(noun, etymology Dutch from ‘boedel’: estate, possession, inheritance, stock.). 1. Crowd, pack, lot, as in ‘the whole boodle.’ 2. a. Counterfeit money b. Money acquired or spent illegally or improperly, particularly when used in bribery for political purposes. 3. Slang for money in general.

Stock Prices and the Social Nature of Money (Part II)

Posted on: Sep. 28, 2010  |  By: Ronnie Kahn  |  Category: General

In Part I, we examined that individuals are strongly affected by what others are doing.  In normal circumstances everyone examines a stock and makes an independent decision as to whether to buy or sell.  This decision though can be greatly affected by the influence of others with, for example, the result being a behavior called herding or also others can be affected by the emotional nature of an event as well.  We have a tendency for follow a generative narrative that these are boom times with things improving or down times when more caution rules the day.

In a normal stock market, individuals do what is called fundamental analysis.  We research the quality of that company, and then choose to buy or sell depending on the price we have to pay.  Our analysis can get into the company’s management, its balance sheet and revenue, its product’s competitiveness, and so on.  The analysis doesn’t always stop there.  We don’t just use a strategy of what we think is a good price to pay for a stock.  We also base our decision on what others are doing.  It doesn’t matter how good we think a company is unless we figure that others will find it profitable too.  In normal times, the market generally gets it right as there as so many individuals betting one way or another that everything tends to average out.

There is an additional type of stock analysis called technical analysis.  This is traditionally based more on the direction of the stock’s price.  More and more of late, stock prices have been exhibiting this type of emotional swinging gate, or waves of momentum.  We just chalk it up to the irrationality of the markets.  Not only that, but a stock’s price gyrates from one day to the next based on no clear cause, such as lowered profit expectations or bad news.

In theory, we investment folks were taught by neo-classical economists that the markets are efficient and are based on what data rational investors are given.  Then behavioral economists came along and showed us that the other side of the coin is emotions.  Investments are made based on the misapplication of what we think we see in front of us.  For example, when we hear good or bad news about a company, we overweigh this and expect the good or bad news to keep coming.

The problem arises when no one is making an independent choice about what the company has to offer and where they think others will expect the price to move.  In other words, all decisions are being made on what others are doing.  When that happens, there is either a stampede out or a rush to get in.

With all of us so tied together, companies have become more vulnerable to things like available credit, consumer spending and confidence, and “butterfly effects” from a seemingly small crisis in a small country, taking everything down with it.  When shocks and negative events rule the day, emotion seems to trump fundamental stock analysis, and we are left with huge institutional bets on technical stock prices and computer programs designed to crunch the data to find a trend as to whether to bail out or charge ahead.

Institutional investing is indirectly effected by herding as well.  Even if investors aren’t investing in individual stocks, they put large chunks of money in the same investment pools such as 401(k) retirement plan separate accounts.  Some managers have huge blocks of securities which when bought or sold effects prices.  In addition, these institutions are using computer models that use their own thresholds.  They put buy or sell orders in, which kick in automatically based on a certain prices or certain percentages of movement.  These thresholds can start to resemble each other.  At any rate, once a threshold is reached, large amounts are moved which may kick in other thresholds.  Consequently, there is a larger ebb and flow of prices jumping around.  This leaves fundamental investing looking like the job of  bank teller, in that, when was the last time you saw one?

All of this doesn’t even get into that reputation and image get built into a price.  It also doesn’t touch on the social nature of consumer spending where so much of what we buy has to do with comparison to others, social status, and “keeping up with the Joneses.”  Consumer prices don’t jump around like financial markets since they are not based on negotiations and the possibility of unknown loss.  Stock prices, macroeconomics, and consumer behavior are now as viral as a YouTube video or instant celebrity, yet no one can predict under what circumstances something goes viral. It certainly doesn’t have to be that the video was funny or the celebrity talented.  It just boils down to billions of social interactions that no one is managing and no one is directing.

If more and more of us could resist buying based on what others are doing, then we could lower the threshold where everyone rushes in.  In other words, there are many of us who are fence sitters.  At a certain point, a threshold is reached and we join in.  However, if there were more rational decisions being made early on, that threshold would be harder to reach.

As an investment advisor, it is difficult to steer clear of manias when that is what the media and everyone seems to focus on.  I seem to be doing two different types of investing these days; one for stable markets where independent decisions seem more likely, and another for when mania, panic, or the after-effects or fear of them rule the day.  With something rising so fast, it’s quite the trick to discourage someone from avoiding the whole mess.  Everyone wants to get in and then get out at the right time.  There are so many excellent investments that it doesn’t make sense to gamble retirement incomes and nest eggs on accidents waiting to happen.

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