Downward Trend Risk

“Will the trend continue?  Will the numbers keep dropping?  They’ve been getting worse — every day! — for several months now.  It’s already getting quite bad and it’s only getting worse.  What can we do to reverse the trend?”

I’m not talking about the stock market or the value of European Sovereign Debt.  I’m talking about the number of hours of daylight for people living in the Northern Hemisphere.  Historically, humans did a lot of [what we now consider] crazy things to reverse the very real and downward trend of diminishing sunlight through the fall months.  In other words, they did whatever they could to get the powers that be to increase the number of daylight hours.  Their actions – some gruesome and tragic – were based on their understanding of how the diminishing sunlight phenomenon worked.  Similarly, our actions today to reverse downward economic trends are based on our understanding of how markets work.  My claim is that the current understanding of our economic issues is not much better than the ancients’ understanding of the dynamics of planetary orbits and the Winter Solstice.

Sunrise on the Winter Solstice at Stonehenge

Starting earlier today, at 05.30 Greenwich Mean Time (12:30 AM Eastern Time in the US), this year’s ebbing of sunlight began to naturally reverse itself as the earth passed through that point in its orbit that marks the largest tilt of its axis away from the sun (for Northern Hemisphere dwellers).  Also known as the Winter Solstice, it marks the shortest day of the year for most people on the planet.  Until relatively recently, and probably for millennia in the past, people around the globe did whatever they thought would work to “bring back the sun.”  I can imagine their justification for continuing to perform their rituals, even in the light of evidence that the sun returned regardless of what they did, as something like the still-to-this-day-appealing logic of “you never know what might happen if we fail to do what we did before.”  Similar thought processes lead to “it’s better to do something than nothing,” and “It can’t hurt.”  Nearly identical sentiments were expressed by world leaders and wall street’s finest during the recent financial crisis.

Now I’m not saying that the financial markets are subject to as-yet unknown mathematically deterministic laws like the planets are.  Nor am I saying that economical cycles explain all markets.  And I am most certainly not suggesting that if we do nothing about our economic situation that trends will “naturally reverse themselves.”  What I am saying is that we do not have a good handle on how/why markets behave.  I am also saying that economics is far more complex than “simple” things like planetary motion, axis tilts and solstices.  We have many ideas and some of them seem to work some of the time.  I’ve quoted MIT economist Andrew Lo a few times already in this blog, and I’ll take the risk of repeating myself because this quote is just that good: “We wish that 99% of economic behavior could be captured by three simple laws of nature. In fact, economists have 99 laws that capture 3% of behavior.”

It’s very human to seek explanations.  It seems that the brain rewards itself for accepting an explanation – whether or not that explanation actually holds water.  We have a feeling of satisfaction when we hear or come up with an explanation that ‘clicks’ with us.  Neuroscientists studying this phenomenon point to measurements of the ‘reward centers’ in our brains where small amount of dopamine and other naturally produced hormones/drugs elicit a sensation of pleasure when curiosity is satisfied.  I conjecture that a similar or at least related mechanism was at work in the neolithic brain and is still at work in the modern financial brain: just as early humans were satisfied by mythical explanations of the sun’s return after December, so, too, are many modern brains satisfied by pundits’ explanations of economic gyrations (on the other hand, the very number of so-called pundits may be a measure of our collective lack of satisfaction).  Many of us are at least temporarily satisfied when an authority figuratively rests his comforting hand on our shoulders.  Alan Greenspan was a master of this skill.  His own personal brand of FedSpeak seemed to magically calm markets, and my take on his effectiveness is that most people — professionals included — were satisfied enough with the notion that the “older, benevolent and smart person is in charge and will take care of us.”

I personally believe that this financial crisis has a chance to dispel belief in the economic shamen of our time: it’s quite clear to many people that no one has the answers to explain markets, nor the ability to calm them.  People in my ancestral home – Ukraine – once believed that Poseidon had the power to calm the seas, and remnants of that heritage can be found in the national emblem which resembles his trident and is even called (in translation) the “tri-tooth”.  Realizing that there is no god in charge of the sea must have been terrifying to my ancestors, just as it’s a scary thought today to contemplate that no one really understands economics.  Since markets react to sentiment, the fact that the they continue roiling despite our best efforts these past years may provide a measure of how many people have now adopted that unsettling position.  And if I’m right that the prevailing sentiment is a mass recognition that “the [financial] emperor has no clothes,” then we might do well to expect this economic malaise to continue for quite some time to come.

The Winter Solstice is an appropriate time to reflect on these matters since it is, literally, the lowest point you can go.  Starting today we’ll be making the climb back up to longer, happier and, eventually, warmer days.  We’re also at a point in our analysis of markets that I hope is a nadir: starting “soon,” I hope that more and more economic models incorporate lessons of behavioral finance and complexity science.  That can only lead to more realistic assessments of how markets might respond to different scenarios.

In the meantime, I was fascinated by this explanation of the Winter Solstice.  By my count, over 30 different holidays are derived from – or at least directly related to – the celebration of the Winter Solstice.  Whichever of these or others you may be celebrating this time of year, I wish you a Happy Holiday and a Prosperous 2012.

2 Responses to Downward Trend Risk

  1. Mark I. Lee says:

    Nice post, never knew that about the solstice. I agree, markets have their own rhythmn and much of our explanations for market behavior are more about making us feel better. Happy holidays!

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