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Market Tops Form "At The Margin"

Tyler Durden's picture




 

Yesterday, Federal Reserve Chairman Ben Bernanke likened monetary policy to landing a jet on an aircraft carrier which reminded ConvergEx's Nick Colas of a few choice 'Top Gun' quotes...  "Son, your ego is writing checks your body can’t cash" seems most appropriate. But Colas' review of a recent academic paper on the social dynamics of how long people applaud - and why they stop - is perhaps useful in comprehending the market's reaction.  The funny thing about the work is that the distribution of ‘Clapping duration’ looks pretty much exactly like the P/E ratio of the U.S. equity market going back to the 1800s.  Why do people start and stop their applause or buy into a stock market?  It all happens "at the margin" in both cases, and just a few people putting their hands in their pockets is enough to get the rest to stopWe still can’t get “Highway to the Danger Zone” out of our head.

Via ConvergEx's Nick Colas:

One of the most entertaining features of the 1980s is that the entire decade is neatly summed up by just 2 movies: “Top Gun” and “Wall Street”.  The first glamorized the defense industry, one of the big industrial winners of the day, and the other codified the public’s perception of modern finance.  Who can forget “Greed is good” or Maverick buzzing the tower?  Good times…

I had an 80s flashback today when Federal Reserve Chairman Ben Bernanke likened the challenges of managing monetary policy to landing a jet on an aircraft carrier.  Now, the Chairman bears very little resemblance to Tom Cruise, to be sure.  But in my mind’s eye there was Dr. Bernanke in a flight suit trash talking his fellow naval aviators in the ready room.  The thought didn’t really get as far as figuring out who might play the doomed “Goose” character, but I suppose the current chatter about San Francisco President Janet Yellen taking the reins next year makes her the logical choice.  Since her job isn’t as dangerous as the #2 on an F-18, I expect she will be fine.

As tempting as it would be – and consistent with the spirit of these notes  - to find some similarities between dog fighting and monetary policy, that’s not where we are going today.  If you need to take a moment and put on Kenny Loggins’ “Highway to the Danger Zone”, I understand.

I recently read a novel study by some European researchers about how long people applaud.  They taped a variety of audiences at college lectures and then parsed out when and how long individuals gave the requisite round of clapping after a lecture.  The goal of the work was to understand how “Social” issues – the manner in which individuals response to the actions of others – change human behavior and how long an impact they might have.  This is a hot topic at the moment, given the valuations given to social networking companies.  If there are discernible clues to how people join groups and how long they stay, leveraging these observations would be the veritable pot of gold at the end of the rainbow.

What struck me about the study, however, was distribution graph of how often the population being studied actually clapped.  There is a link to the study at the end of this note, but here is a brief description:

  • The distribution of claps is a typical “Bell curve, anchored at zero (no clapping) on the left and with a longish tail on the right.  A few people clap a lot, evidently.
  • The average number of times someone claps at a lecture was about 10.  The fat part of the distribution is 5-15 claps.
  • No one clap-count had more than 10% of the observations.  It is unusual for people to clap exactly the same amount repeatedly, which also makes sense.

The bit that surprised me was that the clap-count graph looks pretty much like the typical market P/E ratio histogram we’re all used to seeing.

Yes, there are plenty of ways to value the stock market, but the Price/Earnings ratio is still the most widely quoted.  The relevant data from this graph is:

  • The most common P/E ratio based on current earnings is 14 times.
  • The “Chunky middle” of the distribution is 12-18 times (remember this data goes back to 1871).
  • There are a handful of long-tail high multiple periods (north of 30) and a few (10 years) at or below a 10 P/E.

Now, there are plenty of naturally occurring data sets which exhibit the same kind of sloppy “Normal” distributions, but this comparison makes some intuitive sense to me.  Stock valuation is essentially a form of ‘Approval’ that investors are confidence in the fundamental underpinnings of the equity market.  And, of course, clapping is a sign of approval from an audience about a just-witnessed performance.  Consider that the U.S. stock market currently trades for 15x current year earnings, and you’ve got a pretty typical level of “Approval” that fundamentals are reasonably robust.   At least as strong as the average of the last 130 years or so.  Not bad.

So what gets a group of people to stop clapping, and are there any lessons for those of us who look at capital markets?  Here is what the researchers found on this point:

  • Applause starts with just a few people in an audience and gathers steam.  The end of the clapping starts in much the same way, with a few participants putting their hands down.  It’s not like everyone stops at the same time, followed by eerie silence.
  • Humans are social animals, and once people see that others in the crowd have stopped applauding, they quickly cease as well.
  • You don’t need to be near a just-stopped-clapping person to be aware that the number of people applauding has diminished.  Just hearing the level of noise created diminish slightly is enough to get the rest of the group to stop quickly.

