Hussman Weekly Market Comment: Optimism vs. Arithmetic

Link to: Optimism vs. Arithmetic

Current market conditions provide an ideal moment to highlight the distinction between investment and speculation. Sound investment is a) the purchase of an expected stream of future cash flows that will be delivered to the investor over time, where b) the price paid today will result in an acceptable long-term return if those expected cash flows are delivered, and c) the expectations are set using assumptions that allow a reasonable margin of safety. As Benjamin Graham observed long ago, “Operations for profit should not be based on optimism but on arithmetic.” 

Speculation, by contrast, is the purchase of a security in the expectation that its price will increase. Speculation relies much less on calculation than on psychology, particularly of two forms: a) expected changes in sponsorship, and b) expected changes in risk aversion.