The Limbic Market

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–It’s that time. Check out the latest YouTube update from Slipstream Trader Murray Dawes. You can watch the report here.  He’ll give you the latest technical analysis on the market.

–And speaking of the market…well you don’t see that every day. We mentioned yesterday there would come a point when the Big Money jumped back in the market. It came just after lunch, when all the panic selling orders had been placed and margin calls met, or positions liquidated. And then….lift off!

–The ASX/200 staged a 7.4% rally from the intra-day low to the closing high. In previous eras, 7.4% would have been a respectable return for the whole year. In a market made increasingly unstable by low interest rates and high debt and slap dash intervention, it’s just another day. But where does it leave us now?

–The US market managed to rally overnight too. The Dow Jones Industrials closed up 4%. The US Federal Reserve met during the day. The Fed didn’t announce any new money printing. But it did say that it has a range of policy tools it was “prepared to employ”. It also said it would keep short-term interest rates low until the middle of 2013.

–What a bunch of jokers, eh?

–We imagine the range of policy tools to include a green panic button, a red panic button, a bearded panic button, a cone of silence, a cordless power drill, an EZ-bake printing press, a passport with which to flee the country when the rabid mobs come calling, and an electric bubble blower to appease said crowd with pretty colours and…bubbles.

–The trouble is, there aren’t any more bubbles left to blow. Just bubbles to pop. Those include the US Treasury bond market, the Chinese economy, and the Australian housing market. Also probably Facebook.

–Really, at this point, short of trying to control longer-term interest rates or buying stocks directly, the Fed is playing a confidence game. And confidence is exactly what the public is losing in fiat money. Yesterday’s rally, predictable as it was, felt more reflexive than anything else.

–This allows us to introduce a complicated sounding term for coordinated market irrationality: the limbic market. We’ve borrowed the term from science fiction writer Robert C. Wilson. He uses the term “limbic democracy” to describe a society in which people are literally networked at the emotional level, through an implant in the limbic part of their brains.

–The theory of the brain that we read about in college (the Triune Brain theory) says that the limbic system controls emotional (or non rational, non cognitive) human decisions. Fight, flight, lust, greed, fear, excitement, terror. These all come from the limbic system.

–Brain science is always changing (as is the brain itself). Not everyone agrees that you can isolate emotional responses to one part of the brain’s geography. The triune brain theory is disputed. But we’re going to stick with the theory anyway because it helps us make a point about markets: they’ve been emotionally collectivised and the result is negative.

–Of course, this probably isn’t that stunning of an observation. Markets are a kind of collective expression anyway. Markets generate prices. And prices tell you what the aggregate value is of all those millions of buying and selling decisions on a security (or on anything). All those separate decisions about what something’s worth are made emotionally, rationally, or randomly. But they are synthesised and collectivised in the form of a price. Gold is worth US$1755 today, for example.

–So how is a limbic market different than a normal market? Well, let’s assume a normal market exists. It’s a big assumption. But let’s make it anyway. In a normal market, the value of a security is calmly determined by a rational analysis of the future earnings of a company and whether the current price of the security is at a discount or a premium to its “intrinsic value”.

–After typing all that, we clearly realise no such normal market has ever existed. But what makes the current market especially abnormal is the amount of debt upon which it is built. Surplus money is really like speed. It accelerates everything. And it makes everyone less rational, more speculative, and more emotional.

–It also seems to synchronise emotional reactions to the same event. And let’s emphasize the term reactions. This is a reactive market. There aren’t really any bulls or bears. Just like returns in all asset markets became correlated and synchronous beginning in 2003, investors have synchronised their emotional reactions to the news cycle in 2011.

–When the news is made to feel positive, the reaction is bullish. When the news is made to feel negative, the reaction is bearish. Thus you get the big one-day or intra-day swings. It’s an emotional market, where investors are behaving collectively and reacting without thinking.

