Greed, Fear & Stampedes


Fear & greed. 

Their battle for dominance creates a most dangerous time.

Like a drug addict…  investors know the bull market might kill their wealth.

They cannot stop.

amygdala

See how this small almond shape cluster can bring Wall Street down…. in minutes.

Are there high levels of greed in the US market today?

A New York Times article “Investors Push Into a Resurging Market: House Flipping” (1) suggests that greed is on the rise.

Investors are putting their hard earned cash back into funds that invest in shaky real estate deals.

The article says:  House flipping, which declined after the financial crisis in 2008, is on the rise again, thanks to low interest rates and rising home prices. And with the renewed interest come investors looking for a high return.

Last year, 5.7 percent of all home sales were flips, the highest level since 2006, according to Attom Data Solutions, a national property database.

It’s going to come to an end at some point, but why not make it while you can?

Investors seem undaunted by the risk of a collapse.

Funds set up these days by lenders like Genesis Capital in Los Angeles and Anchor Loans in Calabasas, Calif.

Goldman Sachs’s acquisition of Genesis Capital might demonstrate the evolution of the industry.

Here are signs of fear in the market.

Four months investors began moving away from stocks.  They had pulled $30 billion from the stock market by the beginning of August 2017.

Fear grew.  In September investors pulled $24.36 billion from stock funds. Net outflows increased despite the market rising for a fourth straight month.  This marked 15 consecutive weeks of net mutual fund outflows.

Other signs of fear in the market include a decline in the number of U.S. stocks that are hitting new highs along with the broader market.  Also Dow transports, traditionally thought to rise and fall with the economy, have been on a downtrend.

Fear… investors continue to leave the market.

Greed… the Dow Jones Industrial, S&P and NASDAQ indices continue to rise into new, all time high territory.

Is fear building?

We have almost made it though October, but don’t discount the power of fear.

A New York Times article “A Stock Market Panic Like 1987 Could Happen Again” (2) by Robert Shiller, who won a Nobel Memorial Prize in Economic Sciences in 2013 reminds us how a rapid equity downturn could happen.

The article says: On Oct. 19, 1987, the stock market fell more than 20 percent. It would  be comforting to believe a crash couldn’t recur. But we are still at risk.

From this perspective, I believe a rough analogy for that 1987 market collapse can be found in another event — the panic of Aug. 28, 2016, at Los Angeles International Airport, when people believed erroneously that they were in grave danger. False reports of gunfire at the airport — in an era in which shootings in large crowds had already occurred — set some people running for the exits. Once the panic began, others ran, too.

Like the 2016 airport stampede, the 1987 stock market fall was a panic caused by fear and based on rumors, not on real danger. In 1987, a powerful feedback loop from human to human — not computer to computer — set the market spinning.

Ultimately, I believe we need to focus on the people who adopted the technology and who really drove prices down, not on the computers.

Instead, it appears that a powerful narrative of impending market decline was already embedded in many minds. Stock prices had dropped in the preceding week. And on the morning of Oct. 19, a graphic in The Wall Street Journal explicitly compared prices from 1922 through 1929 with those from 1980 through 1987.

The declines that had already occurred in October 1987 looked a lot like those that had occurred just before the October 1929 stock market crash. That graphic in the leading financial paper, along with an article that accompanied it, raised the thought that today, yes, this very day could be the beginning of the end for the stock market. It was one factor that contributed to a shift in mass psychology. As I’ve said in a previous column, markets move when other investors believe they know what other investors are thinking.

Such feedback loops have been well documented in birds, mice, cats and rhesus monkeys.

Fear that stampedes causes the worst stock market collapses (and greatest opportunity).  The stampede instinct is part of our animal  nature.   The stock market is the savannah where life’s endless struggle continues to play.  Fight or flight.  Which? How do we know?

An article at “Learning fears by observing others: the neural systems of social fear transmission” (3) tells one tale of how our brain reacts when markets crash.

This hard read says “fear acquired indirectly through social observation, with no personal experience of the aversive event, engages similar neural mechanisms as fear conditioning. The amygdala was recruited both when subjects observed someone else being submitted to an aversive event, knowing that the same treatment awaited themselves, and when subjects were subsequently placed in an analogous situation.

This study suggests that indirectly attained fears may be as powerful as fears originating from direct experiences.

The amygdala is a small almond-shaped group of nuclei located deep in the middle of the brain.  It’s part of our lizard limbic system that helps us survive through fight or flight.  The amygdala processes memory, affects decision-making, and emotional reactions.  When senses danger it floods the body with fight or flight stress.

amygdala

Do we fight (buy)?

Or should we be in flight?

The human brain will react and answer these questions based on rumor, despite the facts.

Technology has made viral rumor transmission much easier so the stock market could fall much faster.

This does not mean we should not invest in equities.

We should protect against fear and greed by using these seven ways instead of our fight or flight responses.

#1: Do not care too little about strategy.  Do not overextend yourself.  Invest in good value for the long term and avoid fight or flight stress from the getgo.

#2: Do not panic during the stampede.  Make rational decisions.

#3: Turn on the auto pilot and normally add to your position.

#4: Do not let feelings influence you too much.

#5:  Add some restructuring stories to your portfolio

#6:  Know that a period of low returns will be followed by a period of high returns.

#7:  Place a higher priority on numbers rather than good stories.

Fear & Greed.  They are partners… creating the thrill and the macabre.

Ignore them.  Build on solid, sensible good value foundations that are sized for your wants, needs, desires and timing.  That’s the true path to everlasting wealth.

Gary

(1) www.nytimes.com: House flipping loans

(2)  www.nytimes.com:  Stock market crash 1987

(3) academic.oup.com – Learning fears by observing others


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