Sunday, March 12, 2017

Chart of the day:[ITB] and other stuff.

When something is a bubble, most market participants cannot see it because they are part of it, moving with it.  In fact, history shows that they think it will continue forever, that trees will grow to reach the sky, etc.  Why do they think this?  Simply because it seems to have been working like that for a long time and thus the locality of reference doctrine (a computer engineering term which I am for the first time hijacking for application as a parallel reference to herding behavior) suggests to the herd that it will keep on happening.  You look to the left and they are still running.  You look to the right and, yep, they are still running as well.  Guess I'll keep running too.  When something bad happens, we'll deal with it then (read the lyrics of Adele's "Skyfall"...) but for now the spiked punch bowl is open and the sky is the limit.  A more common way of saying "locality of reference" is "the trend is your friend".  Trend following is clearly herding behavior.  Trend followers don't care about fundamentals, they simply care about what everyone else is doing.

At the other extreme we have those who sit apart from the herd: watcher-theorists if you will.  You can always spot these people because they look at logic and data more than anything else.  Mish is a watcher-theorist.  Alan Greenspan is as well.  All the famous Austrian economists like Rothbard are/were watcher-theorists.  They all know when something is unsustainable when they review the data.  Remember Greenspan's warning about irrational exuberance?  He was correct but significantly early that if you just listened to his warning you would have been on the sidelines for even more gains (and then perhaps jumped back in right as the collapse was about to begin).

Elliotticians are part of a 3rd class: watcher-chartists.  We also know when something is unsustainable but we do not discount the fact that irrational behavior can continue longer than anyone ever expects.  Stampedes are difficult to predict without some kind of model.  For example, this recent article by well followed and highly regarded Seeking Alpha contributor Eric Parnell is not his first regarding the overvaluation of stocks.  Many people have been calling this a bubble market for a long time.  But this time he is lucky to be getting a clear blow off top in investor sentiment (see chart below) which allows him to pretty safely entitle the article to "The Greatest Fool is Here".  His view that (paraphrased) "when everyone is 100% confident there are no buyers left" is correct.  These markets are zero sum games where losers pay (or default on) winners; wealth is only transferred, never created by markets.  These are clear watcher-theorist kinds of statements.  But high sentiment can linger for quite some time before it reverses so a high instantaneous sentiment reading is not a clear market sell indicator.