The News
August 5, 1997

Dr Manzur Ejaz

Economists and financial analysts try to understand the stock market
movement through macro-economic variables and potential or actual
profitability of business firms. However, there are several other schools
which explain market fluctuations and investment strategies in
non-economic terms. Most prominent among them are the contrarian and the
cycle theorists. The contrarian theory propounds that the stock market
mechanism can be better understood by looking at how big money plays
against small money while cycle theorists forecast the future direction
on time-line basis. Such approaches were very popular during the boom of
the eighties, however they have disappeared from the centre-stage during
the nineties. Nonetheless, in developing countries like Pakistan, these
approaches may still be relevant.

To understand contrarian approach, one should be cognisant of the basic
mechanism of the stock market. When the stock market goes up and it
appears that investors are going haywire for buying stocks, in reality
there are equal numbers of sellers: a mass is buying while another mass
is selling. If this were not so, trading would be impossible. The sellers
group, even in a rising market, anticipates a bleak future and calculates
that it is better to get out of the market or a particular stock. On the
contrary, new buyers have an optimistic appraisal of the future direction
of the market. Therefore there will be a loser to every winner in the market.

The contrarian assert that the large investors (big money) usually win
while the small investors lose. Large investors, comprising wealthy
individuals, financial institutions, mutual and pension funds, having
access to big pool of capital, substantially effect market trends: buying
or selling sprees by the big money can take the market up or down in a
significant way. The small investors on the other hand, playing with
modest amount of funds, remain on the receiving end and usually trail the
market trends. Put more bluntly, the small money is, usually, sucked in.

The big investors are better informed because of their research staff and
having quasi-legal and illegal sources of information gathering. By
having early access to information, they take a head start in buying (or
selling). On the contrary, the small investors are poorly informed
(usually getting information through public media). By the time they get
the news and make a trading move, the big investors have already done
most of the work.

After the initial trend is triggered, the big money keeps on feeding the
buying (or selling) frenzy. It is designed to hype and to suck the
maximum number of small investors. However, when the big money perceives
that most of the small investors are in, and the potential investment
money has dried up, massive selling starts. Therefore the contrarian
strategist watch the small investors' sentiment very closely. They
believe that if the scepticism about the market rise lingers on, there
would still be small investors who stay out of the market and, therefore,
the market has a potential to go up further. However, once buying
euphoria becomes pervasive and engulfs most of the investors, indicating
that almost all potential investors have jumped in, the market takes a
sharp turn.

These moves are usually sudden and big. By the time the small investors
catch up with the trend, the market moves substantially, leaving them
stunned. Nevertheless it should be underscored that in large markets like
the New York Stock Exchange, this process does not take place as a result
of a grand conspiracy hatched by the rich classes: the market is too big
to be manipulated in the large industrial economies. But it is possible
in the smaller markets.

Even if the markets go sour, the large investors have more staying
capacity than the smaller ones. For example, if the market or a
particular stock temporarily goes down because of a political crisis or
any other adverse circumstance, the large investors can wait it out: they
can borrow or sell their assets to sustain the temporary losses. On the
other hand, the small investors are quickly washed out in such
conditions. First they get nervous easily, and second they cannot
calculate the risk rationally and third, they don't have the financial
means to stick around.

To the uninitiated, the contrarian approach might smack of Marxian class
conflict theory. Nothing can be further from the truth because most of
the contrarian stock market gurus are mainstream millionaire investors.
Further, the ownership of stocks is widely distributed in the US
population. For example, every sixth household had ownership of the
largest corporations' (IBM, AT&T, etc) stocks for many decades. More
importantly, mutual and pension funds have become the largest investors
in the market. The money in these funds is contributed by millions of
ordinary citizens and workers which is invested by professional managers.

Essentially, the contrarian developed a psycho-social model of investment
within a realm of a capitalist economy. These gurus were given so much
importance that during the runaway boom of the eighties their statements
used to move and shake the markets. However, in the US they faded from
the scene during the nineties. It can be hypothesised that the resurgence
of economy and extended period of sustained growth coupled with
domination of mutual and pension funds has made this theory irrelevant in
the US. However, such an approach may be still valid in markets of
developing countries where stock ownership is not dispersed and large
investors consist of wealthy individuals possessing foreign mutual funds.

On the other hand, cycle theorists believe that the time cycles are more
important These cycles are calculated on the basis of number of weeks.
Some cycles are considered to be more important than others: a four-week
cycle may be more important than a thirteen-week cycle. In simple terms,
they believe that if the market starts rising, it may continue its upward
swing for a definite number of weeks and will come down somewhat
(technically called correction). A whole mythological theory is developed
on this basis which comes close to astrological forecasting. Nevertheless
there are millions of investors who believe in this approach and several
other such superstitions in a society which is otherwise rational and
scientific.

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