|By Mark Galasiewski, originally published in the October 2008 Asian-Pacific Financial Forecast|
Contrarian investors have long known that “the time to buy is when blood is running in the streets.” That statement, famously made by the nineteenth century London financier, Nathan Rothschild, makes more sense when viewed from the socionomic perspective. Socionomics is the study of human herding and the collective behavior that follows from it. It holds that both stock market trends and society’s mood are patterned according to the Wave Principle. Rising social mood causes both rising stock prices and constructive social behavior. Falling social mood causes falling stock prices and destructive social behavior. For a closer look at the negative side of social mood, we have collected data from Asia’s three active warfronts, to see whether they support this hypothesis. This month we look at past and current violence in Afghanistan and Iraq, as well as Al Qaeda’s war on the United States.
Afghanistan and Pakistan
Our story begins with Pakistan’s main stock index, the Karachi Stock Exchange 100 (KSE-100), because we have determined that it is a likely proxy for the social mood in Islamic Central Asia. (For background, refer to the August and September 2008 issues of The Asian Financial Forecast.) As we will soon see, fluctuations in Pakistan’s stock market have great significance for the conflict in neighboring Afghanistan. We would prefer to use data from Afghanistan’s stock exchange, but we know of no index for that market. First, let’s analyze the KSE-100 in terms of the Wave Principle.
Figure 1 shows that at the April 2008 high, the Karachi Stock Exchange 100 (KSE-100) completed a 10-year impulse wave with an ending diagonal in the fifth-wave position. The nation’s main stock index is currently undergoing a correction of that impulse. Our target for the end of the correction—and it’s only our minimum target—is 6500. That level sits near the end of the previous fourth wave of one smaller degree [i.e., wave (4)] and the 61.8% retracement of the previous impulse (i.e., the rally from 1998-2008), both of which frequently mark the end of corrections. Depending on the position of the 1998-2008 impulse within Pakistan’s multi-decade wave count, the ultimate end to the bear market could be much lower.
Within Figure 1, you will also see an illustration originally published in 1978 in Elliott Wave Principle. A.J. Frost and Robert Prechter wrote that book as a guide to the financial price patterns that Ralph Nelson Elliott discovered in the 1930s. The inset shows an idealized impulse wave with an ending diagonal in the fifth-wave position. Its resemblance to the advance in the KSE-100 since 1998 is no mere coincidence. Such patterns occur every day in stock markets around the world at smaller degrees of magnitude. This one just happens to be of Primary degree and to have implications reaching far beyond the borders of Pakistan.
The first of those implications is that Afghan resistance fighters tend to become most agitated when the regional social mood—as reflected by the Pakistani stock market—is falling. Foreign military fatalities in Afghanistan have generally surged during declines in the KSE-100 as shown by the red circles in Figure 2. Those waves have tended to peak at the same time as or, most commonly, soon after major stock market bottoms. Fatalities have generally subsided during rallies in the KSE-100. The gradual decrease in fatalities from 2002 to early 2005 (as marked by the downward green arrow) reflects the positive mood of wave (3). Third waves are known to be periods of broad participation, which in the stock market is known as breadth. For example, during multi-year bull markets, the number of stocks that participate in the advancing trend generally peaks during third waves. In Afghanistan, you can see the “breadth” of the positive mood of wave (3) in the willingness of guerrillas to lay down their arms in accordance with the positive social mood of the period.
The escalation in fatalities during 2005 reflects the severity of wave (4), which was the largest percentage decline since the end of wave (2) in 2001. The spikes in fatalities during 2005, 2006 and 2007 graphically illustrate another socionomic observation: that the dominant mood trend of the coming correction often begins to reveal itself during wave four and can even intensify during corrections within wave five.
With the correction of the 1998-2008 impulse well under way, that dominant mood trend is now in full swing. In August, the foreign forces suffered their largest monthly losses ever in Afghanistan. And, with our minimum target for the end of the bear market in the KSE-100 still well below current levels, we believe those losses are likely to continue to escalate. However, countertrend stock market rallies are likely to coincide with lulls in insurgent activity.
Al Qaeda and Pakistan
Let’s take this social mood research a step farther by looking at Al Qaeda’s attacks around the world to see how they fit into stock market trends. Pakistan’s stock market also appears to be a meter of the mood within Al Qaeda, the Sunni Islamic movement dedicated to ending foreign influence in Muslim countries and to the creation of an Islamic caliphate (state). Osama bin Laden and other key Al Qaeda leaders may be Arabs, but for most of the past 30 years, they have lived with the Pashtun and other peoples of the former Afghan Mujahideen, who have long been supported by Pakistan. So it makes some sense that their activities would also ebb and flow with the KSE-100. Indeed that is the case, as seen in Figure 3.
