Behavioural error called ‘representativeness’ suggests that humans can be easily anchored. These anchors are psychological biases, which are more inaccurate than accurate. If you buy a used car based on just the odometer reading and the model year, you are anchored (biased not objective).
Stock markets are no different and market players work on similar anchors. Now what are the most watched popular anchors? Gold or dollar may be important anchors but nothing beats the allure of the Dow (Dow Jones Industrial). What happens in America (especially American markets) still gets the most eyeballs. Why America? Why Dow? Call it soft power, spin or Mac burger @ IPhone. The more we get globally interconnected, the more we get emotionally hooked, and the more we get anchored (hooked onto a bias), the more global markets get correlated.
Despite limited emerging market history, it has not taken us much time to sync regional market lows and highs with Dow. Be it the 2000 high, September 2011 lows, 2007 highs and the recent 2009 lows, the equity brotherhood oscillates together with the Dow. So, if the Dow is so important, then watching it closely for cues remains essential.
One may say, Ok! Dow is an anchor, but why the fooling? There is one thing about the market I have learnt over the years. It always surprises. The element of surprise is repetitive. The cyclical nature of the market exists because the majority of market participants are intuitive. So, if there are only 95 per cent of us bearish, the possibility of a bullish reversal is more likely. Surprise is also because when majority clusters at the intuitive bearish end, it leaves the market no choice but to surprise. Ninety five per cent bears have limited counter party to keep falling. In other words bears need a buyer to sell, too.
The Solomon Asch three line experiment illustrated how foolishly we herd and confirm. The “naive participant” was fooled to believe the group opinion by calling lines of different lengths as having the same length. If humans have an instinct to herd then how can we ever believe public opinion to have any predictive value. And on the other hand, the fact that sentiment clusters makes it predisposed to failure.
Human opinions don’t transform if we replace lines on a piece of paper to one on the trading desk. The Dow is a line for the “individual participant”, the one not in the market hypnosis experiment.
The majority may say that Dow is bearish because of various causes. But what would the individual participant say; the one who is outside the influence of the herd. Well he would say that “I see a line that is moving sideways for 10 years and now I see it heading to the 10 year level”. If this participant would be shown a yearly chart, he would change his opinion and say that “now the line has already reached the 10 year high”. If this unbiased observer was given the Dow denominated in Indian Rupee, he would say “the line (Dow Jones) is above the previous multi year highs and seems to be headed higher”.
Unfortunately, if most of us are bearish and fail to objectively shout out that the “king is naked”, it is tough for us to conserve, leave aside profit. Now that on a yearly basis the Dow is already at a historical high, the five per cent daily up-move is a mere formality that would reconfirm that the world’s foremost wealth anchor is bullish. And the other interesting part here is that all of the majors; the Brazilian Bovespa, Shanghai Index, India Sensex and Dollar Index are witnessing a multi-year underperformance against Dow. The respective underperformances are getting ready to bottom and reverse course. This would mean that if we assume Dow is breaking 14,000 shortly, a minimum target would be 50 per cent higher. This could mean a multiple times growth for most emerging markets like India, a potential upside of 150 per cent in 18-36 months. Now one may call, the “individual participant” foolish, but success comes to the one who rather be alone and “foolish” than be in a group and “smart”.
The author is CMT, and Co-Founder, Orpheus CAPITALS, a global alternative research firm