“Well they blew the horns
And the walls came down
They'd all been warned
And the walls came down…” – The Call
Speed seems to be the name of the game in professional trading these days. Algorithmic traders are locked in an arms race to build the best tools to identify and exploit high-frequency signals. Yet often it is the extremely low-frequency signals that deserve attention.
One fairly idiosyncratic, and admittedly ersatz, signal I have always found compelling is the Jericho indicator.
The walls come tumbling down
"The best qualification of a prophet is to have a good memory." – George Savile
Introduced by George Goodman, the famed Wall Street commentator who for decades wrote under the nom de plume “Adam Smith,” the Jericho Indicator is a simple (and considerably tongue in cheek) heuristic for determining whether the stock market (or part thereof) may be getting carried away by overexuberance. As the author put it in his magnum opus, "The Money Game":
“It is related to the number of walls in Wall Street office buildings that come tumbling down. As more and more walls come tumbling down, the Indicator starts flashing. The reason the walls come tumbling down is that prosperity touches Wall Street, the partners have a meeting, they figure they could make twice as much money if they had twice as many registered representatives – brokers – on the telephone. They take over another floor, they move to another building. Tumbling walls are a slightly lagging indicator, but walls never tumble in a bear market.”
The logic made more sense in Goodman’s heyday, when individual investors had to communicate directly with flesh-and-blood brokers instead of having access to the wonders of such services as TD Ameritrade (NASDAQ:AMTD) that have put the power of brokerage into the hands of all sorts of unqualified characters who can get up to all kinds of trouble online and without the interposition of any other human’s thoughts. But the underlying reasoning still holds.
In fact, now that brokers and trading floors are evaporating thanks to the internet’s doing away with the need for most middlemen, we could get an even more accurate indicator – if we have a way to know the number of active trading accounts in use and being created month to month.
Powers of prediction
"Prediction is very difficult, especially if it's about the future." – Niels Bohr
The problem with timing a market correction is that predicting the turn with any regularity or certainty is fiendishly difficult. It is certainly beyond the scope of this article and probably beyond the scope of this author’s abilities to offer a definitive method for quantifying irrational exuberance. But the Jericho Indicator, or something like it, can offer one more valuable datum to the investor’s understanding of the world. Even if it cannot be effectively quantified, tracking it can offer a valuable heuristic for investors seeking to understand the market and whether their expectations, and those of others are diverging from underlying economic and financial realities.
Tracking account openings at companies like Ameritrade is one way investors might be able to build their personal Jericho Indicators for the stock market. They might also consider expanding the same insight to other industries. For example, real estate seems to have its own version of the indicator: The number of new realtor licenses. The number of realtors exploded in the run-up to the 2008-2009 financial crisis only to evaporate when the market turned. Today we can see that the numbers have climbed once again. Perhaps real estate investors should add this to their list of signals to track, especially considering that the National Association of Realtors updates its rolls in nearly real time.
Avoiding the deluge
“Bulls make money, bears make money, pigs get slaughtered.” – Old Wall Street maxim
To be sure, serious investors have long known that day traders tend to pop up like mushrooms during sustained bull markets and that these same dilettante financiers suffer worst when the inevitable market correction arrives.
One oft-told (but almost certainly apocryphal) tale about Joseph Kennedy, patriarch of the political dynasty, is testament to that. As the story goes, Kennedy was getting his shoes shined in 1929 and found himself being offered some hot stock tips by his shoeshine boy. The proffering of advice from such a totally unqualified source was supposedly justification enough to bail out of a stock market that was clearly being driven up by exuberant amateurs.
While it may not be the most novel of ideas, investors should still look to ways of monitoring their own versions of the Jericho Indicator.
Disclosure: I/We own no stock mentioned in this article.
