It’s Not the News – It’s the Mood (Stupid)

As the days counted down to the end of September 2016, all was looking pretty rosy for the Rand.

It had enjoyed three weeks of gains and had all but regained the ground it had given away in the latter half of August – and was closing in on its strongest levels this year.

And the outlook was more positive still…

…the US Fed had decided to keep interest rates on hold.

…things had calmed down in the spat between the Hawks and Pravin Gordhan (for now!)

…and the market had just received the ‘good’ news that SAB Miller had clinched a deal in a $103bn takeover by London-based Anheuser-Busch InBev, with these inward flows expected to provide further impetus for the Rand’s positive run.

Yes, things seemed to be looking rosy – or so the local economists thought!

Because all it took was a couple of days for the headlines to change to “Rand continues puzzling decline” with mainstream pundits perplexed and confused by the seemingly inexplicable weakening back above 14.00 to the Rand – for no reason at all.

What had happened?

The Rand obviously had not been reading the news.

Or perhaps those players that ‘move the markets’ had also not been keeping up to date on these positive events.

Or perhaps they were, but didn’t agree with mainstream opinion, and thought otherwise.

So, why had the Rand just lost 65 cents in less than 3 days?

Thinking about today’s headlines, it made me realize that economists – and conventional wisdom – would like us to think of financial markets as physical objects that merely react to Newton’s First and Second Laws of Linear Motion (remember them?)…

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• 1

  Rule Number One

  An object in motion stays in motion with the same speed and in the same direction unless acted upon by an external (unbalanced) force.

• 2

  Rule Number Two

  An object will accelerate in the direction of and in direct proportion to the net force acting on it.

So, based on this, this past week prognosis for the Rand was easy:

• The Rand had been heading stronger for three weeks so unless any unbalanced force acted on it, it would continue to strengthen. ✓
• There was additional good news (net force in the right direction) which should have the effect of causing the Rand to accelerate still stronger. ✓

Simple.

But the market did the opposite.

Which has puzzled the ‘experts’ out there.

But perhaps they forgot about the fact that, IF financial markets did abide by Newton’s Laws of Linear Motion (a big IF – more on this later), then we would need to apply his Third Law too, which states:

“For every action, there is an equal and opposite reaction.”

Of course, what this would mean is that news that is considered positive by one person could be perceived to have negative implications by another.

Which is very often the case.

And, in fact, is exactly how I feel about the touted SAB Miller Anheuser-Busch InBev (ABI) deal. What is positive about this deal? Some might think a $103bn inflow is great, but let’s put this in context.

Isn’t this one this country’s prime income-generating assets?

…that is now being sold off to a foreigner?

…meaning that all future profits will no longer be for the benefit of the local economy?

…and instead will add to our already swollen Services Account deficit through dividends and interest payments offshore (as all the other FDI deals have done)?

The fact is, you will always get a contrary view on any data release and news – that’s just how us human beings are.

But secondly, and more importantly, financial markets are certainly not linear and if they were governed by any Physical Laws of Motion, it would be to the Laws of Non-Linear (not Linear) Motion.

Just imagine a pendulum, and you can readily see how this more reflects how the markets move, as they swing from one extreme to the other.

Now if you thought of a pendulum on a moving base, you would start to get a bit closer.

And if you had a pendulum on a moving base where the pendulum itself had a smaller pendulum hanging on it…and that one had another still smaller pendulum hanging off it…and so on, then you would start to get more of the idea of how financial markets work.

But even then, it would still not be quite like that…

Yes, the markets are a lot more complex than an apple falling onto Newton’s head!

But that doesn’t mean they are completely unpredictable…

Because financial markets do abide by the Laws of Nature – the Laws of Human Nature!

You see, it is not the news, but humans acting and reacting to news and events and making financial decisions that drive the market.

Emotional (we rationalize these decisions with logic thereafter)

Recurring (we make similar decisions in similar circumstances)

We all tend to make decisions based on how we are feeling at the time…

…and the result is that these patterns of mass sentiment or social mood are reflected in the zigzag patterns of the market

…as they move from one extreme of pessimism, fear and despair

…to the other of optimism, complacency and euphoria

…which recur over and over again - in smaller and larger degrees.

The beauty of this is that if we understand the Laws of Nature that govern these actions (discovered by Ralph Nelson Elliott in the 1930s), it provides some predictability to this irrational behaviour.

And as a result, when others are puzzled because the Rand should have been continuing its run weaker or stronger (based on Newton’s Laws), by following the laws of Elliott’s Wave Principle, you would have known that the investor mood pendulum (mass sentiment) had reached an extreme and was about to swing the other way.

As an illustration, did you find anyone that was Rand positive in early February this year, when the Rand had just hit close to 18.00 to the Dollar a few weeks earlier?

Not likely! Most were expecting R25, R30 and higher…

Well, (despite my emotions telling me the same thing as everyone else) my Elliott Wave analysis at that time showed that the market (read Rand-negative sentiment) had likely topped out (reached an extreme) and was expected to take the Rand down to around 14.00, then bounce before heading still lower.

Click to enlarge

But that negative view only confirm our conviction that the pendulum had reach the end of its swing.

So what lessons can be taken away from this?

• Markets don’t move in linear directions but in waves of sentiment
• That we need to apply the applicable laws of Nature to understand financial markets
• That when everyone you speak to is very bullish (or else very bearish) about a market, it is time for the market to turn
• That we each need an objective view of where the market is position, else we WILL be swayed by our emotions – with (more often than not) negative results!

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