Would you rather be an honorable person perceived to be a fraudster, or a fraudster mistaken for an honorable person? The answer can help you understand why otherwise good people do devious things to avoid standing up against prevailing beliefs.
Groupthink fallacy is the surrender of one’s opinion for the collective. This accounts for as a loss of critical thinking and is reflective of emotional impulses in the decision making of the crowd. When groupthink becomes the dominant mindset of the crowd, an ensuing volatile episode can be expected to occur applied to both markets and politics (bubble implosion or political upheaval).
-The unrecognized trend,-The beginning of the self-reinforcing process-The successful test-The growing conviction, resulting in the widening divergence between reality and expectations-The flaw in perceptions-The climax and-The self-reinforcing process in the opposite direction
It's not always easy to do what's not popular, but that's where you make your money.
Most people get interested in stocks when everyone else is. The time to get interested is when no one else is. You can't buy what is popular and do well.
Economics does not allow of any breaking up into special branches. It invariably deals with the interconnectedness of all the phenomena of action. The catallactic problems cannot become visible if one deals with each branch of production separately. It is impossible to study labor and wages without studying implicitly commodity prices, interest rates, profit and loss, money and credit, and all the other major problems. The real problems of the determination of wage rates cannot even be touched in a course on labor. There are no such things as "economics of labor" or "economics of agriculture." There is only one coherent body of economics.
As the great French economist Jean Baptiste Say wrote[5], (italics original)That which is called productive capital, or, simply, capital, consists of all those values, or, if you will, all those advances employed reproductively, and replaced in proportion as they are destroyed.It is easy to see that this term capital has no relation to the nature or form of the values of which capital is composed (their nature and form vary perpetually); but refers to the use, to the reproductive consumption of these values: thus a bushel of corn forms no part of my capital if I employ it to make cakes to treat my friends, but it does form part of my capital if I use it in maintaining workmen who are employed on the production of that which will repay me its value. In the same manner a sum of money is no longer a part of my capital if I exchange it for products which I consume: but it does form part of my capital if I exchange it for a value which is to remain and augment in my hands…Capital is augmented by all that is withdrawn from unproductive consumption, and added to aconsumption which is reproductive.
It must be remembered that to consume is not to destroy the matter of a product: we can no more destroy the matter than we can create it. To consume is to destroy its value by destroying its utility; by destroying the quality which had been given to it, of being useful to, or of satisfying the wants of man. Then the quality for which it had been demanded was destroyed. The demand having ceased, the value, which exists always in proportion to the demand, ceases also. The thing thus consumed, that is, whose value is destroyed, though the material is not, no longer forms any portion of wealth.A product may be consumed rapidly, as food, or slowly, as a house; it may be consumed in part, as a coat, which, having been worn for some months, still retains a certain value. In whatever manner the consumption takes place, the effect is the same: it is a destruction of value; and as value makes riches, consumption is a destruction of wealth.
The s-curve maps growth of revenue or productivity against time. In the early stage of a particular innovation, growth is relatively slow as the new product establishes itself. At some point customers begin to demand and the product growth increases more rapidly. New incremental innovations or changes to the product allow growth to continue. Towards the end of its life cycle growth slows and may even begin to decline. In the later stages, no amount of new investment in that product will yield a normal rate of return
Loans for production activities—which comprised more than four-fifths of banks’ aggregate loan portfolio—grew by 14.6 percent in November from 16.4 percent in the previous month. Similarly, the growth of consumer loans eased to 12.1 percent from 13.9 percent in October, reflecting the slowdown across all types of household loans.The expansion in production loans was driven primarily by increased lending to the following sectors: real estate, renting, and business services (24.8 percent); wholesale and retail trade (by 26.9 percent); financial intermediation (37.3 percent); manufacturing (13.6 percent); transportation, storage, and communication (26.5 percent); and public administration and defense (48.9 percent). Meanwhile, declines were observed in lending to mining and quarrying (-39.5 percent) and agriculture, hunting, and forestry (-41.8 percent).
