During May of this year a meme spread through the financial world about the under performance of the Dow Jones Transportation Index (DJTA) in relation to the Dow Jones Industrial Index (DJIA). Everyone was talking about the Dow Theory non-confirmation and what it meant for the markets. Today DJTA is still under performing, but the crowd isn’t talking about it. They’ve moved on. It doesn’t matter anymore. Why? Group think.
Group think is common in the financial markets (and society in general). An idea that seems reasonable often finds wide support regardless of its merit due to market participants repeating the meme without taking the time to do some independent research or even think about it. When dealing with stock market memes it doesn’t matter if it’s correct it only matters how many other people think it’s correct. Group think moves markets.
An example of group think came in early 2013 when a study stating low volatility stocks out perform high beta stocks was widely circulated. This study was repeated via blogs, television, and the financial press. Like all memes it’s difficult to find where it started, but this one began getting traction in December of 2013 with articles on Motley Fool, Barrons, and Forbes. By April of 2014 it was almost everywhere you looked. This caused a surge in search volume on Google for the term “low volatility etf”. Lots of people believed the meme and went in search of a vehicle to give them some “low volatility” exposure.
Group think caused high beta stocks to stumble from February to April 2013 while low volatility stocks surged.
Today a meme about the risks of poor breadth is circulating. I’d like to say I started it in early June, but I don’t really believe most of us have much original thought…so I’m sure I read about it somewhere first. In my defense, I have talked about the dangers of poor breadth and the support that comes from wide breadth from the inception of this blog. Here’s a warning I gave in early October 2014. But back to the meme. It appears that it is now reaching a crescendo. Just this week I’ve seen articles by John Hussman (who added my criteria of 60% of stocks below their 200 dma to his own studies…your welcome John 😉 ), Michael Batnick, and Dana Lyons. The twitter stream and financial press have been littered with even more.
So what impact will the current case of group think have on the market? It could turn out to be nothing (like the Dow Theory non-confirmation meme) or it could cause a substantial disruption in the markets. I tend to think it will be the latter. One reason is that the current meme is causing several measures of sentiment to show very negative readings only a few percentage points from a top. Traders and investors alike are nervous and many of them now believe that the poor breadth will cause even a small amount of selling to accelerate. I suspect panic won’t set in unless we break below 2040 on the S&P 500 Index (SPX) or DJIA breaks below its December lows (which would complete a rounded top pattern). Somewhere near those levels would likely trigger a market risk warning…and as you know a market risk warning when breadth is poor increases the odds of a 10% correction.