The Hindu Business Line : US stock market recovery in anti-bubble phase, say physicists

Two physicists of the University of California in Los Angeles have come out with a statistical physics model that predicts that the US capital market, which is currently trying to find its feet, will tumble again.

According to a report by Jenny Hogan in New Scientist, physicists Didier Sornette and Wei-Xing Zhou claim that their model has identified what they call an "anti-bubble" in the Standard & Poor 500 stock market index, much like an anti-bubble in the Japanese Nikkei index in the early nineties, a phenomenon which preceded a decade of steady market decline in that country.

The physicists say that their model indicates that the on-going recovery of the US stock market will last only till spring next calendar - and that stock prices will plunge thereafter.

However, New Scientist quotes Neil Shephard, an economist at the University of Oxford, UK, as demurring on two grounds: firstly, the track record of empirical prediction isn't very good and secondly, economic theory says it shouldn't work. "This is because traders tend to act on new information about the market by buying or selling shares, making it impossible to make a prediction without it affecting the outcome."

The prestigious magazine goes on to report that the physicists' predictions are, nevertheless, in line with those of some others. Haydn Carrington, a dealer at the spread betting firm City Index in London, also believes the US market is in a long decline, but that a short-term rally is likely: "The Americans are optimistic about recovery, so that will probably happen." Rebuttal from certain quarters notwithstanding, the physicists are sticking to their guns. Bubbles and anti-bubbles, Sornette says, are traits of herding and imitative behaviour. Investors and traders constantly exchange opinions and information, generating a feedback loop that can drive the performance of the market.

A bubble, or bull market, occurs when optimism spreads, pushing the market value artificially high. The bubble may then burst. Even if does not, a slow period of downward adjustment will follow - a bear market which Sornette calls the anti-bubble phase.

An anti-bubble market has two key characteristics. The value slides steadily downwards - but oscillates as it does so. The value of the S&P 500 has been riding this roller coaster since August 2000. Sornette adds that the "up" seen now is just one of the oscillations, and that hopes of a recovery will be dashed by a "down' in mid-2003. And the trough that it sinks into may be deeper than this year's low.

The model used to make this prediction describes "crowd" behaviour of the type Sornette expects from traders and investors. It consists of a set of three equations that describe feedback processes. He developed the equations when studying failure mechanisms in materials - the way cracks develop and cause damage. This is similar to the way that information seeps through the market and changes opinion, he believes.

The model requires the input of two constants: one quantifies the overall trend (down in an anti-bubble), the other the frequency of oscillation. He chose constants such that the model matched the S&P data from the past few years - and then extended the model to 2004.

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US stock market recovery in anti-bubble phase, say physicists