(An Interview with Robert Prechter, president of the Socionomics Institute)
Q: In a nutshell, what is socionomics all about?
RP: Socionomics is the study of social action that expresses social mood. Social mood arises endogenously from unconscious herding impulses inherited through evolution, and is patterned according to the Wave Principle.
Q: Endogenously, meaning that nothing impacts social mood?
RP: Right. No outside forces change the trends and patterns of social mood. This idea is counter-intuitive, but our studies demonstrate time and again that even the most dramatic news events do not change the dynamics of stock pricing, which is our measure of social mood. A positive mood motivates people to produce more, act peacefully with their neighbors, purchase uplifting entertainment, etc., and a negative mood motivates the opposite actions. So mood shapes economic, political and social trends. Most people think that social events cause the public’s mood to change, but it’s the other way around. This idea is the basis for what I call socionomics.
Q: How then can you explain the depressed mood after 9/11? It seemed the event put a gloom over everyone, which is contrary to what you’re saying? Was that an aberration?
RP: On the contrary, it is exactly in accordance with socionomics. People had been getting gloomier for a full year and a half before the attack, not after. Six trading days after the attack, social mood improved non-stop for half a year to a far more optimistic level than it was at the time of the attack. The positive trend showed up in stock prices, consumer sentiment and measures of advisor and investor optimism. When the event occurred, people unconsciously latched onto it as an explanation for their waxing gloom. “Ah, there’s a reason!” But if the attack really were the reason, then it should have occurred when optimism was strong and preceded a change toward pessimism. That’s not what happened. All our studies show that mood trends, as revealed by the stock market, precede compatible social actions. So you can’t use social actions to predict the stock market, but you can use the trends in the stock market to predict the character of social actions.
Q: Why then do people believe that social events impact social mood?
RP: Because people’s brains naturally default to mechanics when they think about social events. Knowledge of mechanics has helped keep the species alive. We know that an object in motion will continue in motion unless acted upon by a force. So we duck when a rock is thrown at us and we swerve out of the way of a drunk driver who is drifting across the median. So people assume, with deep conviction, that any change in the stock market’s direction must have been caused by some outside force. If they can’t find one, they make one up. That’s what the newspaper writers do every day after the market closes. But the stock market is not an object in motion, and outside forces are not required to change its trajectory. Unlike rocks, people have minds, and they can change them. In fact, they do change them, all the time, in accord with the impulse to herd. That is what moves markets. It’s also what makes markets patterned. Herding is not rational, but neither is it random. It trends and reverses by its own dynamics.
Q: Are the effects of crowd psychology more pointed when we find ourselves in a more turbulent and critical era?
RP: Crowd psychology creates peaceful eras and turbulent eras. After the mood has trended positively for a longtime, peace reigns, as it did in the 1920s, from the mid-’50s to the mid-’60s, and during the 1990s. After the mood has trended negatively for along time, turbulence reigns, as it did in the 1930s, the 1970s and since the peak in 2000. Social mood induces social actions, which express that mood. If you really want to get down to what I’m talking about, the eruption of scandals did not cause a negative social mood; a negative social mood caused the eruption of scandals. You say that notable social events follow, rather than precede, corresponding stock market waves (hence socionomics).
Q: Does the market cause changes in mass psychology or does mass psychology drive market prices?
RP: Mass psychology drives markets. But it also drives other things. A positive mood induces people to expand businesses, dress with flair, buy happy music, make peace with others and buy stocks. A negative mood induces people to contract businesses, dress conservatively, buy morose music, fight with others and sell stocks. So social mood moves not only the stock market but other measures of social action as well.
Q: Social mood, and therefore behavior, is always in flux. Change is constant.
RP: Absolutely. There’s not such thing as social equilibrium. What we have is an unceasing dynamism. The thrilling thing about it is that it’s dynamism at all scales. Dramatic moves lasting years or decades to the upside, equally or even more dramatic moves on the downside, over and over again. There’s no such thing as equilibrium.
It’s the buyers and sellers, it’s the people who lend and borrow in the marketplace, it’s the depositors and the bankers, all the people throughout society who are determining things like interest rates, how much economic production will occur, whether they’ll be a recession or not, it’s those summed decisions, which I believe emanate from shared moods that people have, that ultimately dictate all of those things.
See the list below for more examples of socionomics’ perspective of social causality.