Put in Wall Street parlance, applause happens “At the margin” with a few people starting up and others joining in.  The analogy to capital markets activity is clear.  Bottoms form when investors begin to value potential investments more highly than the previous day or week or month.  The resultant price action entices others to “Join in” and the perceived value of the assets in question rise further.  One set of hands clapping becomes many, then all...

The reverse process is how markets form tops.  When everyone is clapping there’s no one left to add to the noise.  Then someone stops, and someone else sees that.  They stop.  The noise begins to fade, just a little at first.  But as it becomes perceptible to everyone, human nature kicks in.  Who wants to be the last guy or gal clapping?  Everyone will stare… The applause stops quickly at that point.

In the end, this is a simple analysis, but one which speaks to capital markets as essentially large “Social networks”, and that is an intuitively appealing construct.  Attention and engagement ebb and flow based on macro confidence, micro financial results, and other fundamental inputs.  Valuation becomes an analysis of whether more or fewer investors will be clapping next month or next quarter.  But one thing is for sure – you want to be among the first people to clap and quit when the noise is the loudest.

Getting that bit right is the hard part.

 

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Thu, 06/20/2013 - 21:56 | 3677631 LetThemEatRand
LetThemEatRand's picture

"which reminded ConvergEx's Nick Colas of a few choice 'Top Gun' quotes..."

Here's one:  "you've lost, that quantitative easing.  Ohoh that quant...itative easing.  You've lost... that quantitative easing, now it's gone, gone, gone, go o o o ne."  And then it's back! 

Thu, 06/20/2013 - 23:08 | 3677895 SafelyGraze
SafelyGraze's picture

rather than actually ending, a standing ovation continues all the way through the audience leaving the auditorium and the janitors coming in to pick up the discarded program notes

and then turning out the lights

locking the doors

 

Thu, 06/20/2013 - 23:40 | 3678011 fourchan
fourchan's picture

cnbc is still cheering, which is nauseating.

Fri, 06/21/2013 - 03:56 | 3678361 Oh regional Indian
Thu, 06/20/2013 - 23:45 | 3678030 disabledvet
disabledvet's picture

"and gold and silver get crushed." keep clapping indeed. "great news! we're all dead!" I mean this is what's been yearned for isn't it? not "money" but "revenge satiaited"? amazing how simple the human race always can be understood...and always will be. all I have to say is "good luck pointing that canon in the right direction" because we always kill the one's we love. "that would include the fools who we kept telling to keep stacking" yes, yes? hmmm. "what is the difference between buying something and paying for it"? I would argue "it is the difference between having gold and parting with it." as if cash money is any different!!! hahahahaha! go back to your poisoned wells sheeple! you're not capable of imagining the world any different "without you front and center in it"! (as if death cares about a "you"!??? by all means...explain.)

Thu, 06/20/2013 - 21:56 | 3677636 otto skorzeny
otto skorzeny's picture

the clap-count is higher the drunker you get.

Fri, 06/21/2013 - 05:23 | 3678401 Disenchanted
Disenchanted's picture

clap on, clap off...

Sat, 06/22/2013 - 17:33 | 3682442 mkkby
mkkby's picture

Hey Nicky, what about HFT clapping?  That muddies up the water quiet a bit, no?

Thu, 06/20/2013 - 21:57 | 3677637 Dr. Engali
Dr. Engali's picture

So what you're saying is the Bernank better start clapping like a mother fucker.

Thu, 06/20/2013 - 23:48 | 3678038 disabledvet
disabledvet's picture

THERE IS NO INFLATION YOU DIPSHIT.

Thu, 06/20/2013 - 21:57 | 3677638 Newsboy
Newsboy's picture

Yeah, but the margins are rigged.

Now what do I do?

Huh?

Gotta' think this over.

Thu, 06/20/2013 - 21:58 | 3677648 buzzsaw99
buzzsaw99's picture

bennie has the clap?

Thu, 06/20/2013 - 22:01 | 3677655 LetThemEatRand
LetThemEatRand's picture

All those Rothschild fuckers have it.  It was only a matter of time before Ben joined the club, especially with all of the goo that gets caught in his beard during the secret "meetings."

Thu, 06/20/2013 - 22:11 | 3677682 kliguy38
kliguy38's picture

Hillsy works hard to rub that glue in Ben's beard so back off jack

Thu, 06/20/2013 - 22:02 | 3677657 Oldballplayer
Oldballplayer's picture

There is always that suck up that claps and bounces up and down a little too much. She is also usually blowing the boss.

