Rather than use the cold language of economics, deploying terms which describe various states of human emotion are helpful when observing financial markets – words like hope, enthusiasm, optimism, euphoria, trepidation, anger, fear and resignation.
We move from enthusiasm to excitement, and we tell anyone who might listen. More jump on the bandwagon, underscoring JP Morgan’s observation that “nothing so undermines our financial judgment as the sight of our neighbour getting rich”. At this exciting stage banks offer leverage to investors, reducing the collateral needed to qualify for target investment.
What was bullishness last week becomes bearish today. Most investors, on seeing prices fall a bit, reassure themselves that a few percentage points fluctuation doesn’t matter, because we are in for the long haul, long term investors! Aren’t we? The herd, whipping itself into a pessimistic frenzy, panics. Everyone tries to sell at the same time, deflating the price yet further. The moment of capitulation isn’t far off. Momentum towards surrender is accelerated by contagion, where the problems in one market bleed into another. Good assets must be sold to pay for bad assets.