Those of us who hold Canadian stocks or have watched houses in our neighbourhood soar to previously unthinkable prices wonder if we can time things perfectly and sell at the top. It could be our time in the sun. Or we could get royally burned at our own barbecue if we get caught in a plunge.
How can you tell when the best is over? Economists and financial analysts offer lots of insight, but no definitive answers. Fortunately, big-brained theorists in other disciplines have pondered similar questions, and I think you can apply their theories profitably to the markets.
Take Quentin Michard, a researcher at the School of Industrial Physics and Chemistry in Paris, and Jean-Philippe Bouchaud, a PhD in physics who works at the French Atomic Energy Commission. In one study, they looked at synchronization in social and economic behaviour. Michard and Bouchaud argue that the users of any free-market economic system make decisions based on personal opinion, public information and social pressure or imitation. Those social influences are often the most critical.
The duo crunched three sets of data to test their theory: European birth rates from 1950 to 2000, cellphone adoption rates in Europe between 1994 and 2003, and how long audiences clap at the end of concerts before heading for the exits-literally.
The birth rates declined substantially in the postwar decades, and Michard and Bouchaud say that is the result of long-term social trends, including birth control and the decline of religion. Cellphone use has grown rapidly. The duo say some of that is due to immediate social influences: feelings of inferiority if you don't have a phone, and the phones getting more useful when others have them too. When do audiences stop clapping? Most of us stop quickly when others around us stop. You don't want to be clapping alone.
I've applied Michard and Bouchaud's theories in my own far-less-rigorous studies of three recent market trends: the spread of monster homes, the huge run-up in commodity prices and the frenzy over the Tim Hortons share issue last March.
The average size of a house built in Canada in 1976 was 1,100 square feet. In 2004, it reached 1,800 square feet. Yet the average size of a Canadian family declined to three people in 2004 from 3.5 in 1976. So why have so many families bought monster homes? Social pressure.
My prediction: Over the next 20 years, other social pressures, such as our aging population, will prevail. Monster homes will be replaced by smaller ones with ramps for our walkers. Should you sell your big-box house now? Probably not for another three to five years.
As for stock-market and commodity-price cycles, a couple of years ago, Howard Balloch, Canada's former ambassador to China, showed me a chart of Chinese nickel demand and domestic supply. It indicated a shortfall of supply stretching far into the future. I bought shares in Inco. My prediction: The nickel boom will last quite some time, but there will be bumps.
Doughnuts are different. I can't turn around in downtown Toronto without seeing a Tim Hortons. Here's a market where supply is obviously meeting demand, so the frenzy around the "new" share issue was just too intense.
Yet I still haven't figured out exactly when to get out of the stock market. It sure looks frothy-people talk about their portfolios as if they were family members. It reminds me of a New Yorker cartoon called "What lemmings believe," which showed the little rodents running en masse to a cliff and taking off in free flight.
Last year, three researchers at Columbia University-Matthew Salganik, Peter Dodds and Duncan Watts-created a pop music internet site. It asked visitors to rate unknown bands. The researchers were trying to see how opinions are formed.
Some visitors could only hear songs on their own. Others could see what songs other listeners downloaded. As expected, they were affected by what others did. The quality of the songs had some impact, but what is scary for investors is that the more socially influenced the listeners, the more unpredictable the result. The "best" songs didn't do badly among any listeners, and the "worst" songs didn't do very well, but the stuff in the middle was a crapshoot.
So, based on all the studies, I have some thoughts on how to get in and out of the market: Buy only quality stocks that aren't the subject of mass opinion-in other words, out-of-favour stocks. Avoid comparative evaluations of hot stocks, like saying RIM or Apple isn't all that overvalued relative to its peers. Finally, to make big money, you have to sell when everyone is talking about your investments. Or, as at a concert, clap along with others for a while, then dash for the doors.
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