Lemmings, Sir Isaac Newton and Financial Markets
by Ian Andrews
What do Bison and Covid19 have in common?
What do the financial markets and Sir Isaac Newton have in common?
How about mask and vaccine mandates and lemmings?
From “The Socionomic Theory of Finance”, by Robert Prechter, “herding” is a much better answer,
if not “the answer” regarding the age-old question,
“how do I analyze financial markets and their trends. What makes the markets do ‘what they do’ ”.
What causes price movements?
Is it supply and demand?
Is it the price-to-earnings ratio?
Is it the cash flow of some big tech company?
Is it “the FED”?
Is it the war in Ukraine?
Is it the Covid19 pandemic?
Was it the Arab oil embargo back in ’73?
Was it the Cuban missile crisis in ’62?
Or the invasion of Kuwait in 1990?
The answer is,
“all the above”, yet,
“NONE OF THE ABOVE.
External (exogenous) factors, and endogenous (internal) causes
play a role.
But, NOT anywhere near the extent that
Like lemmings, and like Bison, people herd.
they herded into two differing camps regarding the pandemic
and its solutions -
mask mandates and vaccine mandates. The fearful.
And those that opposed both. The ones that desire freedom of choice.
But, nowhere does herding show up “in spades” like in the financial markets.
The following is curated from The Socionomic Theory of Finance,
with my commentary interspersed.
Quotes from the book are in Cinzel font.
My words are in Calibri font.
I’ve “curated” as much as I could legally – EWI graciously says I can quote up to 500 words from the book,
as long as I credit the book and let them know I did an OpEd/book review, which I have done.
It’s a “heavy” book – some 788 pages, 44 chapters.
BUT!!! It reads extremely easily.
The Socionomic Theory of Finance (by Robert Prechter)
explains “Herding” in great detail.
I think it’s an extremely interesting, eye-opening read.
As always, there are plenty of charts – seeing is believing. A picture’s worth a 1000 words.
(I hate using trite old sayings. But sometimes, what the heck. Sometimes they’re appropriate.)
… nearly all subsets of financial market participants herd, including individual investors, futures traders, financial advisors, hedge fund managers, mutual fund managers, corporate insiders, Wall Street analysts,
and even government agencies. (pg337)
Individuals aren’t the only ones to herd. Corporations do too.
Corporate buybacks are a great example.
Chapter 31 offers … numerous … examples … in which corporations act as a herd in expressing social mood.
Economists steeped in the mechanics paradigm of exogenous cause, do not understand this dynamic … (pg. 341)
They think corporate buybacks should make a company’s shares go up,
and vice versa. (pg. 341)
One headline says,
“Bad Sign: CEOs aren’t buying stock in their companies.” (pg341)
In this case, they (the economists), feel this is “bearish”.
A socionomist, in contrast, recognizes that trends in buybacks express social mood. The article just quoted is dated Feb.16th, 2009. The stock market bottomed three weeks later, and shortly thereafter the economy joined it for one of the longest advances on record. (Pg341)
It starts with individual investors and individual money-mangers.
It continues with corporations.
It culminates with governments.
Governments aren’t just part of the herd; they represent the herd. (pg342)
Buying and selling is not the only way in which herding is manifested.
Herding is manifest not only in the actions of buyers and sellers of investment items but also in the inaction of holders and non-holders. Some non-holders resist buying (in) an advance until their optimism becomes so intense they can’t stand being out of the market. Some holders resist selling in a decline until their pessimism becomes so intense they can’t stand being in the market. … their inactions turn to action. Their inaction was not an avoidance of herding; they were herding throughout the process. (pg346)
One of the greatest mistakes investors, and those that advise, make, is, embracing “exogenous causality” – believing external factors cause movements in markets. They do not. Social mood does.
Right behind this erroneous philosophy, is trying to apply “economic principles” to financial markets. Economic models do not fit financial structures – Socionomics do.!!!
Believing in external causality in finance dooms people to herd … One accomplished neuroeconomist, echoing a widely shared opinion of the time, told a reporter that the stock market decline up to late Sept. 2008 was an illogical overreaction due to a herding mentality among investors … and scolded a colleague for having sold stocks earlier. He said he had bought stocks because he perceived no evidence indicating an approaching depression. … mainstream economists all agreed there was no evidence of an approaching depression … The market started panicking two trading days later and suffered an additional 40% drubbing over the next 6 months. (pg346)
Sir Isaac Newton was a brilliant man.
"New Scientist" once described him as “the supreme genius and most enigmatic character in the history of science.”
His three greatest discoveries —
the theory of universal gravitation,
the nature of white light,
— are the reasons he is considered such an important figure in the history of science.
And yet he “herded” with the best of them.
During the South Seas bubble,
He invested a little bit early in the trend and ‘wisely’ took a small profit. Watching the trend continue, he finally bet heavily and ‘wisely’ held on for the long run. He eventually sold out at a near-total loss. In the long run,
all herders lose money. (pg348)
An article titled, “The World’s Smartest Bad Investors”
cited six brilliant scientists and professors, including Nobel prize winners, who suffered dismal experiences in financial markets. The writer exclaimed, “These are some of the top finance and economics professors in history. Their deep and penetrating research has revolutionized the world of academic finance.
To call them brilliant would be an understatement. So why have they stumbled … ?”
Socionomic theory easily explains why the smartest people on the planet typically lose money speculating.
It has nothing to do with IQ, which is an attribute mostly of the rational neocortex. It has to do with most speculators’ inappropriate assumption of exogenous causality … (pg355)
Hopefully, I’ve whet your appetite to invest more time studying Prechter’s theory.
(And no, I am not compensated in any way for this OpEd/book review.)
BSOT (be safe out there)
P.S. While it’s become stuck in metaphors, it’s a myth that lemmings commit mass suicide – they do not!!!