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May 02, 2008


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Greg Feirman

Interesting post Kent.

I think the heart of the issue you are raising is: Is perception reality in finance and economics?

And the answer is No.

Just because many now believe that the stock market has turned a corner does not mean that it has. People base their decisions, including decisions to buy or sell stocks, on their perceptions. So the current perception that stocks have bottom can, for a while, create that reality.

But perception is not completely myopic. Perception can be altered by the emerging reality. Should it start to become apparent that the facts don't fit with the emerging consensus, there is no reason perception can't change and send stocks heading down again.

Wall Street, like any other group, is subject to herd behavior. But there are also a lot of smart thought leaders on the street that can sway the herd if they voice contrary opinions.

Philosophically, the issue is what Ayn Rand termed the primacy of existence. It goes back to the origins of modern philosophy in Descartes "Meditations": I think, therefore I am. What is the relationship between mind and reality? It is not cut and dry but for the most part the mind is able to perceive an independent reality and not create it. Not completely, but for the most part. Reality is primary.

The investor who best understood this, and profited massively from it, was the great Michael Steinhardt whose theory of Variant Perception is an application of this to investing.

The Financial Philosopher


I will not argue your thoughts but will clarify mine:

1. If we are not in a recession by definition but the American consumer perceives it as so, then they will act according to their perception, not according to the observations of economists.

2. If the investor herd becomes complacent, evolving into greedy, then real risk increases as perceived risk decreases, creating "over-bought" conditions. Similarly, the investor herd will push stock prices lower as fear increases, regardless of valuation, creating "over-sold" conditions, as perceived risk increases and real risk decreases.

3. Economic reports and market data may say one thing but the herd may act in a completely different way, which leaves economists and financial pundits either scratching their heads in disbelief or saying, "I told you so," depending on their most recent rants.

As for your comment, I absolutely agree that an investor can take advantage of dislocations caused by extreme herd perceptions or emotions and make contrarian moves accordingly.

Above all, I simply enjoy observing human behavior. The stock market is the ultimate "people watching" experience!

Thanks for the thoughts...


It is interesting to study what causes these periodic moments of panic in markets and the economy. It typically starts out as a story of greed and misjudgement concerning risks and rewards.

Here are a couple of articles on the 1907 panic, which few people know about:



The events of the past year again focus on banks and large investment companies. Many banks and Bear Stearns were seduced by the high returns of the sub-prime market, but failed to properly analyze the risks involved. Greed overcame reason.

When problems started to surface last summer concerning these sub-prime investments, banks started to become suspicious of other banks, and refused to lend money to anyone. The initial attempts by the Federal Reserve did not help because banks are reluctant to borrow from the Federal Reserve short term window, since it may make their bank look desperate and perhaps signal underlying problems in their bank.

The net result was cash flow from banks into the economy was approaching zero.

With this uncertainty, healthy investment firms decided to remove money from the equity markets and put it into commodities and foreign currency. It has not been until this week that indications seem to point to these investment firms rolling money back into the equity markets and away from foreign currency and commodities. These rollovers involve a lot of money, and take a long time to complete. However, the rolling-over process does seem to be taking place.


Greg Feirman


I agree with all your comments.

I think Soros's theory of reflexivity comes in here: perception effects reality and reality effects perception. Causation goes both ways.

But I do think it is important to keep clear in one's mind the distinction between prevailing perception and reality.

The fatal flaw of pure technical analysis, in my opinion, is that it looks only at market action and therefore only at perception. If you just look at the charts and various sentiment and technical indicators, this move can look very much like a V-bottom and that the worst is in. And, of course, it looks that way because many who are buying and pushing the indexes up do in fact believe that.

But they could be wrong. There is always the question: Is it true? Pure technicians have nothing but contempt for the question of "fundamentals" which is essentially the question of truth (Of course, this is a very thorny subject in modern philosophy, but I think you are more classical in your beliefs about truth, like me).

Fundamentalists make the mistake of looking only at facts, and sometimes an incomplete set of facts that ignores macroeconomics, and therefore have no resources for understanding the role perception plays in driving market action.

That's why we have to heed the wisdom of JS Mill, the greatest philosopher of reason of all time, and take what is good from all the different schools and put it together into a coherent whole:


(You have to scroll down a bit for the JS Mill quote).

The Financial Philosopher

Greg & Charles:

Thanks to you both for the added insight and links! I've learned a great deal from you...



All that we see or seem is but a dream within a dream.
- Edgar Allen Poe

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