The concept of Wall Street as an efficient market where the prices of trade-able assets are a (mostly) real-time reflection of all known information, has taken a harsh beating these past couple of months.
In its place has been a panic-driven, sell at ANY price mindset that has sent many a stock off the rail of sound pricing. Yet, in the face of seemingly all-time low bargain prices, buyers remain scarce and in some cases, the selling accelerates.
While it is intuitive to suggest that fear begets more fear, creating a vicious cycle on the downside (just as euphoria begets more euphoria and a virtuous cycle on the upside), it's worth noting that other systemic forces are at work that make our financial marketplace especially volatile in times like the present.
Two different articles frame this topic from slightly different, albeit complimentary, perspectives. In ‘Greasing the Slide,’ James Surowiecki (author of “The Wisdom of Crowds”) looks at the interplay of credit rating agencies, industry analysts and hedge funds, and the destructive harmony by which they amplify runaway trends (versus holding them in check and balance). Here is an excerpt:
“In a healthy market, there are countercyclical forces—mechanisms and institutions that go against the general market trend and encourage diversity of thinking—that make it harder for feedback loops and vicious cycles to take hold. Lately, though, many of these institutions and mechanisms have become procyclical: instead of countering trends, they amplify them.”
Read the full article HERE. It is excellent.
By contrast, Andy Kessler, one of my favorite writers and a former hedge fund manager himself, looks at the technical drivers that lead the market to gravitate between efficient market and manipulative liar.
In ‘Ignore the Stock Market (until February),’ Kessler ponders, “So which is it now: an efficient mechanism or a manipulating liar? Should you listen to it warning of doom or anticipating renewal? I'd say stick wax in your ears and don't listen to the market until February.”
He goes on to cite five major market dislocations currently taking place that leave the stock market at its least efficient today. They are:
- Tax-loss selling
- Mutual-fund redemptions
- Mutual fund cap-gain distributions
- Hedge-fund redemptions
- Margin calls
Kessler goes into some detail on the impact of each point, and guestimates when such dislocations should work their way through the market (hence, the February reference), arguing that investors should NOT read too much into any move until then.
Of course, there is always the contrarian call of following the axiom of Warren Buffet, who prophesizes that it is wise to “Be greedy when others are fearful, and fearful when others are greedy.”
That is the funny thing about market cycles. They do come to an end, and then we wish, oh how we wish, that we just had a bit more fortitude to trust and follow our convictions...all the way to the bank!
Related Posts:
- Capitalism 2.0: TED Spreads and Lessons from Japan’s Lost Decade.
- Death by Derivatives: on economic viruses and financial WMDs.
- Engine Failure - When Financial Markets Fail: an analysis of the current financial crisis.
- Black Swans and Bank Runs: on why this crisis was predictable.
- Financial Tsunamis: connecting the dots in the sub-prime mess.
