Crowd Psychology and the Stock Market

Anatole Kaletsky wrote an article in Gavekal Research – ‘Five Features Of Market Madness’ – (Ideas June 16 2020) in which he talked about ‘Nominative determinism’. Two examples:

  1. Chinese property company called Fangdd Network where its value jumped from US$800mn to US$10bn in four hours of trading. Fangdd Network made it sound like a cheap ETF (ETFs give you a way to buy and sell a basket of assets without having to buy all the components individually) for the FAANG technology giants.
  2. Nikola, an aspiring electric vehicle manufacturer with no revenues that launched three months ago on Nasdaq saw its value spike to almost US$30bn, up from US$300mn at its March IPO, mainly because, like Elon Musk’s electric car company, it was also named after 19th century Serbian-American inventor Nikola Tesla.

Anatole Kaletsky 5 features of market madness

  • While monetary easing usually starts a bubble, a reversal in monetary policy is unlikely to deflate the bubble once the speculative momentum builds.
  • Valuations do not matter while a bubble is inflating, but they become very important after it bursts.
  • Bubbles typically end with the some huge corporate collapses (Charles’s analogy of dynamite fishing), often tainted with fraud.
  • Bubble dynamics need not bear any relation to the strength, or weakness, of the economic cycle.
  • Speculation increases dramatically when prices break through major highs.

These examples show that it is not analysis of valuations, monetary policy or economic data that is driving prices up. Famous economist J.K. Galbraith once remarked that ‘economic forecasting was invented to make astrology look respectable’. He also said that we are mush reassured by the ‘conventional wisdom – i.e. strongly held beliefs that have, at best, a tenuous grounding in reality. John Maynard Keynes stated that ‘the market can stay irrational longer than you can stay solvent’. Mervyn King, former Governor of the Bank of England, argues that economic decisions always occur under conditions of, what he calls, ‘radical uncertainty’ – unaware of what might happen in the future. King says that people use ‘narratives’ to make sense of the world. He also suggest that economists in the 2008 GFC didn’t learn from history – the Great Depression before they were born.Each time they suggest that this time it is different – an expression by experts suggesting that the new situation (GFC) bears little resemblance to previous crises. Carmen Reinhart and Kenneth Rogoff in their book entitled ‘This Time is Different’ show that we haven’t learnt from what happened in the past – short memories make it all too easy for crises to recur.

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