Historic examples of Crowd madness

November 2007:- To fathom today’s gyrating markets, look no further than crowd psychology. The slide is unsurprising, considering the boom that preceded it. If investment bank strategists and fund managers were frank with themselves and their clients, they would admit that a rampant speculative bubble had to implode. All the warning signs were there.

Central bankers, treasury ministers and others were sounding about inflation for many months and steadily raised interest rates. Those amber flashes failed to slow down stock, commodity and property booms. Salaries and bonuses surged and the champagne flowed.

Then suddenly, the sense of euphoria of ever increasing asset prices became nervous when prices dipped. The slump continued and we have experienced the first signs of market paranoia. Shares that were eagerly bought in previous weeks have been dumped. Blue skies have  turned grey.

Investors always fear whether a mere shakeout in a major bull market is the initial phase of a bear market. Worse, some fret that there will be a Japanese-type asset price deflation that could cause a US recession and global downturn.

Central banks, have already begun to pump money into the system to avert a credit crisis and recession.  The US Federal Reserve has led the way.  But the Bank of England and European Central Bank have been slow to slash interest rates.  So the euro and sterling have soared.  At some point the market will realise that the US economy will turn around quicker than Europe and the currency markets will swing the other way.

Historical guidelines

Investors need to guess what the gunslinger mutual and hedge fund manager crowd intends to do.  Here are some historic guidelines showing that markets, despite sophisticated technology and systems, hardly change. The reason is that there is a swift turnover of participants, so that at most, only a few of the current professionals would have experienced prior bear markets.

—- In the 1920s, easy money policies contributed to a stock market boom and property speculation in Florida . In October 1929, Wall Street crashed. There was a swift bear market, followed by a sizeable recovery. But that was a false signal in the depression years of the 1930s. The bear market that followed was far worse than the initial crash.

—- In the 1960s, there was another stock market boom followed by a bear market in the early 1970s and a sideways trawl until 1982. Then, interest rates were high and there was deep pessimism – the classic beginnings of a long bull market.

—- Instead of equities, commodities were the fad in the 1970s with oil and copper soaring and gold surging from around US$40 to a peak of US$850 an ounce in 1980 and silver reaching US$50 an ounce. By the mid-1980s, gold was around US$250 and silver under US$4 an ounce. Oil was trading about 75 per cent below its late 1970s peak.

—- Equities reached for the sky in the 1980s and then came down with a horrible thud in October 1987. The market revived, but remained tentative for several years before commencing the final leg of a long-term bull market in the latter part of the 1990s. That market became the famous tech bubble. Then followed a severe three-year bear market, aggravated by Sept 11, 2001 and the events leading to the Iraq war.

—- By early 2002, pension funds and insurance companies were dumping shares that were offering exceptional value. Of course, the market then turned and with minimal corrections, kept rising in a three-year bull market that reached a peak early May this year.

—- The most intriguing market bubble this time round revolved around commodities. They were shunned in 2001 when they were at rock-bottom prices. The silly aspect of the boom was pension fund investment in this so-called asset class. These new investors, or should we say, suckers, were sold on the ‘super cycle’ of ever-increasing purchases by China regardless of price. Most bought late in the day.

—- Paradoxically, the final phase of the commodity boom was precipitated by bears, who had sold short, expecting to profit by buying back the commodities at lower prices. They were correct in their fundamental analysis as high prices have caused demand to contract and supplies to rise. But their timing was wrong. Having sold too soon, the bears pushed up prices in frantic efforts to cut their losses


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