Share Synthesis

I have mentioned on the theory of reflexity in my previous posts and even though I have yet to grasp hold of the concept but just the initial understanding has already intrigued me to find out more. I did an extensive search on the net and found an article discussing on this..

This concept is founded by Soros and he attempted to explain his concept of reflexity in the following statement :

"There is an active relationship between thinking and reality, as well as the passive one which is the only one recognized by natural science and, by way of false analogy, also by economic theory. I call the passive relationship the “cognitive function” and the active relationship the “participating function,” and the interaction between the two functions I call “reflexivity.” Reflexivity is, in effect, a two-way feedback mechanism in which reality helps shape the participants’ thinking and the participants’ thinking helps shape reality in an unending process…”

Example (Extracted from the article)
Consider the relationship between a company and its publicly traded stock under normal business conditions. It is intuitive that when the fundamentals improve the share price rises. However, does it make sense that a changing share price might, in turn, impact the fundamentals? Sometimes the answer is yes.

A simple and timely example is seen from the effect of credit ratings. When Moody’s or S&P downgrades the credit ratings of a given financial institution (think AIG), it can have an impact on the amount of collateral the company must pledge to back its obligations. A downgrade also increases the cost of capital for new debt issuances. The view of the S&P analyst is, in part, subjective. The perception of the company’s future prospects and current financial condition plays an important role in the assignment of the credit rating, and and a falling stock price gives a bad impression. The negative feedback loop between capital requirements (fundamentals), stock price, and credit ratings (perception) causes a vicious cycle.

Common to all recessions are forces that cause dynamic disequilibrium between fundamentals and prices. 

Some of these are,
A. Jobs losses --> declining consumer spending/confidence --> contraction in businesses targeting consumers --> more job losses due to business contraction, etc.

B. Credit crunches: Business and consumer balance sheets deteriorate --> tighter lending standards and less credit available --> business/consumer spending slowdown --> worsening balance sheets, etc.

C. Stock market declines --> reduced “wealth effect” --> decline in consumer spending --> business contraction --> more stock market declines, etc.

D. Stock market declines --> lower capital gains tax revenues --> rising government deficits --> decreasing investor sentiment -- > more stock market declines, etc.

Details can be found here

His ideology is often mistaken as trend following but one contrasting difference is that he always managed to enter/exit at the reversal point so from this, I gather a clue. I need to come up with an objective view by looking at a bigger picture and in order to do that, I must constantly remind myself not to be distracted/mislead by the daily reports and news.



Reproduced with permission from http://melynn-lynch.blogspot.com