Monday, February 14, 2005

 

Socionomics

Update: Socionomics Part II

Socionomics is a new theory of market behavior with roots in behavioral economics; specifically behavioral finance. Behavioral analysis of the markets take human emotional response into account for economic decisions. This is counter to the efficient market theory which requires rational decision making among, more or less, informed market participants.

Socionomics, as you can see from its wikipedia entry, is new and controversial. The theory postulates that human herding instincts govern market movements. (If you have the picture of lemmings running over a cliff, then you have the right idea) Social mood changes govern the markets and the economy, even esoteric subjects like fashion and whether somber or joyful music is popular. Social mood is endogenous. News events do not change social mood, the way we look at news events is shaped by social mood. You can see it in the way that markets are reported. If the market drops then it is because of some bad news that was reported that day and vice versa. Is it the trade deficit that is driving the dollar down? We have been running trade deficits for decades so why is the effect only felt now?

So how is the herding instinct reflected? By the fact that financial markets are robust fractals. That is, a fractal that has certain forms that it adheres to within randomness. A tree can grow any number of branches in random configurations. It still looks like a tree even though we cannot guess to what it will look like when it is a seed. This is completely contrary to the way that classic economics looks at the world. The following contrast is from the November 2004 Futures magazine:

Economic model
  1. Objective, conscious, rational decisions to maximize utility determine financial values
  2. Financial markets are random
  3. Financial markets are unpredictable
  4. Financial markets "tend toward equilibrium" and "revert to the mean"
  5. Investors' decisions are based on knowledge and certainty
  6. Changing events presage changes in the values of associated financial instruments
  7. Economic principles govern finance
Socionomic model
  1. Subjective, unconscious, pre-rational impulses to herd determine financial values
  2. Financial markets are patterned
  3. Financial markets are probabilistically predictable
  4. Financial markets are dynamic and do not revert to anything
  5. Investors in financial markets typically use information to rationalize emotional imperatives
  6. Investors decisions are fraught with ignorance and uncertainty
  7. Changing values of financial instruments presage changes in associated events
  8. Socionomic principles govern finance
As you might have guessed this has profound implcations for the way we view finance. What should have immediately caught your eye is the claim that "financial markets are probalitically predictable." The chief proponent of socionomics is a man by the name of Robert Prechter who began as a market analyst in the 1970's when he discovered the works of Ralph Nelson Elliott. Elliott's wave principle is a model of the markets that breaks market movements down into fractal patterns. (All long before fractals were "discovered") Prechter used Elliott's wave principle to predict the markets and achieved the title of "market guru of the decade" in the 1980's. Prechter took the next logical step with socionomics. It was a case of the useful tool being discovered before the science that could explain how it worked. If markets are fractals, does this say something about humanity? Socionomics is the answer.

Why am I writing about this? I want to give you an idea of what might be coming to the US economy in the near future which will not be very pretty. Rather than present my predictions in a vacuum I thought you would better appreciate what I have to say if you understood from where my prognostications are derived. One more thing I want to address. I am sure that some of you look at this as an attempt of some sort of predetermination. It is not at all. Probalistically predictable means that you can look at a chart of prices and make a better than random, but not certain, guess at what the next move will be. If you study the wave principle you will find that there are times when it is simply impossible to make a determination with confidence. And you will find that there are times when it seems like the market is screaming, "I am about to go up/down right now!"

My next post on this subject will make the case for deflation and depression.

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