Pattern – The Wave Principle
Q: So far we’ve established that social trends unfold of their own accord. Let’s get back to the Wave Principle. Tell us more about fractals and waves.
RP: I think a lot of people are familiar with fractals these days, they became rather popular in the early eighties. A fractal is an object that is similarly shaped at different scales. Fractals permeate nature. Nature’s fractals tend to be irregularly shaped, they don’t come in circles, triangles and squares, they are irregular shapes such as clouds and trees and so on. They are self-similar at all scales.?
Let’s take a tree as an example. A branch will look very much like a whole tree. A twig off the branch will look very much like the branch and the whole tree. You have similarity at every scale although the branches are not similarly shaped they are quite irregular, you’d still recognize the tree because of that fractal pattern.
This brings us to waves, because in the mid 1930s until about the mid 1940s a man named Ralph Nelson Elliott began to investigate the price patterns in the stock market and other financial markets and he concluded what he was observing was a fractal. Of course, he didn’t use that term, it hadn’t been invented yet, but he drew out the patterns he was seeing and he said they linked together to form larger versions of the same patterns. So he was dealing with a fractal. Modern research has expanded on this quite a bit. The idea that the stock market is a fractal is no longer considered unusual; it’s pretty much mainstream acceptance in academia.
The difference between Elliott and even modern researchers in the stock market is that he said, “It’s not an irregular fractal, such a tree or a cloud formation, this is a very specific fractal, it’s got specific patterns that make it up.” Some researchers call it a quasi fractal. I call it a robust fractal because I think it’s typical of nature’s forms that involve growth, expansion and progress.
Pattern – Fibonacci mathematics
Q: What is a Fibonacci progression?
RP: A Fibonacci progression is any progression in which two numbers are added to get the next and then those two later numbers are added again to get the next. The classic Fibonacci sequence, which was brought back to western civilization by Leonardo Fibonacci in the thirteenth century, starts with one. One added to nothing gives you another one, add that one to the first one you get two, one plus two gives you three, three plus two gives you five, eight, thirteen, twenty one, thirty four, fifty five, and so on.
What’s interesting about this sequence, besides the fact that it shows up throughout nature, is that as the terms approach infinity the ratio between the two terms approaches an irrational ratio called phi. It’s .618034 and of course it goes on forever. You can shorthand describe it as .62 or 62 percent. The interesting thing is that it’s throughout nature. You find Fibonacci patterns in plants, in animals and throughout the human body as well.
Q: Tell us about Phi and human judgment.
RP: This is where the fractals, waves and Fibonacci begin to come together. The physiology of animals, including human beings, is full of phi or .62 relationships. Roger Penrose pointed out that the microtubules in our brains are arranged according to Fibonacci numbers. Our neurons electrical potential is not equal on both sides, one side is weighted by the Fibonacci ratio to the other. Even the fractal dimension of our neuronal system is 1.62. Throughout of bodies, everything related to thinking, the brain, the neuronal system, DNA and everything else, is extremely intertwined with Fibonacci relationships. Now, what does that mean? Does it have any effects? Do we think in Fibonacci terms? Some researchers have found that we do. A man named George Kelly back in 1955 presumed that people made judgments based on what he called bipolar constructs. Good is on one end, bad on the other end, happy is on one end, sad is on the other end and so on. He, like most of us, assumed that the midpoint for most people would be at the 50 / 50 point. If people felt neutral they would mean they fell right in between, 50 / 50. When he actually began doing his experiments, he found something really interesting. He found out that people’s default was at 62 percent. In other words, a group of people who said they felt neutral would generally mark on a scale that they were 62 percent happy or 38 percent unhappy. Now we’ve had many psychologists in recent years that support that conclusion. So what they’ve concluded is that people default to the Fibonacci ratio for judgment when they have no real basis for judgment. In other words, this is some sort of central processor that the mind defaults to, it starts with Fibonacci.
What does that have to do with history, what has that got to do with human behavior in the aggregate? Here we come to what really got me interested in the first place on this whole topic. Robert Ray, back in the 1930s, charted bull markets and bear markets in stock and he found, even though he no idea what he was reporting, that bear markets tended to last about 62 percent of the time that bull markets did. They tended to retrace about 62 percent on average of what bull markets had performed on the upside.
