“Let yourself be silently drawn by the strange pull of what you really love. It will not lead you astray.” — Rumi
“A group experience takes place on a lower level of consciousness than the experience of an individual. This is due to the fact that, when many people gather together to share one common emotion, the total psyche emerging from the group is below the level of the individual psyche. If it is a very large group, the collective psyche will be more like the psyche of an animal, which is the reason why the ethical attitude of large organizations is always doubtful. The psychology of a large crowd inevitably sinks to the level of mob psychology. If, therefore, I have a so-called collective experience as a member of a group, it takes place on a lower level of consciousness than if I had the experience by myself alone.” — The Archetypes and the Collective Unconscious by C.G. Jung
In “Threshold Models of Collective Behavior”, published in The American Journal of Sociology in 1978, Mark Granovetter outlines a simple model that attempts to shed slight on how seemingly identical crowds can each, collectively, react to events in profoundly different ways.
From the paper:
“Imagine 100 people milling around in a square—a potential riot situation. Suppose their riot thresholds are distributed as follows: there is one individual with threshold 0, one with threshold 1, one with threshold 2, and so on up to the last individual with threshold 99. This is a uniform distribution of thresholds.”
That is, there is one individual amongst the 100 that is willing to riot on his or her own, one individual that will riot if he or she witnesses at least one-person rioting, one who will riot if at least two people are rioting, and so forth.
Continuing from the paper (emphasis added):
“The outcome is clear and could be described as a “bandwagon” or “domino” effect: the person with threshold 0, the “instigator,” engages in riot behavior—breaks a window, say. This activates the person with threshold 1; the activity of these two people then activates the person with threshold 2, and so on, until all 100 people have joined. The equilibrium is 100.
Now perturb this distribution as follows. Remove the individual with threshold 1 and replace him by one with threshold 2. By all of our usual ways of describing groups of people, the two crowds are essentially identical. But the outcome in the second case is quite different—the instigator riots, but there is now no one with threshold 1, and so the riot ends at that point, with one rioter.
Even this simple-minded example makes the main point suggested earlier: it is hazardous to infer individual dispositions from aggregate outcomes.”
While by no means exhaustive, Granovetter’s simple threshold model shows why aggregate outcomes in a socioeconomic context can be so difficult to predict. Moreover, from the simple example provided in the paper, we can see how a very small change in the distribution of preferences can lead to large differences in outcomes.
In today’s hyperconnected world where virality is a daily, if not hourly, phenomenon, Granovetter’s model is highly relevant in coming to terms with the unpredictability of virality. It also helps understand why the giants of the internet-era — Google, Facebook, Amazon, etc. — have, subject to limitations, witnessed an acceleration, not deceleration, in growth as they have become larger.
In an investment context, the model highlights the pitfalls of blindly superimposing the experience of one market on to another or from one time period on to another.
Take for instance the experience of investors that have been betting against the Canadian and Australian housing markets, and by extension their banks, since the Global Financial Crisis. These bets have largely fared poorly and could to some extent be described as ‘widow maker’ trades — the moniker usually reserved for shorting the Japanese bond market. From what we have seen of the cases made against Canadian and Australian markets, most analysts have superimposed economic and demographic metrics witnessed in the US, and the UK in some instances, prior to the sub-prime mortgage crisis.
The trajectory of the Australian and Canadian housing markets over the last decade, however, suggests there are subtle, almost unidentifiable, differences in the thresholds of stakeholders and homeowners in those markets when compared to those either in the US or UK. These subtle differences have resulted in far different outcomes despite the overt similarities across the markets. The housing markets in both commodity exporting economies remaining largely intact, despite years of low commodity prices, seems to confirm as much.
Similarly, we can begin to understand why neither historical nor panel data has served well those calling for a hard landing in China or impending doom for the US equity markets.
Subtle variances can lead to huge differences in outcomes.
For anyone but the most extraordinary, identifying subtle differences is nigh on impossible. That is why, it is generally very difficult to call a market top or bottom. The better strategy, and the one we recommend, is to shoot a trend in the back — i.e. short after a clear break of an uptrend — than to time a market top.
“One of the most helpful things that anybody can learn is to give up trying to catch the last eighth—or the first. These two are the most expensive eighths in the world.” — Reminiscences of a Stock Operator by Edwin Lefèvre
Some Caution is Warranted
With that being said, we will somewhat contradict ourselves by arguing that at this juncture in markets, some caution is warranted. We think now is a good time to build up cash to re-deploy on a pull back.
Market momentum, on a global and cross-asset class basis, is the highest it has been since late 2017 — that is, just before the “volmageddon” of February 2018. Almost two fifths of global markets, irrespective of asset class, are at or have recently recorded 52-week highs. More than two thirds of developed and emerging equity markets have recently recorded 52-week highs.
Cross-asset breadth of 35 per cent or above has generally been associated with subsequent market corrections. That is, a cyclical pullback but not an end of the prevailing uptrend. Moreover, given how defensive investors became in the summer of 2019, the outsized moves in markets in recent months suggest that investors have covered shorts / underweights — making markets more susceptible to short-term pullbacks. Commodity Trading Advisors (CTAs), that is trending following strategies, are now at maximum equity market allocations. Target Risk Funds — asset allocation funds that hold a diversified mix of stocks, bonds and other investments — are also at maximum equity market allocations.
To re-iterate, now is a time for caution not courage.
Cyclical Not Secular
For further clarification, we are, however, not calling for an end to either of the long running equity or bond bull markets.
With the centenary anniversary of the Communist Party of China in 2021 and a US Presidential Election at the end of this year, we suspect policymakers in the world’s two largest economies will be pulling out all the stops to keep the uptrend intact.
Thank you for your support!
This post should not be considered as investment advice or a recommendation to purchase any particular security, strategy or investment product. References to specific securities and issuers are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed