April 14, 2017

A negative feedback process could bring the market down

As investors and human beings we are not perfect and we have our limitations and flaws. Our mind can only process and handle so much information at a time.

George Soros once said 
"It is generally recognized that the complexity of the world in which we live exceeds our capacity to comprehend it. I have no great new insights to offer. The main source of difficulties is that participants are part of the situation they have to deal with. Confronted by a reality of extreme complexity we are obliged to resort to various methods of simplification-generalizations, dichotomies, metaphors, decision-rules, moral precepts, to mention just a few. These mental constructs take on an existence of their own, further complicating the situation."
What does Doug Kass think of how we think and how it affects our investments. He says that our world is complex and it is beyond our capacity to understand it. 

Kass writes about momentum trading specially the robots and algo traders.

"Group stink" is multiplying -- in the canyons of Wall Street where so many investors and traders worship at the altar of price momentum; in the coding of machines and their algorithms; in the leveraged and unleveraged market ETFs that have garnered so much popularity; and in the herd-like opinions of commentators and the legions of talking heads who parade their views daily in our business media platforms."

This kind of herding behavior and type of thinking can be dangerous to our financial health. Doug Kass says,
"Group stink is a reflexive feedback loop. It is a vain pursuit of certainty, often falsified by testing or the idea of a new paradigm in valuation. In our markets it has led to a state of uber and almost perma-bullishness over the last few years as the irrational may have been rationalized in a world of fake news."

What goes up must come down. What Isaac Newton discovered of Gravity applies even for Financial Markets as nothing lasts forever. Kass says that 
"The bullish feedback loop has become self-reinforcing, but it cannot go on forever because eventually the participants' views will become so far removed from objective reality that the participants ultimately will need to recognize them as unrealistic."