1. Markets tend to return to the mean over time
2. Excesses in one direction will lead to an opposite excess in the other direction
3. There are no new eras — excesses are never permanent
4. Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways
5. The public buys the most at the top and the least at the bottom
6. Fear and greed are stronger than long-term resolve
7. Markets are strongest when they are broad and weakest when they narrow to a handful of blue-chip names
8. Bear markets have three stages — sharp down, reflexive rebound and a drawn-out fundamental downtrend
9. When all the experts and forecasts agree — something else is going to happen
10. Bull markets are more fun than bear markets.
Weather forecasters are said to have markedly better batting average making predictions or are far more accurate prognosticators than most stock market experts. (Well this applies to foreign private weather forecasters and not the Philippine government counterpart.)
Justin Rohrlich at the Minyanville writes,
According to New York Times statistical wunderkind Nate Silver, the National Hurricane Center’s accuracy has improved 250% over the last 25 years.
More accurate weather predictions benefit the economy, boosting the efficiency of businesses like FedEx (FDX), which employs 15 in-house meteorologists, as well as companies working offshore, like BP (BP) and Transocean (RIG). Weather is such an important factor in financial markets that Goldman Sachs (GS) employs staff meteorologists, as do Citigroup (C) andJPMorgan Chase (JPM).
While meteorologists have improved, other analysts -- specifically financial ones – are still off the mark more often than not.
“In November 2007, economists in the Survey of Professional Forecasters -- examining some 45,000 economic-data series -- foresaw less than a 1-in-500 chance of an economic meltdown as severe as the one that would begin one month later,” Silver writes.
“Why are weather forecasters succeeding when other predictors fail? It’s because long ago they came to accept the imperfections in their knowledge. That helped them understand that even the most sophisticated computers, combing through seemingly limitless data, are painfully ill equipped to predict something as dynamic as weather all by themselves. So as fields like economics began relying more on Big Data, meteorologists recognized that data on its own isn’t enough.”
So the admission of the knowledge problem is one crucial factor contributing to the weather forecaster’s edge.
I’d add that the unwillingness to think outside the box has been another key variable to why stock market experts underperform.
More…
In a slightly larger than usual nutshell, the crux of the issue was this: Weather forecasters have an “awareness of uncertainty” about the natural world that “causes these experts to manifest a lower overconfidence effect than experts from the other domain.”…
Further, financial analysts were also found to be unwilling or unable to be self-critical after a failure -- something that Raymond Dacey, Professor of Finance and of Statistics and Adjunct Professor of Philosophy at the University of Idaho, suggested to the authors “could pertain to the clients.”
Simply put, the “Disposition Effect” has to do with risk attitude and what Shefrin and Statman colloquially term “get-evenitis” -- an aversion to loss realization.
Another major obstacle is the overconfidence bias
I’d add that egotism has always been a hurdle to self discipline.
Here is a relevant investment ‘war’ tip from Sun Tzu’s Art of War
If you know the enemy and know yourself, you need not fear the result of a hundred battles. If you know yourself but not the enemy, for every victory gained you will also suffer a defeat. If you know neither the enemy nor yourself, you will succumb in every battle
From Bloomberg,
Strategists at the biggest banks are capitulating on their bearish forecasts after the best start to a year for global stocks since 1994 and gains of more than 7 percent in emerging-market currencies.
Just two weeks after saying that investors should “remain cautious,” Larry Hatheway, the chief economist at UBS AG (UBSN), raised his recommendations on global shares and high-yield bonds in a Jan. 23 note to customers entitled, “Wrong, but not too late.” Royal Bank of Scotland Group Plc (RBS), and Benoit Anne, the global head of emerging-markets strategy at Societe Generale (GLE) SA, said their estimates for developing nations were proven wrong.
The MSCI All-Country World Index (MXWD) climbed 5.7 percent in January, surprising strategists at Bank of America Corp. (BAC),Goldman Sachs Group Inc. (GS) and Barclays Plc (BARC) who had forecast first-half losses because of Europe’s debt crisis. JPMorgan Chase & Co. (JPM) and Citigroup Inc. (C), which predicted the rally in stocks, say it will continue as the U.S. housing market rebounds and China eases lending restrictions to bolster economic growth.
