Herd mentality?

Reader question:

How to understand this: “Smartphone buyers are influenced by herd mentality.”

My comments:

In other words, people buy the same smartphones other people buy.

Herd mentality has the same meaning with “herb instinct”, a phrase I wrote about before, a phrase that depicts the animal behavior of crowding together in times of danger – or, in fact, peacetime also.

“Herd” is the word for any large group of animals living together – any animals, cattle, sheep, whatever.

And in any such herds, a common scene is observable: The animals crowd together both when they feed and when they are running away from predators.

Animals don’t think much – not much as humans do, supposedly – and what they do they do out of instinct, nature or sheer habit. If a few sheep begin to feed on a fresh pasture, other sheep soon join them – the rationale being (even if animals don’t seem to spend a lot of time rationalizing): Something has drawn the leaders over there.

So therefore, whatever the leaders do, the rest of the group do, too. Birds of a feather flock together, as they say. True.

Humans act in the same way. If they see people gather, they think: These guys must be on to something and so let me find out. Hence they congregate.

In shopping, the same rationale works: If they are all buying this brand of smartphone, then it must be good. Therefore I must buy one of these too.

A smart move, as a matter of fact, usually.

Not always. Herd mentality, the frame of mind to follow the masses, both drives the stock market up, and down. When other people begin to sell, more people begin to feel the panic and they all start to sell. Hence, in consequence, the market crashes.

Alright, that’s herd mentality, or, if you don’t like animal connotations, crowd behavior. Same thing. No difference whatsoever.

Thing to remember is, sometimes even if there’s a crowd gathering, it doesn’t mean there’s anything going on. I came through a crowd in my neighborhood last month, for instance, brushing shoulders to make my way through people who were all kind of whispering something into each other’s ears. “What’s going on?” I asked our elevator man. “Oh,” he said, “there was a traffic accident two hours ago.”

Two hours ago?

“Nobody’s hurt”, he added, helpfully.

“That’s good,” I said, and we left it there.

Perhaps that’s the difference between the herd and the human crowd. Herds always gather for a reason. Humans gather for no good reason at all, and they linger on.

They should disperse and move on.

Or as Americans say, get a life.

Alright, here are media examples of “herd mentality”:

1. Friday’s 4 percent slide in the Dow Jones industrial average left the market barometer down 5 percent for the week, 27 percent since Sept. 1 and 37 percent for the year.

Daniel J. Howard, a marketing professor at Southern Methodist University, says investor behavior demonstrates the principle of social proof: The more an individual sees those around him believing something or acting a certain way, the more the individual believes that thing to be true or the behavior appropriate.

“Stock market bubbles and crashes are caused by herd mentality,” Dr. Howard said. “It’s scary to me because we make our own heaven, and we make our own hell.”

The herd mentality is more fearful in a falling market, says George Loewenstein, a Carnegie Mellon University business professor who specializes in the emerging field of behavioral economics. That’s because individuals start fearing the economic consequences of the market sell-off: whether they will have a job; whether they should reduce spending; whether they’ll be able to make loan payments or get a loan to buy a car.

Those fears are evident in a CNN/Opinion Research Corp. poll released last week showing that 41 percent of Americans believe that a 1930s-style depression is somewhat or very likely over the next 12 months.

Dr. Howard expects those fears will put a dent in Christmas sales.

“It’s going to be terrible,” he said. “People are either uncertain or afraid. Those two moods ... do not bode well.”

- Herd mentality causes crashes, Post-Gazzette.com, October 26, 2008.

2. Several Bollywood stars have taken to Twitter to commemorate India’s Independence Day.

Amitabh Bachchan paid tribute to the soldiers who sacrificed their lives, while superstar Shah Rukh Khan urged people to be fearless and fight for their rights.

Bachchan tweeted: “Happy Independence Day .. India breathed freely on the 15th of August 1947 .. in remembrance of those that fought and sacrificed!”

Shah Rukh Khan wrote: “The free man is he who does not fear to go to the end of his thought. Be free today and always. Happy Independence day.”

Lara Dutta said: “Happy Independence Day folks! I pray for independence in thought! So that we are informed, mature citizens, not influenced by herd mentality.”

- Bollywood stars commemorate Indian Independence Day on Twitter, DigitalSpy.co.uk, August 15 2017.

3. Privately, some market participants fret that BlackRock’s genie is creating a new orthodoxy when it comes to analysing assets. That is especially true for complex structures which require its forensic expertise to unpick. “Nobody understands some of this stuff” without going through BlackRock, says a portfolio manager who uses Aladdin and regularly trades with the firm. A potentially worrying development is that it is now possible to engineer bonds to maximise the chances of BlackRock investing in them.

The disturbing parallel is with credit-rating agencies such as Moody’s and Standard & Poor’s in the run-up to 2008. Investors blindly relied on the agencies’ analysis of financial constructs underpinned by subprime mortgages, many of which were engineered in such a way as to ensure AAA-rated status but subsequently defaulted anyway. BlackRock’s models are undoubtedly more sophisticated than the credit-rating agencies’, and their use is not mandated by regulators. But Mr Fink is the first to admit that they are flawed, too: “If you believe models are going to be right, you’re going to be wrong.”

The question is whether BlackRock’s clients understand that they are not meant to rely on Aladdin’s prognostications for investing. BlackRock executives insist their models are designed to validate ideas that have been arrived at independently by clients rather than to generate them. That said, the company’s marketing materials talk of Aladdin’s services as a way to “see opportunities” in markets.

Mr Fink concedes the theoretical possibility of a herd mentality taking hold among users of Aladdin, but he is adamant that no such thing is happening in practice. “People can use our methodology or not,” he says. “Our models teach you the kerbs of the road, they don’t tell you the speed you should be travelling, or where the curves are in the road.” Most of what Aladdin does could be replicated in other systems like Bloomberg, he points out; Charles River, a consultancy, also provides very widely used analytic tools.

- The monolith and the markets, The Economist, December 7, 2013.

About the author:

Zhang Xin is Trainer at chinadaily.com.cn. He has been with China Daily since 1988, when he graduated from Beijing Foreign Studies University. Write him at: zhangxin@chinadaily.com.cn, or raise a question for potential use in a future column.