"The Curious Transformation Of The Stock Market Into A Dog And Pony Show," by Fred Carach

I have been an investor for more than four decades. During this time period, I have watched the stock market gradually transform itself from a cathedral of capitalism into a circus freak show. The curious thing about this transformation is that almost no one recognizes that it has even happened. Many ill-informed people will tell you that there never was a transformation. That the stock market was always a circus freak show or a dog and pony show. I know better. I was there when it really was a cathedral of capitalism. You could say I was there at the creation.

The decisive change that has occurred is that the stock market is becoming progressively worse in its central task of providing the public with accurate and reliable figures as to what stocks are worth. A task that it performed well for generations. It is an example of the law of unintended consequences writ large. Very large.

It all started to go wrong in 1971 when the stock market under pressure from the SEC abolished fixed commissions on stock trades. Until that time, the only investors that could day trade were members of the New York and the American Stock Exchanges. The NASDAQ did not yet exist. The members of these exchanges had the invaluable privilege of being able to trade on the floor of their exchange without paying a commission. In those days the commissions were so brutal that they would eat alive any day trader who had to pay them.

As a result of the brutal commission structure, anyone who was not a member of the exchanges was forced to be a conviction investor. You were compelled to be a buy and hold investor. You could not afford to bail out of any trade that went a couple of points against you. This compelled investors to carefully research the stocks that they bought and to hold on to them even if the trade went temporarily against them. The result was that the stock market performed the way that it was supposed to. It provided the public with accurate and reliable figures of what stocks were worth.

Each decade after 1971 saw lower and lower commissions. As the commissions fell, more and more investors felt that they could ignore the cost of commissions. For the first tine, they could afford to guess about the direction of stocks. They no longer were compelled to be conviction investors who carefully researched their stocks. The boom of the 90s coupled with the internet witnessed the full flowering of the day trader. The age of the dog and pony show had begun.

To veteran stock investors the thing that hit you on the head was that the stock market was reacting to every news event no matter how insignificant with a violence that had never been seen before. The stock market was becoming a perpetual overreaction machine. Stocks and the stock market were being jerked around like a monkey on a chain by news reports that in the old days would scarcely move stocks or the market. Knowledgeable investors were noticing something else that the general public was blind to. They noticed that there was an ever-widening gap between the intrinsic value of stocks and their selling price.

The rise of a new investment class of day traders and trend chasers was changing the very nature of the stock market. This new class regarded stock analysis as a waste of time. They would proudly tell you that the only thing you needed to know about a stock was whether it was going up or down. You mindlessly bought whatever was going up and you mindlessly sold whatever was going down. As the conviction investor declined in numbers and power there was no one left to mind the store. There was no one left to keep the market value of stocks from deviating more and more from their intrinsic value.

If this new class of investors regarded traditional stock analysis as a waste of time there was something that they did not regard as a waste of time.
They were obsessed with analyzing the buying and selling actions of other investors. They could not care less about the stocks. In this new world stock analysis was out. Guessing which way the herd would stampede was in. When you stop to think about it. This is very strange behavior. It is much easier to estimate what a stock is worth than to try to figure out which way the cattle are going to stampede.

It is as if the fans in a sport stadium have decided that the best way to find out who is winning on the field is by doping out the actions of the fans in the stadium rather than following the action on the field.

Welcome to the new dog and pony show. The strangest thing about this is that no one seems to have realized that it has even happened. I follow the stock market very closely and I cannot recall the subject even being brought up.

This article is the latest in a series of articles that I have written about today’s weirdo stock market. Those who have found this article of interest should read the latest in this line entitled, “Stupidity Unchained - The Curious Saga Of Today’s Stock Market.”

