The ‘madness of crowds’ will win every time

Henry Jennings | Marcus Today

There is so much written on fundamental analysis. Finding growth companies, becoming your own Warren Buffett Mini – Me. Investors and analysts pour over annual reports, build complex spread sheets and fiddle with inputs to come up with ‘fair value’. Price targets are shuffled around and changed to ensure they are not too crazy compared to the market prices.

Technical analysts fire up the computer, add some moving averages and their favourite trading signals, trying to spot the trend and the pivot points. History and patterns are paramount.

Then along comes a week like last week. The US markets went from the ‘Great Rotation’ in July to the ‘Great Correction’ in August. It happened so quickly. In the Australian Market, we fell from record highs to a big sell-off. The stocks that took us up, the banks came under serious pressure. Every talking head and analyst had been cautious on banks. CBA had become our largest company on the ASX. CBA is the most expensive retail bank in the world by most metrics. Yet where was the huge growth to justify this valuation? Almost tech behemoth-like. It may be a great franchise, but growth? But that did not stop investors from pushing it to irrational levels. Of course, that looks more irrational with hindsight.

And what is driving this correction? Psychology. Crowd psychology. You can build the best spreadsheet and have the best indicators, but the ‘madness of crowds’ will win every time. Human beings feed on fear and greed. Humans program computers, and pass on that fear and greed. In tech speak, that is called ‘momentum’ trading. Nearly everyone has been on the tech trade in the US. The so-called Magnificent Seven. It has been the most crowded trade for months. The trouble is that when the crowd moves, it is every man/woman for themselves. The logic goes out the window, stops from active traders are triggered, and cascade downwards. One step away from sheer panic. A charge of the flight brigade. And with the same consequences.

Smart investors can sometimes sense when the crowded trade is just too crowded. If everyone is long and bullish, who is left to buy it? Who, in the game of pass the parcel, or the greater fool, is going to take the stock off your hands at a higher price? Anyone? Bueller?

The good news is that these crowded trades unwind fast—fast and painfully for some. For others who have been more circumspect and have not blindly followed the crowd, it can be a huge opportunity.

These times of turmoil can be portfolio-defining. Not always in a bad way.

It is important for investors to stay disciplined, stick to the investment plan, and use volatility to build long-term positions in quality companies.

You have to look at what has worked in the past when rates were rising or at least on hold, these trades are unwinding. The so-called ‘carry trade’ has been under pressure; this is when borrowing in low-interest-rate environments is used to gear investments in countries with higher rates. Typically, Japan has provided cheap funding options that have allowed hedge funds and aggressive traders to then put that money to work in taking leveraged bets. That is unwinding. It seems a 0.15% rate rise in Japan was enough to send that shudder through the market with significant repercussions. But we should put this into some sort of perspective, 0%-0.1% to around 0.25%. Maybe more to come.  This was designed to curb the slide in the Yen against the US dollar. The Japanese market actually rallied post the announcement. For a day! It is all about relatives. Japan is putting its rates up, and at the same time, the US is now looking at more cuts in the coming months. Relatives.

Whilst there are opportunities, there is no point in standing in the way of the cavalry charge when the herd is moving this quickly. Wait for the moment. Have a shopping list ready of stocks that you feel safe buying and the prices you feel comfortable with. There is no rush. A rout like this hits confidence and that takes time to rebuild.

But it is important to remember, this too shall pass.
 

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All prices and analysis at 5 August 2024.  This information has been prepared by Marcus Today Pty Limited.  Marcus Today Pty Ltd ABN 57 110 971 689 is a Corporate Authorised Representative (no. 310093) of AdviceNet Pty Ltd ABN 35 122 720 512 (AFSL 308200). The content is distributed by WealthHub Securities Limited (WSL) (ABN 83 089 718 249)(AFSL No. 230704). WSL is a Market Participant under the ASIC Market Integrity Rules and a wholly owned subsidiary of National Australia Bank Limited (ABN 12 004 044 937)(AFSL No. 230686) (NAB). NAB doesn’t guarantee its subsidiaries’ obligations or performance, or the products or services its subsidiaries offer.  This material is intended to provide general advice only. It has been prepared without having regard to or taking into account any particular investor’s objectives, financial situation and/or needs. All investors should therefore consider the appropriateness of the advice, in light of their own objectives, financial situation and/or needs, before acting on the advice.  Past performance is not a reliable indicator of future performance.  Any comments, suggestions or views presented do not reflect the views of WSL and/or NAB.  Subject to any terms implied by law and which cannot be excluded, neither WSL nor NAB shall be liable for any errors, omissions, defects or misrepresentations in the information or general advice including any third party sourced data (including by reasons of negligence, negligent misstatement or otherwise) or for any loss or damage (whether direct or indirect) suffered by persons who use or rely on the general advice or information. If any law prohibits the exclusion of such liability, WSL and NAB limit its liability to the re-supply of the information, provided that such limitation is permitted by law and is fair and reasonable. For more information, please click here.