Markets only misbehave
The other day I was at Niagara Falls. I found at least six tall men of seven feet and a little over and more than twelve to fifteen women of three and half feet width ( no accurate measurement but near approximation of a statistician) in a visitor crowd of over fifty thousand on that sunny day. As a traveler from India, such proportion of odd dimension figures is a rarity. Their food intake would certainly be more than the average person. Wealth follows a fat distribution meaning thereby that there are disproportionately more very rich people than there are, say, very tall people. The reasons are not hard to find why. Wealth has a tendency to gravitate to the wealthy through self-reinforcing mechanism; the more you have of it, the more you acquire. The fat tails of the bell curve of markets oft referred to as Gaussian distribution based on fractals may imply a similar thing: the more they trend in one direction, the more, the trend persists.
I distinctly recall the Economist survey of ‘The Frontiers of Finance’ published nearly two decades ago wherein some such arguments led to three hypotheses: (1) it undermines efficient markets theory – Mrs. Joan Robinson long before emphatically proved that markets are imperfect; (2) it rocks the capital-asset pricing model because that model depends on something called standard deviation as a measure of risks; and (3) it reveals that something is causing the stock market to be predictable. (The Economist: A Survey of the Frontiers of Finance, October 9th 1993). The arguments are used to prove that computerized models are leading to market predictions of a different genre on the basis of a set of non-linearity (“Non-linearity simply means that effect is not proportional to cause”). Non-linear statistics is nothing but a child of the computer. Financial engineers emerged on the scene to produce derivatives of student loans that generate more non-performing assets quickly, mortgage loans where the underlying assets had no value over the time due to fall in rentals and excessive initial rating of such assets ( the sub-prime loans) that led to the great recession of 2007 engulfing the whole world. The trends have time dimension and the time zones differ across the world. Prediction based on the trend obtaining in the US markets can provide useful information to those working in Asian markets and such information gets traded more than the data and the multi-national companies stocks behave differently across the markets providing incentive or otherwise for the investors. It is not as though that the GARCH theory (Generalised Auto-Regressive Conditional Heteroskedacity) which simply means that the volatility is clustered. Believers in this theory straddled securities. In the late 1990s this theory went out of fashion due to embedding time in the computer driven models.
The predictability of markets is like the prediction of the almanac pundits of South India at the beginning of the year when the Chief Minister and opposition leader listen to the sweet prediction of their preferred persons who predict their win and they do win. But only one of the parties they belonged to pick up the majority to stay in power for the next five years. There are pre-election soothsayers on the TV channels whose predictions are based on a survey of the miniscule of the electorate and yet their prediction comes to close to the actual outcome. These are based on computer manipulations.
The markets are volatile in nature and the computers predict based on the manipulations of data that the operator ingeniously does. Very many lose in the market and few only gain like those playing in the Casino. The investors of Casino never lose while most players lose. The few winners are like the broking firms who never lose. The investors employ jobbers who manipulate the prices during the day.
How else do you describe the movement of prices of stocks that move up in anticipation of the budget announcement of the Finance Minister and as he starts reading the budget speech, the stock prices keep oscillating with the up-end averages moving south or north and at the end of the speech, one may find a huge drop in the stock index. Actually, no trading might take place but the prices move. Similarly when there is a statement by the Governor of the central bank that inflation decline is still to be reliable a couple of days before the announcement of the mid-quarter monetary policy, the prices of stocks rise or drop.
All this only demonstrate that the markets only misbehave and not behave as you wish them to be. It is after all the individuals who play on the computers dexterously to make the prices look what the powerful investors like them to be. Changes in the balance sheets of firms like the Wipro, Infosys, Tatas, Reliance etc., when released affect the prices of stock index. The Index bases built by S&P based on fractal and chaos theories have descended on markets and instruments based on such indices also entered the markets. Whether these are signs of growth of the markets or the economy is a big question as it is the few wealthy that determine them and minority shareholders whose numbers may be large would have little voice in making or breaking the volatility. The trade risks are no better than the weather risks.