October 11, 2017

Climbing Mountains

You’re welcome.

Had Karen and I not departed Sep 20 for Bavaria to ride bikes along the Alps, who knows what the market might have done?  There’s high statistical correlation between our debouchment abroad and a further surge for US stocks.

Stocks spent all of September above 5.5 on the 10-point ModernIR Sentiment Index. Money never paused, blowing through September expirations and defying statistics saying 80% of the time stocks decline when Sentiment peaks as derivatives lapse.

Were we committed to the interests of stock investors we’d pack our bags with laundered undergarments and return to Germany before the market stalls.

But is the market rational?

Univ. of Chicago professor Richard Thaler, who won the Nobel Prize this week for his work on behavioral economics, is as flummoxed as the rest by its disregard for risk. While Professor Thaler might skewer my certitude to knowledge quotient (you’ll have to read more about him to understand that one), I think I know why.

Machines act like people.  My Google Pixel phone constructed a very human montage of our visit to Rothenberg, a Franconian walled medieval city in the woods east of Mannheim.  I didn’t pick the photos or music. I turned on my phone the next day and it said here’s your movie.  (For awesome views of our trip click here, here, here and here.)

Google also classifies my photos by type – mountains, lakes, waterfalls, boats, cars, churches, flowers, farms, beer.

Don’t you suppose algorithms can do the same with stocks? We have long written about the capacity machines possess to make trading decisions, functionally no different than my Pixel’s facility with photographs.

For companies and investors watching headlines, it appears humans are responding.  If airline stocks are up because of good guidance from United Airlines and American, we suppose humans are doing it. But machines can use data to assemble a stock collage.

The way to sort humans from robots is by behavior. It’s subtle. If I sent around my phone’s Rothenberg Polka, where the only part I played was naming it, recipients would assume I chose photos and set them to music. Karen would look at it and say, “Get rid of that photo. I don’t like it.”

Subtleties are human. Central tendencies like flowers and waterfalls are well within machine purview. Machines don’t like or dislike things. They just mix and match.

Apply to stocks. It explains why the market is impervious to shootings, temblors, volcanic eruptions, hurricanes, geopolitical tension. Those aren’t in the algorithm.

Humans thus far uniquely grapple with fear and greed. A market that is neither greedy nor fearful is not rational. But it can climb mountains of doubt and confound game theorists. What we don’t know is how machines will treat mismatched data. We haven’t had much of it in over nine years.

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