Thu, 06/20/2013 - 22:03 | 3677663 hamstercheese
hamstercheese's picture

The first one to stop clapping that then gets others to stop is usually the loudest clapper.

Thu, 06/20/2013 - 22:09 | 3677675 Godisanhftbot
Godisanhftbot's picture

 They clapped pretty loud right here that only a fool wasn't loadin gup on gold at 15-16-17-1800. 

 

 I think those greasy , sleazy dealers selling there clapped pretty hard after every sale.

Thu, 06/20/2013 - 22:11 | 3677680 q99x2
q99x2's picture

Steve Keen does a great interview on the Keiser Report 460.

Thu, 06/20/2013 - 22:17 | 3677693 StarTedStackin'
StarTedStackin''s picture

"Tyler"

 

How about an updated chart of COMEX margin increases ? Seems you had one in 2011

Thu, 06/20/2013 - 22:23 | 3677715 blindman
blindman's picture

http://jessescrossroadscafe.blogspot.com/2013/06/taibbi-last-mystery-of-...
.
20 June 2013
Taibbi: The Last Mystery of the Financial Crisis
" Again, how ironic that the truth is coming out, slowly, but certainly not in the mainstream media, which is covering itself in shame.

The financial crisis was not something that just happened. It was nothing like an act of God.

It was a despicable fraud perpetrated by the biggest Banks, and their enablers, over a long period of time.

And many are complicit in the coverup. It is the credibility trap." jca

The Last Mystery of the Financial Crisis
It's long been suspected that ratings agencies like Moody's and Standard & Poor's helped trigger the meltdown. A new trove of embarrassing documents shows how they did it
by Matt Taibbi
JUNE 19, 2013

What about the ratings agencies?
..

"...In incriminating e-mail after incriminating e-mail, executives and analysts from these companies are caught admitting their entire business model is crooked.

"Lord help our fucking scam?.?.?.?this has to be the stupidest place I have worked at," writes one Standard & Poor's executive. "As you know, I had difficulties explaining 'HOW' we got to those numbers since there is no science behind it," confesses a high-ranking S&P analyst. "If we are just going to make it up in order to rate deals, then quants [quantitative analysts] are of precious little value," complains another senior S&P man. "Let's hope we are all wealthy and retired by the time this house of card[s] falters," ruminates one more.

Ratings agencies are the glue that ostensibly holds the entire financial industry together. These gigantic companies – also known as Nationally Recognized Statistical Rating Organizations, or NRSROs – have teams of examiners who analyze companies, cities, towns, countries, mortgage borrowers, anybody or anything that takes on debt or creates an investment vehicle.

Their primary function is to help define what's safe to buy, and what isn't. A triple-A rating is to the financial world what the USDA seal of approval is to a meat-eater, or virginity is to a Catholic. It's supposed to be sacrosanct, inviolable: According to Moody's own reports, AAA investments "should survive the equivalent of the U.S. Great Depression."

It's not a stretch to say the whole financial industry revolves around the compass point of the absolutely safe AAA rating. But the financial crisis happened because AAA ratings stopped being something that had to be earned and turned into something that could be paid for." ... m.t.

Fri, 06/21/2013 - 00:19 | 3678132 HulkHogan
HulkHogan's picture

Like a leprachaun, or Satan Claus, or a money shitting unicorn, I have never met a virgin Catholic.

Fri, 06/21/2013 - 00:49 | 3678205 blindman
blindman's picture

the rating agencies are like witnesses to a fiction that
cover stories a lie and a fraud, like a professional
witness in a kangaroo court who will swear to anything
for a snickers bar and a dollar. aka an essential pillar
(phantom) of the collapsing financial structure.
this is part of how the banksters will steal the pensions
and retirement monies of the baby boom, boomers.
.
Beth Hart - Bang Bang Boom Boom Official Video
http://www.youtube.com/watch?v=oNj_JpWJqEg

Thu, 06/20/2013 - 22:25 | 3677720 blindman
blindman's picture

Louis Jordan - Is You Is Or Is You Ain't (My Baby)
http://www.youtube.com/watch?v=m7M4thNT_EY

Thu, 06/20/2013 - 22:28 | 3677741 chump666
chump666's picture

EUR bid, fat sells on the DXY.  Gold off lows, Asia buying dips, futures bid  =NY Fed and ECB are in full effect with HFTs sprinkled on top. 

