's hard to say. Goldman Sachs reckons there'll be an announcement of $500bn over the next six months, with as much as $2 trillion eventually released.

Those sorts of expectations might make it very difficult for the Fed to surprise on the upside, and very easy to disappoint. And from where I'm sitting, the dollar index looks as though it's just waiting for an excuse to rally. The Fed may well give it that excuse. And the US mid-term elections next month could also provide some catalysts for shifts in the market mood.

However, trying to time your entry to the market based on changes to the macro-economic picture isn't investing. It's speculation. You're simply trying to second-guess what the market is going to do next. Sometimes, perhaps when you've done your research thoroughly and you feel particularly strongly about a trade, it can work out. But it's a risky business. And it's not a method to build your entire investment strategy around. You'll end up losing at least as often as you win.

We can learn a lot from Keynes

So how should you invest? Well, here's something rather ironic. A lot of this money printing and deficit spending by governments is being justified by referring to the economic theories of John Maynard Keynes. His basic idea was that governments should spend when consumers and businesses aren't. It gets the economy over the rough patch and re-ignites the "animal spirits" needed to get people spending and companies investing again.

I don't want to get into a big discussion of those theories right now. Suffice to say that Keynes' name has rightly or wrongly been used to justify much of the government intervention that has effectively turned the markets into a giant casino.

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So what's ironic is that we can learn a lot from Keynes's investment views about how to cope with the market conditions that his economic views have helped create. I've recently been reading Keynes and the Market, by Justyn Walsh. It came out in 2008, and was somewhat overshadowed by the various financial crisis tomes hitting the shelves at the time. But it's a very enjoyable, straightforward account dealing with Keynes' investment skills, rather than his economic views.

You may not have realised, but Keynes was a hugely successful investor. You can read more about that here: The man who inspired Warren Buffett.

When Keynes started out, he was a 'momentum trader', as we'd call it today. He'd ride the ups and downs of trends, buying at the bottom and selling at the top. Like many intelligent people, he thought he could beat the market. You just had to be wiser than the common herd and Keynes knew he was that.

As he put it, "so long as the crowd can be relied on to act in a certain way, even if it be misguided, it will be to the advantage of the better-informed professional to act in the same way a short period ahead."

But the trouble with markets is that there's often a huge gap between what you think they "should" do, and what they do in practice. Keynes ended up losing a lot of money speculating on commodities in 1928. The remnants of his portfolio then took a beating in the stock market crash of 1929. That's when he began to realise that "forecasting the psychology of the market" was a lot harder than it looked.

How to be a successful value investor

So what did he do instead? Simple. He stopped trying to work out what the market would do next. Instead he bought assets that he had worked out were cheap. He reasoned that while the market may not appreciate their value at that moment, it would in time. And he sold them when they became expensive. And he focused on income, rather than capital gains.

This is nothing that you won't have read before in a dozen articles on Warren Buffett. But it's worth being reminded of these simple principles. Because it's particularly easy, when the investment environment is as noisy and chaotic as it is now, to forget the basics and get swept up with the rest of the crowd.

The other thing that comes across strongly is that Keynes was a contrarian another key trait of successful value investors. He took an active pleasure in going against accepted wisdom, and social mores. I suspect as a result that he'd probably have disagreed with the various politicians and pundits who have hijacked his name to advocate higher government spending as a way out of our current mess. He wouldn't have wanted to be associated with mainstream opinion.

You can read more about value investing in general here: The shares you'll never want to sell. And our own Simon Caufield, writer of the True Value newsletter, gave a value investors' take on gold here: Gold: keep buying or start selling? Gold is notoriously hard to value, as it generates no income. However, Simon's found what he believes is a pretty reliable way to value gold and judge whether or not it's time to buy. If you're not already a subscriber, sign up now and you'll be able to read the article, and get your first three issues of MoneyWeek magazine free.

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