Al Qaeda attacks—or those inspired by Al Qaeda—on targets perceived to be American have often occurred near major lows in the KSE-100. (Infoplease.com, a division of Pearson Education, compiled these attack records shown in Figure 3.) Al Qaeda has generally refrained from such attacks during bull markets in Pakistan. This model also appears to explain the timing of other Al Qaeda-inspired attacks that aren’t necessarily aimed at American targets, such as the bombing of the nightclubs in Bali, Indonesia, in October 2002; the London, U.K., subway in 2005; and even the Mumbai, India, railway in July 2006 (which was conducted by another Afghan-Pakistani Islamic extremist group, called Lashkar-e-Toiba).
On the other hand, the model fails to explain the timing of other attacks, such as the Madrid train bombings in March 2004. So we have limited the study to attacks on targets perceived to be American, under the assumption that Al Qaeda’s leaders in the mountains of Afghanistan or Pakistan are more likely to take a direct interest in hitting such targets. It may be that local stock markets explain the timing of other Al Qaeda-inspired violence, as Spain’s IBEX 35 does in the case of the Madrid train bombings.
Our studies show that the intensity of the attacks (and the social sentiment behind them) usually reflects the degree of the wave in question. For instance, the most ambitious Al Qaeda attacks—whether measured by the size of the structures targeted or the number of people killed—have taken place during or after corrections of Intermediate degree. The most severe of those, the 1998 U.S. Embassy bombings and the 2001 attack on targets in the United States on 9/11, appear to reflect the bolder mood at Primary degree. The 1998 low marked the end of the Primary degree correction from the 1994 high. The attack on the United States in 2001 took place near the end of the second-wave test of that low. Sentiment frequently reaches its extreme not at the end of end of C waves, but at the end of second waves. In Elliott Wave Principle, Frost and Prechter wrote that second waves can generate “fundamental conditions often as bad as or worse than those at the previous bottom.” As the most violent event on the list, the attack on U.S. soil on September 11, 2001, fits that profile perfectly.
Like the Taliban attacks against foreign forces in Afghanistan in Figure 2, the severity of Al Qaeda’s attacks on American targets waned during wave (3) up in Pakistan’s stock market. During most of wave (5), Al Qaeda appears to have given up attacking Americans completely. Or the organization may have diverted its attention to the Sunni-Shiite civil war in Iraq during that time (see next section). Regardless, the escalation of attacks in recent months suggests that the lull was only temporary.
The attacks in September on the U.S. Embassy in Yemen and the Marriott hotel in Islamabad, Pakistan, were the most ambitious since those on three American hotels in Amman, Jordan, in 2005, which took place following an Intermediate degree correction. The impulse that the KSE-100 completed at the April 2008 high was of at least Primary degree, so the current correction is also at least of Primary degree. As long as Al Qaeda remains a viable organization, we should expect to see it escalate attacks against targets associated with the United States as Pakistan’s bear market grinds on. Those attacks are most likely to occur near the end of major price declines, and the most lethal are likely to take place near the end of the bear market.
Iraq (and Iran)
Now, turning to Iraq and Iran, we can see a link between stock market waves and populist violence. Fatality data from Iraq also appears to support the idea that social mood as measured by the stock market determines the timing and intensity of populist violence. Figure 4 shows how Iraqi fatalities in the civil war between Sunnis and Shiites in Iraq surged during the correction in Iraq’s stock market from 2005 to 2007. If Iran’s stock market is any guide (since Iraq’s data is sparse), that correction was likely a fourth wave in an impulse that started in the early 1990s.
Although there is little trade between Iraq and Iran, the similarity between the two national stock indexes is understandable from the perspective of social mood. The former government of Iraq was run by Sunni Muslims. Since its downfall, Shiite Muslims now dominate, and they outnumber Sunnis by as high as 2-to-1 (estimates vary, but even the lowest ratio is 3-to-2). About 90% of Iran’s population is also Shiite. So we will assume that the mood in Shiite society is now the driving force in both Iran and Iraq.
We know of no prewar Iraqi stock index, but, if one exists, it likely more resembles indexes in nations dominated by Sunni Arabs, such as Saudi Arabia, Kuwait, Jordan, and Lebanon. (See June 2008 Asian Financial Forecast for charts of Jordanian and Lebanese indexes.) Those indexes began major corrections in the winter of 2005-2006, a year after Iran’s TEPIX and Iraq’s ISX. They also reached their lows along with the Iraqi and Iranian indexes between the summer of 2006 and the summer of 2007. According to socionomics, the study of social mood, it was then no mere coincidence that monthly Iraqi fatalities in the civil war double-topped during that period, in September 2006 and February 2007.
In January 2007, the U.S. government announced a large increase in the number of U.S. occupation forces—the “troop surge”—near the low of the correction in Iraq’s stock market. It finally employed those bodies in major counter-insurgency efforts five months later. EWI’s studies have long demonstrated how government tends to react to trends only after they have reached their peaks, and the battlefield is apparently no exception. Watch for that principle to apply to the foreign military’s behavior in Afghanistan or Pakistan sometime in the future. And don’t be surprised if the United States withdraws or reduces troops in Iraq near the end of the current bull market in Iraqi and Iranian stocks.■
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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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