The Madness of the Market

‘Stocks surge on stimulus hopes,’ says The Sydney Morning Herald.

‘Stimulus hopes spur stock, commodities rally,’ opines Reuters.

‘U.S. Stocks Rise Most Since December on Stimulus Hopes,’ the Wall Street Journal declares.

The saying ‘once bitten, twice shy’ doesn’t seem to apply to financial markets. We can’t remember the number of times ‘hopes of a stimulus package’ sent the market soaring, only for it to be disappointed by the actual effect of said economic stimulus 2-6 months later.

So what is it this time; the collective wisdom of the market or the madness of crowds?

How about the madness of the market?

The market ain’t what it used to be. The retail investor has had enough. Term deposits or cash look good. Bond funds (nearing all-time highs) are more popular than ever. High frequency trading (HFT) is an increasingly dominant force. These things trade based on algorithms that no one really understands. They get their advantage through speed. Their operators install computer hardware next to the Exchange’s equipment so they can read the orders before anyone else.

Given that humans design the algorithms, we’ll assume today’s trading patterns still display human-like qualities. But instead of the market mentality resembling the wisdom of a seasoned trader or investor, it more resembles the behaviour of a three-year-old kid on Redbull…or maybe vodka and Redbull.

If you can imagine that, the adjective ‘chaotic’ comes to mind.

And that’s what markets are these days – chaotic.

With the hope of stimulus back on the agenda, as thinking individuals, we know that it actually does more harm than good to the economy. We know any rally based on hope is one to sell rather than buy. But in a crowd, this clear thinking and conviction dilutes.

The crowd mentality weakens our ability to reason. Not a great deal has changed since Gustave Le Bon wrote about crowds back in 1841. The following is from ‘The Crowd: A Study of the Popular Mind’.

‘The characteristics of the reasoning of crowds are the association of dissimilar things possessing a merely apparent connection between each other, and the immediate generalisation of particular cases. It is arguments of this kind that are always presented to crowds by those who know how to manage them. They are the only arguments by which crowds are to be influenced. A chain of logical argumentation is totally incomprehensible to crowds, and for this reason it is permissible to say they do not reason or that they reason falsely and are not to be influenced by reasoning.’

‘…It would be superfluous to add that the powerlessness of crowds to reason aright prevents them from displaying any trace of the critical spirit, prevents them, that is, from discerning truth from error, or from forming a precise judgment on any matter.’

Is it logical for the US Federal Reserve to buy more bonds when yields are nearly the lowest on record? Only if the real purpose of QE is to finance the US budget deficit while telling everyone it’s designed to get the economy firing.

Clearly QE doesn’t do anything for the economy. The US, the UK and Japanese experience proves that. So if they push the ‘print money’ button again – and they will, it’s just a question of timing – then you have to conclude the whole scheme is a back door method of funding the Federal government.

In other words, it’s a sham.


Greg Canavan
for Markets and Money

From the Archives…

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Greek Game Theory: Default, Devaluation, Austerity, Deliverance?
2012-05-30 – Nick Hubble

Desperate Stock Market Traders Waiting To Be Made Whole
2012-05-29 – Murray Dawes

Greek Elections: The Fear of Uncertainty
2012-04-28 – Dan Denning

Greg Canavan
Greg Canavan is a contributing Editor of Markets and Money and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to Markets and Money for free here. If you’re already a Markets and Money subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Markets and Money emails. For more on Greg go here.

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2 Comments on "The Madness of the Market"

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Why is it that we don’t get kept up to date on matters pertaining to the useful or malicious employ of crowd psychology? If economics is the ‘dismal science’ in the employ of the executive and cronies purely for narrative purposes (but hardly have any effect on events that are moved by public political and imperial court crony forces), then demonstrably you could not say the same thing about the raw forces applied by these crowd psyche practitioners. For proof all you have to do is measure how bestial an interventionist liberal supporting media and public have become and compare… Read more »

I am just wondering when the new currency will be brought in. This isnt going anywhere.

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