Forty Years a Speculator

Fred Carach

Oakland Park, FL 33309

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"Forty Years a Speculator -The Death Of The Stock Market As I Knew" by Fred Carach

When I broke into the stock market more than forty years ago in 1961 it was a radically different beast than it is today. It was a market overwhelmingly dominated by long-term, conviction investors who believed that they were buying or owned a real business rather than a stock certificate. The belief then was that the stock certificate was nothing more than proof of ownership. It was not a lottery ticket. Investors then were committed owners who religiously bought the goods and services of the companies that they owned. What was important was that the stock that they purchased paid a good dividend and in those days, it usually did. It was then common for blue chip stocks to pay a dividend of five or six percent.

It would never have dawned on investors then that they were supposed to rush to sell their holdings even if their stocks fell as much as ten or fifteen percent. In fact it was quit probable that they would not even be aware of a ten or fifteen percent move. The way it worked in those days is that about every six months it dawned on you that you should look in the paper to see what your stocks were selling for. Then you would throw away the newspaper and not look at your holdings for another six months. It was common to think of holding periods of five or ten years and in many cases people expected to retire owning the stock. The dividend was going to be an important supplement to their social security.

This of course assumes that your newspaper even carried the stock tables. In those days, many newspapers did not. When I was growing up the Cortland Standard, our local newspaper did not carry the stock tables. In fact it did not even have a financial section.

When I started investing in the 60s, I refused to look at my stocks during the week. I didn't want to get caught up in the weekly cattle stampedes. I always knew that stampeding with the herd was not the answer to successful investing. I subscribed to Barron's Financial Weekly, which arrived every Saturday. I could then leisurely review my holdings over the weekend. This strategy served me well for decades. However, eventually I had to go on line like everyone else. The decades of discipline served me well. My investment strategy of long-term conviction investing remained unchanged.

Today the stock market as I knew it is dead. The long-term conviction investors who understood that they were buying a business and not a lottery ticket is now a shrinking minority group. The stock market today is dominated by the trend chasers, a category that barely existed in the 60s. it makes little difference if you call this dominate group day traders or momentum players. They are united by their steely conviction that what they are buying is a lottery ticket. Regrettably, they are too stupid to realize that if you treat the stock market like a casino then the stock market will treat you like a gambler.

The world of the trend chasers is to a great extent dominated by technicians or chartists. About the fundamentals of the corporations that they are following they know nothing. Indeed they regard their ignorance as a badge of honor. They are totally clueless that their might be a real business behind the lottery tickets that they own. They are interested in only two things as they track their stocks across their charts, price and volume. They will be happy to inform you that the only reason to buy a stock is that it is rising in price and if it is not rising in price it is a bad investment no matter how great the fundamentals are.

Their other great fixation is their unalterable conviction that paper losses and real losses are the same thing. They have total scorn for anyone who does not share this belief. A paper loss is a loss that would be realized if the holding was sold at its current price. Therefore, since a paper loss and a real loss is the same thing their secret weapon for investment success is the " stop-loss order." The stop-loss order is an order to your broker to automatically sell your stock if it falls to a predetermined price. Which is almost always set at between five and ten percent below the current price.
Trend chasers are adamant that all paper losses greater than five or ten percent must be sold immediately because all such stocks are destined to go to zero. Nothing can dissuade them from this insanity. The brutal result is that every time they turn around they are being blown out of their positions by their stop-loss orders being executed. Stock declines of five to ten percent are as common as dirt in the stock market. The trend chasers refuse to recognize this reality. The brutal result is that all their paper losses become real losses.

As a conviction investor I have made a career out of Turning paper losses into profits. The trend chasers make a career out of turning paper losses into real losses with devastating consequences. If you have a good opinion on stocks and just hold on most of the time the stocks will reverse their decline and your losses will turn into profits. Their insistence in believing that all stock declines greater than five or ten percent is proof that the stock is headed for zero is insanity.

Very few investors who practice this strategy survive over the long term in spite of its tremendous popularity. The way it usually works is that the trend chaser is blown out of his position at or near the bottom. They then sit around in a stunned stupor as the stocks that they sold at a loss reverse their trend and make back all that they have lost and more. Often much more.

What is truly astonishing is that no matter how often they have seen how this film ends. They never change their tactics. The losses keep piling up until they are so shattered by their losses that they end their investing career. They can then embark on a their new career of contemplating how much they wold have today if they only had the courage to hold on to their losers.