Thu, 06/20/2013 - 22:37 | 3677780 Iam_Silverman
Iam_Silverman's picture

The tie-in to the study of humans applauding an event to the human response in a "market" dominated by HFT Algo's is kinda' mute - isn't it?  It is at least a stretch of the imagination.

Thu, 06/20/2013 - 23:52 | 3678052 nicoacademia
nicoacademia's picture

like the hellbear smasher...ben clapped.

Fri, 06/21/2013 - 00:20 | 3678136 FreedomCostsaBu...
FreedomCostsaBuck-o-Five's picture

A few other choice TOPGUN quotes:
'Slider.... You stink'!
'I hate it when it does that'
'I could tell you but I'd have to kill you'
'You live your life between your legs'
'Its just a walk in the park Cougar'!
And of course when the snaggle- tooth Tom Cruise said: 'I feel the need, the need for speed '!

Fri, 06/21/2013 - 01:25 | 3678255 Central Ohio
Central Ohio's picture

"Clap-on, Clap-off, The Clapper."  Along with, "Help I've fallen and can't get up!"

Fri, 06/21/2013 - 03:45 | 3678352 andrewp111
andrewp111's picture

The Intelligence Director always reminds me of that awful device and its more awful ad.

Fri, 06/21/2013 - 01:44 | 3678276 U4 eee aaa
U4 eee aaa's picture

This exonerates charting. Humans have a tendency to form and group themselves according to patterns. The market is not a random walk but a social construct. Chartists try to discern that construct by charting the movements of the participants

Fri, 06/21/2013 - 02:39 | 3678325 Tenshin Headache
Tenshin Headache's picture

The Fed is a special kind of clapper, with very large hands.

They pretty much ignore muppet social convention, preferring the arcane magic of banker convention.

Fri, 06/21/2013 - 03:50 | 3678354 M.B. Drapier
M.B. Drapier's picture

And how applause works under central planning, from The Gulag Archipelago:

A district Party conference was under way in Moscow Province. It was presided over by a new secretary of the District Party Committee, replacing one recently arrested. At the conclusion of the conference, a tribute to Comrade Stalin was called for. Of course, everyone stood up (just as everyone had leaped to his feet during the conference at every mention of his name). The small hall echoed with “stormy applause, rising to an ovation.” For three minutes, four minutes, five minutes, the “stormy applause, rising to an ovation” continued. But palms were getting sore and raised arms were already aching. And the older people were panting from exhaustion. It was becoming insufferably silly even to those who really adored Stalin. However, who would dare be the first to stop? The secretary of the District Party Committee could have done it. He was standing on the platform, and it was he who had just called for the ovation. But he was a newcomer. He had taken the place of a man who’d been arrested. He was afraid! After all, NKVD men were standing in the hall applauding and watching to see who quit first! And in that obscure, small hall, unknown to the Leader, the applause went on—six, seven, eight minutes! They were done for! Their goose was cooked! They couldn’t stop now till they collapsed with heart attacks! At the rear of the hall, which was crowded, they could of course cheat a bit, clap less frequently, less vigorously, not so eagerly—but up there with the presidium where everyone could see them? The director of the local paper factory, an independent and strong-minded man, stood with the presidium. Aware of all the falsity and all the impossibility of the situation, he still kept on applauding! Nine minutes! Ten! In anguish he watched the secretary of the District Party Committee, but the latter dared not stop. Insanity! To the last man! With make-believe enthusiasm on their faces, looking at each other with faint hope, the district leaders were just going to go on and on applauding till they fell where they stood, till they were carried out of the hall on stretchers! And even then those who were left would not falter. . . . Then after eleven minutes, the director of the paper factory assumed a businesslike expression and sat down in his seat. And, oh, a miracle took place! Where had the universal, uninhibited, indescribable enthusiasm gone? To a man, everyone else stopped dead and sat down. They had been saved! The squirrel had been smart enough to jump off his revolving wheel.

That, however, was how they discovered who the independent people were. And that was how they went about eliminating them. That same night the factory director was arrested. They easily pasted ten years on him on the pretext of something quite different. But after he had signed Form 206, the final document of the interrogation, his interrogator reminded him: “Don’t ever be the first to stop applauding!”

Fri, 06/21/2013 - 05:51 | 3678413 Racer
Racer's picture

The problem with this analysis is that humans make up too little of the 'market' now and the  deafening noise is coming from the nanosecond blur of HFTs

Fri, 06/21/2013 - 07:20 | 3678496 esum
esum's picture

lots of my friends i the usn had the clap 

Fri, 06/21/2013 - 08:15 | 3678610 Go Tribe
Go Tribe's picture

If applause is the measure, this market has the sound of one hand clapping.

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