So here we have people, in the aggregate, in a value neutral situation. When people argue what stocks are worth, they have no idea what they’re worth, you could make a case on either side. So it’s a sea of uncertainty and that’s the time when people default to this Fibonacci judgment. When you add all this together, you come to the conclusion that Elliott’s observation about the fractal and the stock market is correct because he found that the wave structure of that fractal is five waves in one direction, three in the other and when you iterate that and create a larger fractal you end up with the Fibonacci ratio and all of that is intertwined with general human thought. What’s really interesting, of course, is the implications of this on human behavior.
Q: Part of the way our minds work is the herding instinct.
RP: Right. We can put what we just talked about together with the herding instinct and come up with what I call the engine of history.
Let’s look at some of the recent research that people have done and discovered very interesting things about the way the human mind works. Dr. Paul McLean who is with the National Institute of Mental Health postulated essentially a three tiered brain. A primitive brain that developed through evolution, around the time of the reptiles, the limbic system which developed along with mammals which is the center of our emotions and then the neocortex which is a very late development that humans have, that’s where we do our rational thinking.
It’s a very interesting situation because we have a lot of things going on mentally that are unconscious, down in the limbic system. The limbic system is extremely powerful, it’s faster than the neocortex, has higher amplitude and can override the neocortex, particularly in stressful situations and situations of uncertainty which is what we’ve been talking about in the stock market.
So here you have people who have impulses that were designed in a primitive way to allow them to survive, this is all mixed with their Fibonacci proclivities and you come up with something very fascinating. One of the things that McLean noted was that a lot of the primitive instincts like fleeing and fighting and so on are in this primitive area of our brains, or controlled by it, and one of those things is herding or flocking in lower animals. I think human beings have a good dollop of the herding impulse inside of them. Researchers have been showing this to be the case in many different areas. I think this is the reason that we have such a colorful human history. All through human history people are essential herding, they are looking to each other for emotional queues and sharing emotional states of mind what I call social mood. It fluctuates between polar opposites just like we were talking about in the individual mind. So people have a tendency toward the positive or the negative end of the social mood, not only as individuals, but in the aggregate.
So when the aggregate of society is feeling better, you tend to find that people do a lot of things the same each time. On of those things is buying stocks. So as mood improves people get a little more daring in their stock speculation, but a lot of other things are happening as well. They get more daring in their romantic relationships. People propose more often in bull markets. You find that people like happier pop music in bull markets. They go to see family fare movies like Disney cartoons in bull markets. A lot of effects come out of that positive mood. People are also more inclined to cooperate with each other and their neighbors. You find more peace treaties coming into being after a long uptrend and positive social mood.
The negative social mood has consequences also. When the trend is down people are more defensive, more self protective, they’re selling stocks, they might be contracting their businesses so you end up with a recession or a depression. People like more depressing popular music and when they go to the theater instead of flocking to see that latest Disney cartoon they’d rather see horror movies.
So, in my opinion, this combination of fractal mental construct and the herding impulse which I believe follows that construct, essentially gives a mathematical shape to the ebb and flow of history and everything that society does.
Q: Social mood swings back and forth between opposites. This is the basis of your predictions, based on cycles.
RP: The important thing is to distinguish between cycles and waves. Cycles are regular things like the seasons. You know that every 365 days you’ll rotate around the four seasons. Waves are very different. You don’t know how large a tree will be when you plant the seed, you don’t know how many branches it will have, but you know it will look like a tree. That’s what we have in waves.
Under the wave principle there are all kinds of quantitative variations that you can have, but the form is always constant. And that form is a swing back and forth between opposites, toward optimism in the uptrend, toward pessimism in the downtrend, toward complacency in an uptrend and in a downtrend, fear and anger.
So you find these emotional states in society swinging back and forth at every degree which is why it’s so complex, why society is so rich. And the ultimate result is human action. People take actions on these moods and those actions are what we read about in the newspaper every day and ultimately what we read about in the history books.
Q: Your work not only has ramifications for the future, but also puts history in a completely different light.
RP: Absolutely. Most people believe, for example, that our political leaders and our financial leaders such as the federal reserve are essentially making these grand decisions that move society from one direction to another, they pass laws that make us behave a certain way, and so on. Our work is showing that this is completely the wrong view of how society is motivated. In fact, the impetus or the motivation comes in completely the opposite direction. These patterns of social mood are completely internally motivated. People are getting clues from each other socially all the time and it’s those moods that end up determining, for example, who our leaders will be.