Those who have found this article of interest will also find my related articles on the stop-loss order and technical analysis which are on this site to also be of interest.

"TODAY'S IRRATIONAL STOCK MARKET AND THE RISE OF THE PROPELLER HEADS" BY FRED CARACH

When I broke into the stock market in 1961 the stock market was a far more rational market than it is today. The type of news that will send a stock up or down four or five points today would have in the 60s and 70s only sent the stock up or down a half point. The stock market today resembles to an ever increasing degree a" perpetual overreaction machine". It is forever being jerked around like a monkey on a chain.
One constantly hears alleged market authorities proudly proclaiming that the market is always looking forward six months. Not any more! Today's market is too stupid to anticipate anything. It does not anticipate it reacts in shocked surprise and with with ever increasing violence. The question is what has brought about this dramatic change in market behavior?
The answer is that the market players and their relative strength has changed. And the most important new factor by far has been the rise of the "propeller heads" as they are fondly called on the street. Their common name is Quants because they are engaged in quantitative analysis.
By the 80s it had became fashionable for Wall Street firms to raid college campuses for math PhDs. Then stick these certified geniuses into a room with a high-powered computer and tell them to come up with a sophisticated black-box algorithm that would enable them to beat the market. And in many cases they succeed. And thus computer-generated program trading was born.
The other key players in this drama were the day-trader and the momentum player. Both of these players had long existed but until the 80s they were small potatoes.
In the 60s when I started out the stock market was dominated by the individual investor. The individual investor in those days was overwhelmingly a "conviction investor". He researched stocks as best as he was able to and based on this research and his convictions (he liked the product). He bought the stock. By long-term I mean at least five to ten years. Today long-term means I might own the stock six months as long as it doesn't go down 5%. If it goes down 5% I am out of there.
It is important to understand the distinction between a market and mob-action. A market requires the prudent, informed, carefully calculated and above all else "independent-opinion" of the entire mass of the decision-makers who make up this market. In the absence of these independent decision makers you don't have a market you have a mob that is pretending to be a market. This results in ever more violent reactions to the news of the day that can not possibly be justified when you analyze the economic realities of both stocks and the market. This assumes of course that anyone is still paying attention to tried and true fundamental analysis. After all why waste your time with this boring stuff that may only pay off in the long term when you can participate in the excitement of the street's latest cattle stampede. Even if it is heading off a cliff. After all we are smarter than the average herd animal aren't we? There is no doubt that we will spot the cliff before the rest of these clowns. Did you ever see a more confused herd of sheep and goats? I don't think they could find a cliff if they tried to!
My god how did that cliff get there? Help!!!
Historically the stock market was soundly based on masses of independent decision makers. As time passed however, these independent decision makers were gradually replaced by the rise of the institutional investors who for all of their alleged vaunted sophistication showed a much greater tendency than the individual investor to stampede with the herd. The transfer of market making power from the individual investor to the institutions resulted in a vast reduction in the number of independent decision makers.The growing tendency of the institutions to concentrate on short term profits and to participate in every cattle stampede went on steroids when the propeller heads arrived on the scene. Their magic black boxes based on their secret algorithms promised and more often than not delivered superior short-term returns. Long term investment went out the window. The future was now.
As this bias took over the market the day traders and the momentum players exploded in importance. As time progressed many of the black box programs seeped down the food chain and became more readily available to them. It was found to be impossible to keep the most successful programs secret for long. As a result everyone began to march to the same drummers.
During this period the ranks of the old time conviction investor with his independent viewpoint and long-term holding pattern shrank to insignificance. And thus was born today's whiplash market. Strangely enough for an old school investor like myself this new world order is a gold mine.The only thing I have to do is hide in the weeds and pick off the game as they thunder pass me in one of their mindless stampedes.
Fred Carach is the author of Forty Years A Speculator. His blog is located at fortyyearsaspeculator.blogspot.com.