 Originally published in the Sept. 2009 Socionomist |
Conventional models of social causality stand in contrast to the socionomic perspective. Robert Prechter explained the difference in the May and June 2004 issues of the Elliott Wave Theorist. When most people forecast cultural trends, they default to a Newtonian physics paradigm: An object in motion tends to remain in motion unless acted upon by an outside force. An intuitive understanding of this law, Prechter observed, is a useful product of evolution and helps us handle physical objects with ease. But cultural trends are not physical entities.
Economists who view cultural trends like physical objects in motion perpetuate two fallacies.
1) They extrapolate the current trend into the future.
2) They believe an event must happen to change the trend’s direction.
Conventional financial and macroeconomic analysts are particularly guilty of committing the fallacies of trend extrapolation and exogenous causality. Let’s look at a recent example.
Economists expected approximately 320,000 Americans would lose their jobs in July 2009. When the Labor Department released the numbers in early August, it turned out “only” 247,000 jobs were lost. The unemployment rate fell one-tenth of one percentage point, its first decline in more than a year. The day the figures were reported, U.S. market indexes closed higher, with the Dow Jones Industrial Average and S&P 500 rising 1.23 and 1.34 percent respectively. Here are two representative examples of conventional analysts’ end-of-day market commentary:
July Jobs Data Lifts Stock Indexes
Stocks rallied on Friday, pushing the Standard & Poor’s 500 to a 10-month high as the July jobs report was less bleak than feared and underpinned hopes the economy was on track for recovery.
—Reuters, August 7, 2009
U.S. Stocks End Higher on Jobs Report
Major stock indexes barreled higher by more than 1 percent Friday after the government said the U.S. unemployment rate unexpectedly fell in July for the first time in 15 months and that employers cut fewer jobs.
—Associated Press, August 7, 2009
This is a physics-based understanding of markets. The jobs report acted like a rock that whacked traders on the head and caused them to re-value share prices (exogenous causality). Furthermore, the decline in unemployment was seen as evidence that the economy and stock market remain on track for recovery (trend extrapolation). Let’s investigate this logic.
First, the unemployment rate had worsened for 15 months; the stock market had trended higher for the past five. During the rally from March, there were no headlines that read, “Rising unemployment sends stocks higher.” Such a headline would make no sense. Analysts had to find some other piece of news to “explain” the market action. Second, as documented in the November 1999 and May 2004 issues of The Elliott Wave Theorist, economic trends tend to lag the stock market. To establish a causal relationship, it is necessary (but not sufficient) for the cause to precede the effect. If jobs data caused the market to rise, then the unemployment numbers should have improved before the market’s five-month rally, not after. So, the chronology was the reverse of what logic demands. Finally, since economic trends tend to lag the market, there is no reason to believe that the jobs report indicates future gains in the stock market.
Exogenous-cause indicators rise and fall in popularity. They do so because they don’t work.
The Wave Principle of Human Social Behavior observed that economists in the 1980s and 1990s believed that a large trade deficit was bad for the market, so they anxiously anticipated the monthly U.S. balance of trade report. But as Prechter noted, the trade deficit expanded throughout most of the bull market in stocks from 1975-2000. Prechter found that a stock trader who was bullish based on the declining deficits of 1978-82 and 1987-1991 would have made nothing; the rest of the time, when he was bearish due to an expanding deficit, he would have repeatedly gone bankrupt. Prechter also observed that business owners who held the false belief that shrinking deficits are good for the economy and thus expanded their operations in 1979 and 1989 did so on the eve of two recessions. Those who held back due to a rising trade deficit missed the entire boom.
Figure 1
Prechter originally published Figure 1 in the February 2005 Elliott Wave Theorist. The chart demonstrates that if there was any relationship between the trends of the trade deficit and the market over the past three decades, it was in precisely the opposite direction of what conventional analysts assumed. Prechter forecasted the trade deficit would shrink when the market turned down in earnest. Figure 2 illustrates how that is precisely what happened. Prechter, moreover, did not extrapolate a current trend into the future, but instead he accurately anticipated a change in the trend, in both data series. This is the power of (1) actually studying the data and (2) adopting a socionomic perspective.
Figure 2
The relationship between the trade deficit and the market in recent decades alone was good reason to offer a forecast. And, once established, the relationship between the U.S. market and the trade deficit also allowed a socionomist to discern where economists’ reasoning went wrong. Prechter reasoned that social optimism leads to a rising stock market and stronger economy. In a strong economy, he said Americans “buy more goods from abroad, while citizens of other countries, most of which have a higher savings rate, save a portion of the money they receive rather than spend it. The trade balance does not cause economic trends; it results from them.” (For a full explanation, see Chapter 19 in The Wave Principle of Human Social Behavior.) Observe most importantly that Prechter did not propose a causal relationship between the trade deficit and the market or vice versa. Instead he posited that a third variable—optimism, or more broadly, social mood—caused trends to fluctuate in the market, the economy and the trade deficit. This is the fundamental difference between orthodox economic, political and sociological reasoning on the one hand and socionomics on the other.
Understanding social mood is crucial to anticipating social trends. Such understanding liberates analysts from the fallacies of trend extrapolation and reliance upon exogenous causality. Socionomic theory provides the necessary tools to overcome these fallacies and make useful social forecasts. It grasps the proper relationship between mood and action, namely that social mood regulates the tenor of social events. With socionomics, analysts don’t need to ruminate about what the central bank’s decision on interest rates will do to consumer sentiment, whether the election of a given politician will make the country more optimistic, or how any social event will affect social mood. None of these external events determines how social mood develops; it is impervious to exogenous activity. Those who use exogenous models and linear extrapolation to forecast cultural trends are doomed to fail consistently. Those who use socionomics aren’t always right, but they at least start from the right premise.■
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Most economists, historians and sociologists
presume that events determine society’s mood. But socionomics hypothesizes
the opposite: that social mood regulates the character of social events. The
events of history—such as investment booms and busts, political events,
macroeconomic trends and even peace and war—are the products of a naturally
occurring pattern of social-mood fluctuation. Such events, therefore, are not
randomly distributed, as is commonly believed, but are in fact probabilistically
predictable. Socionomics also posits that the stock market is the best available
meter of a society’s aggregate mood, that news is irrelevant to social
mood, and that financial and economic decision-making are fundamentally different
in that financial decisions are motivated by the herding impulse while economic
choices are guided by supply and demand. For more information about socionomic
theory, see (1) the text, The
Wave Principle of Human Social Behavior © 1999, by Robert Prechter;
(2) the introductory documentary History's
Hidden Engine; (3) the video Toward
a New Science of Social Prediction, Prechter’s 2004 speech before
the London School of Economics in which he presents evidence to support his
socionomic hypothesis; and (4) the Socionomics Institute’s website, www.socionomics.net.
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The Socionomist enables you to see trend-shaping waves of social mood, as reflected by the stock market — and capitalize on them. The June issue looks at phases of social mood and features a “Research Roundup,” which highlights five academic studies that shine a light on important aspects of socionomic theory. Mood Riffs topics include “quiet luxury,” loneliness, the Writers Guild strike and efforts by countries to trade in currencies other than the U.S. dollar. Read the June issue when you become a Socionomics Premier Member.
