Formological  Economics:    The  Fear-­‐Confidence  Cycle  

 

 1.    Basic  sentiments  reach  an  extreme  and  

then  reverse  

2.    Such  cycles  work  on  various  timescales  

3.    The  current  crisis  is  the  beginning  of  a  

reversal  of  a  very  long-­‐term  cycle  of  

increasing  optimism,  which  is  why  the  

reversal  process  has  been  so  long  and  the  

downturn  will  be  protracted  and  severe.  

 

The  Extreme  Pessimism  of  the  Early  1980s  

 

 

The  Extreme  Optimism  of  2000  

The  illusion  of  control  common  to  the  confidence  phase  leads  to  overconfidence,  and  the  assumption  of  risks  beyond  the  capacity  of  the  economic  base  to  support  them.  

   

The  Extreme  Optimism  of  2000s  

 

 

 

The  Extreme  Optimism  of  2000s  

 

   

Sentiment  Extremes  

Phase  Two:    Alarm  Jan  2000-­‐Oct  2002    

The  initial  downtrend  was  weak  and  investors  were  passive  as  they  held  

on,  waiting  to  see  what  happened.  Even  during  the  decline  from  2000-­‐

2002,  sentiment  was  still  bullish,  remaining  above  zero.      

 

   

 

 

 

Sentiment  Extremes  

 

 

Transitional  Rebound:    Oct.  2002-­‐Oct.  2007  Relief  Rally    

This   was   followed   by   a   rebound   that   exhibited   strong   optimism   in  

which  investors  were  active.    

1.     After  October   2002,   sentiment   rebounded   sharply   and  was  higher  

than  it  was  at  the  top  in  2000.      

2.    There  was  nearly  five  years  of  a  uninterrupted  bullish  plurality  and  

ten  years  in  which  bulls  outnumbered  bears.  

3.    Investors  Intelligence  was  above  70  percent  for  3  weeks  and  has  had  

a  bullish  plurality  for  a  record  180  weeks  as  of  March  31,  2006.      

4.     The   DSI   has   remained   at   extreme   levels   from   2005   until   today.    

During  this  rebound,  the  10-­‐day  DSI  hit  a  record  high.  By  February  25,  

2004,  it  was  74  percent,  significantly  higher  than  it  was  even  at  the  top  

in  2000.    In  the  week  of  March  26,  2006,  it  was  86.6  percent    

5.    At  the  top  in  2007,  AAII  showed  a  bullish  plurality  of  28.87%.  

 

 

Panic  Phase  Part  I:  Insider’s  Panic  Oct  2007-­‐March  2009  

 

 

Panic  Phase  Part  II:  Sovereign  Entity  Panic  

March  2009-­‐April  2010  

1.    Daily  Sentiment  Index  (trade-­‐futures.com)  of  traders  registering  83%  bulls.    

2.    AAII  bullish  plurality  of  26.6  (9/17/2010)  

3.    Between  November  2009  and  September  2010  the  bulls  have  outnumbered  

bears  95%  of  the  time  even  though  the  stock  market  has  made  no  net  upside  

progress  during  this  ten  month  span.    

 

Why the Depression Is NOT OverMichael Green - SUNY College at Oneonta

 

 

 

 

 

 

Next  Phases  of  the  Cycle  

 

1.    Panic  Phase  III:    Mass  Panic    

         Panic  spreads  to  the  mass  of  investors.  

2.    Transition  

         Optimism  is  weak  and  passive.  

3.    Despair  

           Pessimism   is   strong,   and   investors   exhibit   a   fatalistic      

           passivity  and  have  withdrawn  from  the  markets  en  mass.  

           The  retail  market  in  equities  has  completely  collapse.    

When  Will  the  Depression  End?  

The  decline  will  not  be  over  until  there  has  been  

five   years   of   completely   bearish   readings   and  

approximately  ten  years   in  which  there   is  a  plurality  

of  bears  over  bulls.  

The   bullish   plurality   was   broken   in   2007.     This  

projects  a  rebound  around  2017,  at  the  earliest.  

Next  Phases  of  the  Cycle  

 

1.    Panic  Phase  III:    Mass  Panic    

         Panic  spreads  to  the  mass  of  investors.  

2.    Transition  

         Optimism  is  weak  and  passive.  

3.    Despair  

           Pessimism   is   strong,   and   investors   exhibit   a   fatalistic      

           passivity  and  have  withdrawn  from  the  markets  en  mass.  

           The  retail  market  in  equities  has  completely  collapse.  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Institutions  and  

Basic  Sentiments  

1.    Institutions  give  form  

to  basic  social  sentiments.      

2.    Identities,  facts,  and  

norms  are  developed  that  

reinforce  and  are  

reinforced  by  these  basic  

sentiments.  

Basic  Sentiments  in  

Economics  

1.     Pareto—the   sentiments  of  

combination  and  preservation  

2.    Knight—fundamental  

uncertainty  and  the  rashness  

and  timidity  of  entrepreneurs.  

3.    Keynes—spontaneous  

shifts  in  moods  from  

pessimism  to  optimism  

4.    Bandura—strong  and  weak  

senses  of  self-­‐efficacy  are  

determinants  of  action  

Neuroscience  

Individuals   with   damage  

to  the  emotional  areas  of  

their   brain   are   unable   to  

make  decisions  

Human AgencyHuman agency is giving structure to an emotional impulse.

The Depression is Just Beginning1. Excessive confidence leads to excessive risk-taking, which produces unsustainable conditions in the real economy. 2. The longer the excessive confidence lasts, the greater the imbalances and instabilities.3. The unraveling of them will give rise to extreme fear and risk aversion proportional to the preceding confi-dence. 4. Fear and risk aversion has not reached a level propor-tional to the preceding optimism and risk assumption.