Herd Behavior

"Herd behavior, or the tendency of individuals in a group to 'follow the trend,' has frequently been observed in equity markets. Herd behavior in investors leads to a convergence of action." [Yan, Zhao, Sun (2012)]

"Theoretical models on herd behavior predict that under different assumptions, herding can bring prices away (or towards) fundamentals and reduce (or enhance) market efficiency." [Yan, Zhao, Sun (2019)]

Herd Behavior image

For anyone still shaking their head over the recent eye-popping, one-way trends in the stock market, the academic assessments of "herd behavior" above may provide one of the best summations I've seen. 

Or, if you prefer something a little more pop culture oriented, there is Eddie Vedder's view on the subject from the 1996 Pearl Jam hit Do The Evolution... "I'm the man buying stocks on the day of the crash... It's herd behavior, uh huh, it's evolution, baby." (P.S. If you are looking for a little kick-start to your day, this video will definitely do the trick.)

Blame It On The Computers?

To be clear, I have never been involved with a high-speed or high-frequency trading shop. As such, I have to admit that I do not know all the ins and outs of how today's algorithmic trading programs function - or even what triggers them. However, I have done a fair amount of research on the subject and as such, I am pretty confident that algo-induced herd behavior had a hand in both the slow-motion crash that occurred between 12/4 and 12/24 and the ensuing joyride to the upside that began on 12/26.

I know, I know. We can't blame everything on the computers. And yes, there were definitely "issues" that traders and investors had to sort through/deal with in December. Not the least of which was the fear that a policy misstep from Powell & Co. was unfolding before their very eyes. But the bottom line is that the computer algorithms were the herd this time around.

You're Fired!

Lest we forget, the President had a hand in the problem as he appeared to channel his best "Apprentice" act relating to his desire/ability to "fire" the Fed Chair. In short, this put the FOMC in a bit of a spot. While the data - especially the "soft data" and almost anything related to inflation pressures - was clearly weakening, the new Chairman most definitely could not appear to kowtow to politics.

I think it is safe to say that it was the Fed's need to publicly display its independence from the White House that caused Powell to appear more hawkish than anticipated in December. And from my seat, it was the hawkish stance and the use of words such as "autopilot" that seemed to indicate that a Fed-induced recession might suddenly be a reality. A reality that needed to be priced into stock prices.

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Disclosure: At the time of publication, Mr. Moenning held long positions in the following securities mentioned: none - Note that positions may change at any time.

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