The Socionomic Theory of Finance by Robert Prechter

Crowds, Markets, Moods and Events
Book Review by John Casti
(Review of the book, The Socionomic Theory of Finance by Robert Prechter, Socionomics Press, Gainesville, GA, 2017)

The Socionomic Theory of Finance (STF) is concerned with the behaviors of crowds and the events that stem from those behaviors. Thus, the focus is on the psychology of crowds, not individuals. As anyone who’s had the misfortune to experience/witness the behavior of a crowd of hooligans at a football match or the actions of demonstrators in the streets of beleaguered urban ghettos, the psychology of masses operates under entirely different rules than those that apply to individuals. In short, the interaction among the individuals making up a crowd gives rise to emergent group behaviors and consequent events that can differ radically from the behaviors displayed by any individual making up the group. In short, interactions matter—a lot!

The two emergent properties of a crowd/population that concern us in this review are what we might term the “social mood” of the population, how it feels about its future on all time scales, and the collective events that arise from, or at least are strongly biased, by this social mood. Let’s look a bit more deeply at both these emergent properties of the group.

Social Mood: For simplicity, we take the mood of a population to be simply the collective feeling/belief the population holds about its future simultaneously on all time scales.

Collective Actions and Events: A social event is one that arises from the collective behavior of the entire population. In other words, it is not the action of a single individual that gives rise to the event, but rather is the outcome of the collective decisions/actions taken by a significant portion of the population as a whole. For instance, the outcome of an election is a social event, while an airplane crash is not.

The importance of time scale comes into play when we recognize that collective events have a natural unfolding time characteristic of the nature of the event. For example, an event involving some aspect of popular culture such as the type of fashions that are in vogue or the sorts of books that are popular at a particular time are short timescale phenomena, generally unfolding over a period of a few months to a year or so. On the other hand, a collective event like the shift in a dominant political ideology has a much longer unfolding time, normally several years to a few decades. Finally, very slowly-unfolding events like the decline of a global power may take a century or more. So if we want to argue that the social mood of a population is a driving factor in the type of event we can expect to see, we must match the timescale of the event with the timescale of the social mood underlying the event. For example, it would give no insight into the likelihood of a country like the USA leaving the world’s center stage to look at the social mood in the USA on a timescale of weeks or even months. That time scale is just much too short to see the unfolding of a long timescale event like the collapse of global political and moral power. Such an event would require examining the shift in social mood on a time scale of decades, not weeks or months.

Our first order of business is to examine the connection, if any, linking the group’s social mood M and the collective events E that arise from interactions among the people making up the group. Logically, there are four collectively exhaustive and mutually exclusive possibilities:

I. M and E are logically independent: In this case, M does not imply E or vice-versa.
The two are totally independent of each other.

II. M and E are mutually dependent: In this situation M implies E and E implies M;
in other words, there is a feedback loop from one to the other and vice-versa.

III. E implies M: Here an event impacts the social mood, but not vice-versa.

IV. M implies E: In this case, the social mood implies the collective social event,
but not vice-versa.

Conventional wisdom argues that hypothesis II is the case, and in fact, this is such a taken-for-granted background belief that it is almost never questioned. The book under review argues that the fact that everyone believes this hypothesis doesn’t necessarily make it true. After all, a few centuries ago everyone believed the Earth was flat too. But that universally-held belief did not make it so. One might call hypothesis IV the Fundamental assumption of Socionomics, a term coined by Prechter to separate this working hypothesis from the closely-sounding label “socioeconomics”, a very different field of investigation.

Notice what’s involved here. The concept of logical implication is an all-or-nothing proposition: Either A implies B or it does not. There is no room for ―sometimes. So either a feedback from E to M exists all the time or it doesn’t exist at all. With this caveat in mind, the conventional hypothesis II says that collective events always impact the social mood, and vice-versa. Hypothesis IV, on the other hand, states that a feedback from events to mood is never present for any collective event.

The work by Prechter and his group at the Socionomics Institute, along with other socionomists provide many cases when such a feedback is, in fact, totally absent. Thus, by Popper’s ―black swan falsification criterion, these
examples serve to invalidate hypothesis II. Here’s another argument that points in the same direction.

The essence of the scientific method is to provide a systematic procedure for testing alternative hypotheses about how to best explain a given set of observations. An essential element in this procedure is Occam’s Razor, which asserts that when faced with several hypotheses that account equally well for a given set of observations, preference should be given to the simplest of the candidates. Oddly enough, the default hypothesis II above, the one almost everyone feels is self-evident, is actually the most complex/complicated of the four candidates, not the simplest! So to accept hypothesis II, it must do a better job of accounting for the observations than any of the other three candidates. And not just do equally well, but do better, in order to be the hypothesis of choice. In STF, the author shows convincingly that the argument that hypothesis IV explains observations and events in the financial realm at least as well as hypothesis II and is much simpler.

As a short aside, it’s interesting to ponder why hypothesis II is so universally accepted. The reviewer’s feeling is that this universal belief in a very dicey proposition stems from a completely unjustified extrapolation from individual beliefs to the beliefs of a group. In other words, if I feel this way and everyone I know feels this way, then the group consisting of me and my friends must necessarily feel that way too. As noted above, this is a totally false generalization. A group can and often does feel and behave completely differently than any of its constituent members, viz., a group of rabid football fans. The root cause of this discrepancy between individual and group behavior is the network of interactions linking members of a group. This network gives rise to the emergent properties of group psychology and behavior, properties that cannot be seen by examining any individual making up the group. STF identifies this difference as social mood vs. individual emotion.

At this point, you might ask: What’s the harm in adopting hypothesis II? Why not take the more complex hypothesis and cover all bases? The answer is that there is no harm in doing that other than you then move the question out of the realm of logical implication into the domain of likelihood and probabilities. In other words, you’re now asking whether the feedback loop is present ―most of the time‖ or some of the time‖ or almost never‖. Without an analysis of the issue from an exhaustive database of examples, it’s difficult to give an unambiguous answer to this question. On the basis of the investigations explored in the book under review, the feedback is always absent.

Socionomics and Finance

Early in his career, Bob Prechter worked as a financial analyst on Wall Street and had the opportunity to see first-hand herding behavior and mass psychology (social mood) in action, and how those beliefs got translated into market movements (actions/events). This experience led to his conviction that it is not events that move markets but beliefs. Thus was the seed sown for what we now call the “theory of socionomics.” Prechter has been developing and sharpening this basic insight into human activity for several decades now, extending it from the financial arena to almost every field of human endeavor. STF is a summary of how social mood drives financial events. Two more volumes of a similar nature are planned, the next book focusing on political events, the third on society and culture.

Over the years, Prechter has formed a strong team of researchers at both his own company, EWI and in other institutions around the world who have explored the fundamental principle of socionomics in just about every human activity from popular culture to wars to the rise and fall of civilizations. As just noted, the current volume restricts attention mostly