Investors are like deer in the headlights

This post rhymes with my earlier post on investor fatigue. Fear and uncertainty are at all time highs. The frequency, intensity and persistence of negative news has frozen people into inaction and made them disengage from financial markets.

We see this phenomenon clearly playing out in the Indian markets. As investors have disengaged, underlying cash market volumes have plummeted. Many stocks outside the top 200 have not traded in weeks and some in months (beyond a few hundred token shares).

This has made the market fertile ground for bull and bear (mostly bear) raids. In the absence of investor participation, the raids can become extremely successful and self-fulfilling. When sharp movements without reason (other than the raid itself) in one direction are accompanied by false causality of external markets (mostly global), it can panic investors into rengaging in markets in the direction of the trend often at tops or bottoms.

When this phenomenon takes place across the market and in a large number of securities, it can sometime lead to reflexivity in the real economy. i.e. the underlying reality can follow the trend/direction of the market. When reflexivity fails, reality periodically rears its head invalidating market movements and causing extreme volatility.

What does it all mean? It means that the market is becoming more and more inefficient and the process of price discovery has been completely impaired. Since the markets are sometimes used as a signalling tool, investors are receiving all kinds of mixed and wrong signals.

The markets therefore offer a tremendous opportunity to those who can filter out the noise, stay clear of reflixivity, maintain conviction and a tolerance for extreme volatiltiy.