Another instance where the mainstream admits to have gotten their analysis, and subsequently their predictions, all so wrong. Independent (usually contrarian) thinking pays. And most important is adhering to the methodology taught by Professor Ludwig von Mises.
There is only one way of dealing with all problems of social organization and the conduct of the members of society, viz., the method applied by praxeology and economics. No other method can contribute anything to the elucidation of these matters.
Regulators generally have deep aversion for falling prices (deflation), or applied to financial markets, they fear bear markets.
So they apply all sorts of price control measures to prevent the required adjustment in prices that essentially reflects on the underlying fundamentals of the securities or markets.
Today, South Korea copycats Greece.
Here is Bloomberg, (emphasis mine)
South Korea banned equity short sales for three months while the two biggest state-run funds said they may boost investments as the government seeks to shore up a market that’s had its biggest six-day drop in three years.
The Financial Services Commission said it will ban short selling on all shares until Nov. 9 from today. The National Pension Service, the country’s biggest investor, said yesterday it plans to buy more stocks this month than it originally targeted. Korea Teachers Pension said it purchased about 70 billion won of stocks amid the sell-off and may buy more.
South Korea joins Greece this week in banning short selling after the Kospi Index (KOSPI) slumped 17 percent in six days. The gauge reached an intraday level yesterday that was 24 percent below its May 2 record close. Domestic institutions should play a bigger role to contain volatility that is often caused by sell- offs by overseas investors, the FSC’s Chairman Kim Seok Dong told lawmakers in parliament yesterday.
The current ban exhibits the same attempt made in September 2008.
From the same article,
South Korea imposed a ban in 2008 on short sales following similar actions taken by U.S. and U.K. regulators in the aftermath of Lehman Brothers Holdings Inc.’s collapse. Korea lifted the rule from June 2009, while keeping the ban for financial stocks. The nation already bans so-called naked short sales, where investors don’t need to borrow the shares.
How effective has the been the ban which South Korean authorities imposed in September 30th of 2008?
Apparently a big failure as the Kospi index’s crash even accelerated when the ban was imposed (blue arrow).
Korea wasn’t alone, she was accompanied by Taiwan and Indonesia who also imposed short trading prohibitions.
And the results were identical.
Like South Korea, both Taiwan (TSEC black candle) and Indonesia (JKSE-blue candle) fell sharply during the final phase of the bear market of 2008, in spite of the short selling ban. In short, regulators failed to control their respective equity markets.
The good news is that actions of regulators are almost always mechanically reactive to unfolding events (present and past events). Usually the failed policies they implement occur during the culmination of major inflection points.
Another good example of this was UK’s Gordon Brown infamous “bottom” selling of the Bank of England’s gold reserves in 1999. BoE’s loss has been the market gains.
An important lesson is that actions of politicians may function as good or reliable contrarian indicator.
Applied to the short selling ban by South Korean authorities, if the past will rhyme, short-term market pressures may still proceed, but this may also signal the near conclusion of the current selling pressure (mid term) cycle.
“Without education we are in a horrible and deadly danger of taking educated people seriously.” G.K. Chesterton (1874-1936), English author
One of the important sentiment indicators that I use in examining short term trends is measuring the actions of small retail investors.
This group comprise mostly the unsophisticated market participants, whose decisions are mostly swayed by emotions. Market tops (greed) and bottoms (panic) are frequently associated with aggressive actions undertaken by them.
Pigs Get Slaughtered
And there’s even this famous Wall Street axiom which alludes to them: “Bulls and Bears make money, but pigs get slaughtered”.
Pigs, according to Investopedia[1], are high-risk investors looking for the one big score in a short period of time. Pigs buy on hot tips and invest in companies without doing their due dlligence. They get impatient, greedy, and emotional about their investments, and they are drawn to high-risk securities without putting in the proper time or money to learn about these investment vehicles. Professional traders love the pigs, as it's often from their losses that the bulls and bears reap their profits.
While I don’t have sufficient data to substantiate this phenomenon today, except that market breadth has considerably deteriorated, my sense is that the recent correction in the local markets may have incited some retail investor’s into panic selling.
