Weekly Update 7/5/2019 What Kitty Genovese and the Bystander Effect Teaches Us about Bubbles?

Weekly Update: What Kitty Genovese and the Bystander Effect Teaches us about Bubbles?

Little was known of the “Bystander Effect,” or the role social proof plays in comprehending what our senses are telling us, until a young woman was brutally murdered over 55 years ago.  Kitty Genovese was murdered, over a 30 minute period, while somewhere between 12-38 bystanders, many of these her neighbor, heard her cry out yet did nothing to stop the attack. 

The horror of the murder, and the incomprehensible inaction on the part of the bystanders, shocked a city and a nation.  How could so many hear a woman scream for help and do nothing?  Was this a sign of an American society in decay, or more specifically urban apathy?  A few years after the event two social psychologists, Bibb Latane and John Darley, studied the case and developed the concept of the “Bystander Effect.”  The Bystander Effect describes an individual’s tendency to relinquish responsibility to act to a situation where action is required when that individual is surrounded by other individuals witnessing the same event.  The cause of this inaction is either one of two things: either the individual is simply waiting or assuming someone else will take the responsibility to act, or each individual doubts what they are witnessing simply because no one else around is responding, thus creating a feedback loop of unresponsiveness.  This second contributing factor is what I find intriguing—the idea that our reactions are uniquely shaped and influenced by the reactions of those around us.  That we would perhaps respond differently to the same situation if we witnessed it in a vacuum.  And, what that tell us about market price movements and the creation of valuation bubbles.

How much of what we understand about events we witness—things that we experience—when witnessed or experienced by a group, is distorted by seeing the reactions of those around us?  Sadly, when reading the research on social proof and the Bystander Effect it’s easy to conclude we concede a lot of ground to the group in how we interpret events when those events are witnessed in the company of others.  Even before the Genovese murder in 1964, launching the exploration of the Bystander Effect, its influence was already being employed.  The laugh track, for example, was introduced in the 1940’s and became a major contributor to extending the life of many horribly unfunny sitcoms throughout the 1980’s and 90’s.  I’m talking to you Family Matters and Who’s the Boss.

If a simple, easily recognized device like a laugh track can distort our ability to determine the quality of humor in a sitcom, imagine its influence when those experiences involve more complexity or opaque systems of interactions.  Put it this way:  if already we are somewhat uncertain what to make of things we see around us we are even more likely to yield our interpretation to the reaction of the group.  When it comes to complexity, spurious correlations, and uneven information dissemination financial markets are high on the list of the top 10.  Therefore, it would seem that financial markets, and the stock market in particular, are highly prone to the influences of social proof.  It could perhaps be the greatest contributing factor to the phenomenon of price action momentum.  When carried out over longer time periods this social proof can create market can bubbles. 

Between 1998-2000, this was evidenced by the hyper-valuations of technology stocks.  Despite all common sense many people ignored a company’s lack of revenue, or even a business plan, and pushed up the prices these stocks higher and higher, particularly if the company had .com in the name.  A few years later this scenario played out again, this time in the real estate market.   Many, while believing that prices had gone up much too high and much too fast, went against their beliefs and bought overvalued homes anyway.  To a large degree because they saw others doing the same thing.  I should know, I was one of them. 

Now, here we sit today:  market valuations are at historically high levels, the Fed is promising/threatening to lower interest rates, trade wars seem to be showing no real sign of abating, and the market is deep into its longest expansion in history.  While none of these things uniquely spell doom for the stock market, all of them combined should make us concerned or skeptical about the sustainability of this market boom.  Yet, the market keeps marching higher and higher.  The market’s reaction to all of these signals, i.e. the response of the group, seems to be in direct conflict to what many of us believe we are witnessing; therefore it must be us who are missing something, right?  This, I believe, is the reaction of many of the participants in the market today, which could explain why the market keeps going higher.  Speculating as to when the music will stop is nearly impossible because it would involve divining the mindset of herd mentality, which can be like guessing the direction of a starling murmuration.  However, by adopting a momentum approach perhaps we can adjust our direction, not before or even as the herd begins to change direction, but still far sooner than we would have had we not even been examining the herd’s effect. 

Enjoy your holiday weekend extension!

Thanks for reading,

Zach and Dave

Calibrate Wealth
515-371-5316  

https://www.calibratewm.com/blog-01

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