The Faddishness and
Unreliability of Purported Economic
and Financial Relationships
This section undertakes a cursory review of the role that conventional economic discourse has played in influencing investors' views of what data is helpful in stock market forecasting. It should give you an idea of how lacking is a coherent framework from which to reason. Throughout most of the 1980s, stock market watchers waited in fear
of the weekly money supply report.It was widely and firmly believed that this figure would determine the course of the stock prices. When that fixation died, the bond market became the key. Every tick in bonds was scrutinized for foreknowledge of the next short-term move in stocks. Later came the insistence that the near-term trend of the
U.S. Dollar held the answer to where stocks would go.In every case, economists had ready detailed explanations of the causal relationship involved. Investors abandoned
each focus as readily as they assumed it, the difference being the lack of any explanation for doing so and the lack of any notice that there wasn't one.
How did each of these points of focus fare as keys to market behavior? The popular argument concerning the money supply was that a „high“ figure is bearish because it might result in higher interest rates, which are bad for stocks. The only thing contracting this conventional wisdom is the fact, that the money supply roared throughout the 1980s bull market, and when the increases finally slowed, the market crashed. In other words, the correlation was the opposite of what popular economics wisdom supposed.
The „bond market indicator“ became very popular by the mid-1980s on the theory that the since declining interest rates are bullish for stocks and vice versa, and since everyone knows this, then every movement in U.S. T-bond futures prices would translate into a movement in the same direction in the stock market. In other words, a rise in bond prices means a drop in interest rates, which means less competition for stocks, which means stocks go up. The daily and weekly trends of stocks and bonds began to diverge about the time this relationship was popularized. They became almost entirely disconnected for months during mid-1987, when the most money was being bet on their prior lock-step relationship. Soon, daily commentators forget about the whole idea.
The dollar's value was the next point of focus. The dollar had risen from 1979 to 1985. It was first viewed as a welcome event, evidence that inflation might be slowing and the U.S. Was becoming strong again in the eyes of the world. Then economists said the dollar was „to high“ because its value was supposedly hurting exports. Stock market followers initially welcomed the decline in the price of the dollar that began in 1985. that trend was dramatic and persistant as well, so it created full-blown worry by early 1987 that it had gone „too far,“ and what was worse, there had been little change in exports. All this hand wringing amounted to naught.
Throughout this time and despite huge oscillations in the price of the dollar relative to other currencies, the DJIA continued to advance as if nothing about the dollar mattered to it. This was in fact the case. Eventually, people stopped watching the dollar, too. What do these fixations have in common ? First, they reveal a desire among investors to have one simple indicator of the future course of stock prices. Second, not one of them is an indicator derived from market activity itself, each one is from outside the market and simply presumed to have an impact upon it. Third, all have apparently logical implications. Fourth, intense scrutiny of each one of these „key figures“ was in fact counter- productive to
a correct assessment of the trend of the stock market. All served to keep investors' eyes off the ball. Finally, each new key-relationship claim appeared at first blush to sound reasonable, but it was never connected to enough, or any, history. Indeed, none of them was the least bit investigated, as in each case, a brief glance at a graph would have instantly debunkedthe claim. Nobody, it seems, ever bothered to look. [The Wave Principle of Human Social Behavior, 1999, Robert R.Prechter jr.]
Direction, Volatility and Duration Do Not Determine the Source of Sociological Motive
Obscure NYSE rule to curb panicky trading lights up the Internet Robert Schiller polled individual and institutional investors about why they sold stocks on October 19,1987. Most of them admitted candidly
that „they sold because others were selling,“ they were herding. It is welcome to have research telling us that the crash of 1987 was a „psychological event.“ However, no one ever thinks to poll investors about why
they had bought stocks relentlessly throughout the preceding year.
If any pollster did ask, the truth would be exactly the same, but he would find little honesty about that fact because in rising markets, people
have plenty of time to let their neocortexes formulate all kinds of rationalizations for herding action. Panic is a faster-acting emotion than hope, and the neocortex is often stumped in coming up with an explanation for it. One of my favorite quotes in this regard, undoubtedly rusehd out near press time, is this one from
The Wall Street Journal: „The U.S. Dollar continued
to decline yesterday despite economic news that could
have been bullish for the currency if traders' mood weren't so bearish."
Market commentators often blame a declining trend on herding, but they virtually never ascribe a rising trend to herding. This convention is displayed so often that all one need
do is read the papers for a few days
to find an example. On June 2,1998, the Dow Jones News Service quoted a brokerage firm's director of investment strategy after a few weeks of price decline in a broad list of technology stocks as follows:
„The herd mentality is taking over.“ That is to say, herd mentalitiy had nothing to do with the multi-year buying binge on all-time record volume producing all-time record valuation for technology stocks, that, we are
to presume , was all fueled by the rational decision-making of independently minded individuals. On June 15,1998, the morning after the intraday low of a correction in that index , USA Today, parroting economists,
repeated, „the drop is based more on psychology than fundamentals.“ A mere six trading days after that assessment was published, the NDX rocketed to a new all-time high. Once again, no experts claimed that that the rise was due to psychology . As always, they found adequate „fundamentals“ to explain the leap.