Figure 1: Net Foreign Trade
Since the peak of the Phisix in October, foreign trade have been mixed (figure 1).
Last week foreign trade reported net buying, reversing almost half of the outflows seen from the previous week. This means that most of the selling pressure came from local investors. With the broad deterioration of the market’s breadth, this likely signals panic selling by retail investors.
And for whatever reasons which may have prompted for their actions I see this as an opportunity to accumulate rather than to flee.
Where weak hands dominate the activities, taking the contrarian stand would be the most prudent path. It seems almost the same case where we successfully called for “top” in the US bonds and the “bottom” in US stocks[2] based on the activities of the Pigs.
Phisix (and ASEAN)-Global Market Divergences
We have to remember market actions have never been a one-way street, as buyers and sellers reacting to perpetually changing conditions, always struggle to tip the scale of balance in their favor.
I’d have to admit that over the short-term even global markets may take a reprieve. As to whether this would materially influence the actions in the local equity market, which appears to have foreshadowed the global trend, is something I can hardly predict.
And gold prices, which in my view, has functioned as a very important barometer of global equities, seems to have augured for this hiatus (see figure 1).
But the point is: the major drivers of global financial marketplace, particularly inflationism and globalization, remain intact which means likely a consolidation phase first, as a consequence to last year’s fiery run up, before the next leg up.
Figure 1: Growing Divergences In The Financial Marketplace?
One thing we can observe, so far, is that the Philippine Phisix, along with our Southeast Asian contemporaries, which has been one of the world’s best performers in 2010[3], appears to be diverging from the trends of the global equity markets[4].
This can be seen in based on the actions of the Dow Jones World Index (DJW) and Dow Jones Asia Ex-Japan (P2DOW), which means bourses of major economies have been sustaining the rise of global markets, via the DJW, aside from the other non BRIC emerging markets.
In fact, many of the today’s best performers have been last year’s laggards, which only implies of the rotational effects on equity asset prices as corollary from central banks inflationism.
Yet with most countries still showing advances more than those suffering from losses measured on a year to date basis, it’s hard to argue for bearishness unless current conditions dramatically degenerate.
Peso-Phisix Divergence
Another source of a slight divergence appears to be in the tight correlation of the Phisix and the Philippine Peso (see figure 3)
Figure 3 Peso-Phisix Divergence?
Almost each time we see the Phisix fumble, the Peso follows. The chart demonstrates this relationship where a peak in the US dollar coincides with the bottom of the Phisix and vice versa.
This week we saw a sharp rally in the Peso even as the Phisix just eked out inconsequential gains. This implies that foreign investors buttressed Phisix as locals sold the market resulting to a broad based selloff.
My point is that if foreign investors increase their accumulations in the equity markets as the locals sell, we should see a consolidation (bottoming).
And where negative sentiment eases, and locals reverse from selling, we’d probably see a substantial recovery.
By then the Pigs will likely jump on the bandwagon.
[1] Investopedia.com Stocks Basics: The Bulls, The Bears And The Farm
[2] See US Markets: What Small Investors Fleeing Stocks Means August 23, 2011
[3] see How Global Equity Markets Performed in 2010, January 14, 2011
[4] See Global Stock Market Update: Advancers Still Dominate, January 25, 2011
Mr. Peter Schiff of Euro Pacific Capital is an iconoclast economist who subscribes to the Austrian school of economics and has served as economic adviser to Ron Paul’s presidential campaign in the recently concluded elections, and has been one of the grizzly bears who successfully predicted today’s crisis during the boom days of 2006-2007.
The purpose of my posting this video is to show you how contrarians suffer from the ordeal of challenging mainstream or popular thinking at the risk of being mocked, heckled and or excoriated. But of course, Mr. Schiff gets sweet vindication overtime. (Hat Tip: Robert Murphy)
Lesson: Be wary of mainstream or popular views. Most of the popular thinking have been influenced by an oversimplified comprehension of complex problems, the “rear view mirror syndrome” outlook or the “ticker tape performance” outlook where recent performance are interpreted as tomorrow’s outcome.
Enjoy!
