US stock decline to continue, Sell into the rallies! (page 1 of 2)

Up to the end of August, US equity mutual funds attracted $255.5 billion, more than twice the comparable year-earlier total of $112 billion. In August alone, equity mutual funds drew in more than $23 billion and even as the market fell in September they still attracted over $20 billion.

Indeed, with the exception of the month of May, so far this year, equity mutual fund inflows have exceeded in every month the inflows of both 1998 and 1999. Thus, the public's optimistic expectations with respect to the future stock market's performance has not been dented at all, neither by the sharp decline in the NASDAQ nor by the spate of companies' earnings shortfalls and the rise in oil prices.

The fact that such unfavorable developments have had little impact on investors' psychology isn't entirely surprising, though it shouldn't provide current shareholders with much comfort about the market's future resilience to adversity. As I have explained in the past, an investment mania has much to do with mass psychology, crowd behavior and 'herd instinct.'

Now, while we cannot discuss crowd behavior in any depth here, it would appear that all analysts who have studied the phenomenon of crowd psychology agree that individuals long to be part of a crowd, and once part of a crowd, they behave very differently than when alone. The 'voice of the herd' is a powerful driver of people's actions and it is common for crowds to identify themselves closely with one or several leader and an idea.

According to Sigmund Freud, the leader has a similar impact on the individual as a hypnotist: the individual loses himself by identifying himself with the leader. Thus, there is an intimate relationship and close association between a leader or an idea and the crowd, and over time the crowd becomes totally dependent on its leader or the idea in which it believes.

It is also important to understand that because of the intense attachment of the crowd to its leader(s), the loss of the leader or of his 'prestige' usually leads to a panic. Freud explained that ideas can also be 'the leader' of a crowd, and the people who represent them become, in such a case, 'secondary leaders.' This would seem to be the case during investment manias.

The idea of 'large profits' is the driving force of the mania, while the successful investors and speculators who enjoy great prestige and are written up in magazines and interviewed on television are the 'secondary leaders.'

In an investment mania, the imagination of the crowd is captured by the notion that great wealth can be gained from participating in the boom. Therefore, instincts, simple reflexes (Pavlov), release impulses, self perpetuating habits, the suggestive power of the media, association with and imitation of successful investors, emotional excitement, insistence and irrationality, all override 'individual judgement' and 'thought.'

Driven by these impulses, the intelligence of a crowd is always inferior to the intelligence of the individual. Already Gustave Le Bon observed this in his book, 'The Crowd.'

He wrote that 'the reasoning of crowds is always of a very inferior order', and 'however great or true an idea may have been to begin with, it is deprived of almost all that which constituted its elevation and its greatness by the mere fact that is has come within the intellectual range of crowds and exerts an influence on them.'

Among similar lines, Carl Gustav Jung wrote that a large group consisting of decent people is, in terms of morality and intelligence, like a large, stupid and violent animal, and that an assembly of one hundred very influential people forms a blockhead.