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| Patterns, valuations and the AIDS vaccine | |
| POUND WISE | | Mukul Pal / New Delhi November 24, 2008, 0:55 IST | |
I was in Mumbai for a few days, and the city rush caught me yet again. I was forced to cancel a few meetings and stick to the conventional telecon. One call made after three years, caught me with a pleasant surprise when the person on the other end took my name and greeted me, just after I said "Hello". The human mind has a great ability at recognising patterns. Be it voice, or face, a chess board, architectural plans, or market patterns, our mind just sees them all. Rather, a study of the most successful people in any profession has been linked with extensive reading and pattern recognition.
We are still in the process of understanding or accepting the significance of this human skill. Margaret Heckler, Health and Human Services Secretary under President Ronald Reagan, mistimed a health initiative (by 24 years) by failing to understand the strength of pattern recognition. She expressed a two-year timeline for discovering a potential AIDS vaccine in 1984. Recent studies in 2008, indeed seem path breaking and nearing a solution to find a vaccine for the virus. The studies are aimed at training the human body to recognise the pattern of the disguising AIDS virus. Such is the skill that a solution to AIDS lies in pattern recognition. Behavioural finance pushes up the debate between mass psychology patterns and conventional value approach. And non-linear or fractal approach challenges valuation theory further by saying that if the pattern itself is linked with growth and decay, there are many times that the fundamental valuation will be revisited over a certain time frame. No wonder the conventionalists have survived for so long, justifying the value debate over something that was always pattern driven. It is only in crisis times, that we sit up and rethink, how strong our local or fundamental reasons are? Or are we really driven with macro, top down reasons?
Understanding patterns
Everywhere we look, we see a pattern and everything which has life, owes it to a pattern. Recession is a pattern. Implanting the bull on Dalal Street below the exchange is a pattern of euphoria. Greed and fear cyclicality is a pattern. Recurring crisis is a pattern. Majority expressing concern and extreme reaction to that crisis is itself a pattern. Lack of extreme reaction is a completing pattern. No wonder we are only able to read sentiment at extremes and not otherwise. Credit growth and leverage extreme is a pattern. Credit advertising at every station on the local rail network in Mumbai, at every elevator in commercial high rises is a pattern. Consumption is a global pattern. Hiring and firing is a pattern. There are social patterns, economic patterns, natural patterns, psychology patterns and market patterns. Ask a biologist, chemist, physicist and they will speak about the patterns in their work, recurring patterns. Dig a bit deeper and you can connect most of them like natural pattern periodicity occurring in stock markets, social patterns explaining market patterns and seismologists using their models to explain market crashes. Typical pattern recognition also includes automatic speech recognition, classification of text into several categories (example. spam/non-spam email messages), the automatic recognition of handwritten postal codes on postal envelopes, or the automatic recognition of images of human faces.
Why such resistance to change when pattern recognition is so popular in scientific pockets. Why don't we challenge the status quo? A few conventionalists call it magic explaining why Fibonacci Golden ratios appear in pyramids, paintings, flower petal arrangement, in the human DNA, and in markets all as a chance. They look for statistical significance as nature, coastlines, social mood and indices are considered mere coincidences. We ignore the pattern as it describes the futility of the very structures we build. Challenging an illusion is tougher than living it.
An intriguing problem in pattern recognition is the relationship between the problem to be solved and the performance of various pattern recognition processes. The market problem to be solved is more than a scientific quest. And this is why classic pattern matching scheme where a target's small patterns can be searched from a large set of learned patterns is inefficient.
This problem is faced by fundamentalists and even chartists looking at just conventional price patterns or extrapolating trends. Extrapolation to Sensex 40,000 at 20,000 is easier than looking at a 60 per cent crash. Looking at $5 a barrel of oil at $50 or looking for $200 a barrel at $145 is linearity not pattern. A pattern by very nature is cyclical. Any pattern that lacks a cycle aspect is incomplete and lacks consistent accuracy.
Pattern recognition is also about long term memory (human or system), which is linked with a study of history (data or economic).
And since a pattern is about repetition, a significant pattern should be recurring like a fractal. Though a wide range of algorithms can be applied for pattern recognition, the powerful neural networks are now being redefined as the Fractal Neural Network (FNN) to tackle the limitation of traditional models in representing higher cognitive functions .
Business impact
We have pattern recognition software, but still markets have a history of black box model failures. It's a lack of pattern understanding that structured finance has failed against basic finance and conservative banks have outperformed. The financial model which incorporates the economic cycle works better than the financial model without a business cycle (leveraged).
Gold cycle of 30 years suggests a move from paper assets to hard assets. A large 30-year economic pattern is the cycle itself. Pattern training whether linked with sentiment, macro economics, and social behaviour is key to stock market success. Patterns connected with cycles and fractals are an effective way to understand why markets crash, or why they should stop falling? Why the Chinese ghost malls exist, and what will happen to the Indian consumption boom? Whether the dollar will rise against gold or fall? And where are we headed in 2012?
Market reaction
In conclusion, there are a host of aspects linked to the market pattern viz. the economic, socio economic, historical, intermarket etc. Economic cycle talks about a low not now but later in 2010-2011. And since markets have already collapsed more than 60 per cent, we need at least a few months of rise. Socionomically speaking, the majority continues to see lower prices, as the sentiment is skewed toward negativity.
Too much negativity is not necessarily positive. But it definitely warns of an extreme behaviour, not perfect for fresh sales. Historically, we are at decade lows for many markets around the world (Dow) and it may be presumptuous to just expect sellers to have strength after nearly 12 months of fall to break through conventional supports so easily. Intermarket aspects linked with falling oil and gold prices also give more positivity to the local equity case. All these interlinkages make us believe that Sensex is in a large corrective pattern structure, not ready to break down lower yet. Let's see.
The author is CEO, Orpheus CAPITALS, a global alternative research firm
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