When the stock market opened deep in the red early Tuesday morning, investors frantically searched for explanations, as they tend to do during times like these.
Is it China again? How long will this volatility last?
Will the Fed do anything to fix it? Sell everything? Buy everything? Throw your arms up in despair! marketwatch.com, Sep 01,2015
[The Wave Principle of Human Social Behavior, 1999, p.395-396, Robert R.
Financial Man is Not the Same as Economic Man
It is univerally presumed that the primary law of economics, i.e., that price is a function of supply and demand, also rules finance.However, human behavior with respect to prices of investments is,
in a crucial way, the opposite of that with respect to prices of goods and services. When the price of a good or service rises, fewer people buy it, and when its price falls, more people buy it. This response allows pricing to keep supply and demand in balance. In contrast, when the price of an investment rises, more people buy it, and when its price falls, fewer people buy it. This behavior
is not an occasional financial market anomaly; it always happens. Look at back at Figure 7-3, the graph of the dollar-valued trading volume in the U.S. stock market divided by the prevailing gross
domestic product. As you can see, volume expands as stock prices rise and contracts as they fall. In economicmatters, rising prices repel buyers; in investment matters, rising prices attract buyers.
This difference is not incidental; it is fundamental. Many market theorists argue that the law of supply and demand operates in finance but is simply "suspended" for periods of time because people "overreact" and "rationalize" with "elaborate arguments"
why they should pay up for investments. The difference between any such idea and what happens in markets for goods and services is irreconcilable by conventional economic theory. People never act
in any such way with respect to goods and services. Most investors can quickly rationalize selling an investment because its price is falling or buying it because its price is rising, but there is not a soul who desperately rationalizes doing with less bread because the price is falling or who drives his car twice as much because the price of gasoline has doubled. In economic behavior the law of supply and demand does not lie dormant ever. It is like the law of gravity; it works all the time. It cannot "fail to apply," even temporarily. Prices are the balance beam from which the scales of supply and demand hang.
Changes in buying patterns are virtually instantaneous in responding to price changes for bread, cars, TV's and shoes.
In the same way, investment behavior has its own law; the Wave Principle. This law governs unconscious, logical, individual economic decision-making. The former law governs prices for intangible values,
whether associated with tangible goods or not; the latter law governs prices for utilitarian tangibles. Attempting to apply the law of supply and demand to investment markets is akin to attempting to apply
the laws of physics to falling in love. They do not pertain.
The law of supply and demand always produces practical behavior in the realm of
The Wave Principle
(despite its apparent value for life and progress per se) produces impractical behavior in the realm of
finance. In the product marketplace,
the rational goal of survival leads to price stability and objectivity. In the investment
marketplace, prerational impulses of survival lead to wild overvaluation and
undervaluation. Time and again, observers, particularly those who understand the iron
law of economics, complain that the stock market's action appears
unreasonable. That observation is wholly correct. The decision to buy into rising prices and sell into falling prices is not governed by the reasoning neocortex but by the unconscious herding
impulse, which generates inappropriate behavior in the financial realm as part of a generalized attempt to enhance the odds of
survival. It is baffling only to those who insist that "supply and
demand" rule finance.
It is not that reasonableness in finance is utterly absent; we are not talking about
irrationality. People who invest in markets know through cold reason that they value their own lives and
prosperity. Those who buy in bull markets are following the very
reasonable desire to enhance their sustenance, while those who sell in bear markets are following the very reasonable desire to
survive. Unfortunately, the portion of the brain that generates unconscious urges directs their behavior in this
regard. The primitive mechanism employed is so inappropriate to the situation that insteadt of enhanced
success, it produces guaranteed failure.
Because these desires per se are rational, they work just fine in the world of goods and
services. In the product marketplace, the consumer wants prices lower while the producer wants them
higher, and for the same fundamental reasons: survival and self
sustenance. The process of mediating these identical goals between polarized dealers produces an
objective, natural balance expressed as price.
In the world of investments, however, the consumer (who buys it) and producer
(who creates and wants to sell more of it) both want prices higher.
Rather than become excited to buy as prices rise. Since desire and hope are entirely on the side of price
only fear and despair can be on the side of price decline. Thus, when prices
fall, investors are pressured past endurance to sell. Both of these impulses are contrary to the way consumers
behave with respect to goods and services. The dynamics of the Wave Principle underlie financial markets and lead to nonobjective
valuation. Individual investors who desire to be objective in financial speculation face the inescapable requiremnt of understanding that fact and its
(The Wave Principle of Human Social
Behavior, Frost & Prechter jr. , 1999, p.393-395)