Apr

12

 As markets all over the world move from down 50% last year to up 10% this year, there are numerous examples of herding behavior. Of the 20 major Asian markets, 19 are up, led by China — up 40%. Of 20 major European markets 16 are down, all ranging from -10% in UK to -1% in Norway, with Sweden, Austria, Hungary, Greece up on the year from 1% to 10%. In North and Latin America, all markets are up except for the US and Mexico down 7% or 8%. Looking at individual stocks, of the S&P 500, 232 are up on the year and 268 are down with the distribution as follows:

% change number of stocks
100% or more    2
50%-100%       15
30-50%            24
10-30%            88
0-10%              83
-0 to -10%        117
-10% to -30%   135
-30% to -50%    30
-50% or less        6

And in 2009, actually 41% of the days have shown comovements in bonds and stocks, versus the normal 35% of the preceding several years. I would attribute the herding to a number of positive feedback cycles. As consumers become pessimistic, producers curtail their output, which curtails employment and lessens confidence that jobs will be held. On the real estate front, as employment prospects worsen, the demand for housing decreases, which pushes real estate prices down, which drives stocks down, which causes capital costs to rise, and employment prospects to worsen. Brett Steenbarger has a nice indicator of herding based on advancing and declining volume, but I find the results somewhat coterminous with the corresponding changes in the stock market averages themselves. Thus, as the situation turns, I turn to the originator of herding theory, Francis Galton, for guidance. He points out in Human Faculty and Its Development, 1883 (one of the five most important books for specinvestors, right alongside Ben Green on horse trading and Robert Bacon himself):

Terror at any object is quickly taught if it is taught consistently, whether the terror be reasonable or not. There are few more stupid creatures than fish, but they notoriously soon learn to be frightened at any newly introduced method of capture, say by an artificial fly, which, at first their comrades took greedily. Some one fish may have seen others caught and have learned to take fright at the fly. Whenever he saw it again, he would betray his terror by some instinctive gesture which would be seen and understood by others and so instruction in distrusting the fly appears to spread. All gregarious animals are extremely quick at learning terrors from one another. It is a condition of their existence.


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