–This is a bad market to be an investor in. It’s not as bad for speculators. But it’s a sorry state for 300 years of Western financial history that our capital markets have become hijacked by unsound money and short-term time horizons. For economic psychologists, it must be fascinating. For the rest of us, it’s bewildering.

–The simplest way to separate yourself from a limbic market is to un-hitch yourself from the network. Break your link with the news cycle and with conventional wisdom, which is really just the condensed version of common opinion distilled to a headline and amplified by a large font (the Drudge Report and the Huffington Post). Those headlines tell you what everyone else is feeling. That’s about it.

–Some good sound thinking will anchor you to reality. It will also allow you to make and stick to a long-term financial survival strategy. Sound thinking will tell you that debt is not money. The Fed is a fraud. Trillions in capital has been misallocated since the advent of central banking. Those mistakes in capital allocation must be corrected before the economy can be definancialised.

–Sound thinking will tell you not to buy “the market.” Buy individual stocks. And buy good businesses only when they’re cheap. Unplug from the network. The network is the noise. The network is subtracting value. The media is the obstacle to understanding, not the conduit.

–Of course you can’t really blame social media for all this. Social media is just a means of transmitting thoughts, feelings, and ideas quickly, and usually in a deeply superficial way. The fault is in our embrace of this media as the source for important ideas or thoughtful analysis. By paying attention to it constantly, we spend a lot of time on superficial things and very little time thinking deeply or simply unplugging.

–The real danger of the limbic economy is that it becomes the limbic democracy, or limbic mobocracy, as the case seems to be in London.  We live in a world where we are encouraged to believe that how we feel about things matters more than what things actually are. Placing our subjective individual feelings above reality has been a disaster for our economy, our culture, and our democracy.

–You cannot separate where we have arrived socially from the quality of our money. The departure from the gold standard in the early 20th century allowed for the expansion of the Warfare and Welfare State. And what are the Welfare and Warfare States if not the ultimate indulgence of how we collectively feel about what the world should be? The only way to make these public policy and Imperial aspirations a reality was to fund them with fake money.

–That indulgence in fake money has had real consequences we are only now starting to understand. Nearly 100 years of unsound money—the Fed was created in 1913—has led us to the natural limits of this unsound system. When the value of money is destroyed, a slow erosion in economic and social values takes place. That erosion is apparent in the way investors are behaving on Wall Street and in the way looters are behaving on Oxford Street.

–It’s probably not a coincidence that this has happened first in London. Britain deindustrialised while the City of London became the financial capital of the world. The economy and the society rewarded a small number of people for financial speculation.  They created a very complicated casino in which they gambled with other people’s money. Meanwhile, real jobs making real things were “off shored” to improve profits.

–It’s important to realise this was not capitalism. This was financial corporatism. Value wasn’t added. It was aggregated and hoarded among the elite of the City and of the political establishment. This was neo-feudalism in the age of globalisation. And now it’s coming apart as the credit depression sets in.

–And here we are today. What range of policy tools does the Fed have to cope with cultural and economic distortions wrought by sound money? None. It only has psychology and belief to work with now.

–Anyone who believes otherwise feels too much and thinks too little. The Fed has been the instrument of economic and monetary destruction. The limbic democracy will realise this soon. What happens then is fairly predictable, too. A violent temper tantrum from the children of the Nanny State.

Regards,

Dan Denning
Daily Reckoning Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.
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Comments

  1. Anonymous say they are going after Facebook

    I watched which stocks were being pulled up yesterday and the line at which the rest were being left to follow the tail. The large caps on the super fund’s preferred lists were doing all the pulling. The residuals crawled up a few notches today.

    Reply
  2. Oh, forgot. The AUD bounce followed after the equities clawed back. It showed no sign of hot money flow impetus to me.

    Reply
  3. This really is superb analysis Dan – as good as it gets! To steal a quote from the bible…John 8:32 – “And you will know the truth, and the truth will set you free”

    Reply
  4. For now, I am still sticking with a cyclical bull market high of over 13,000 – in this secular bear.

    Every bull market since 1929 has experienced at least one 10% correction before reaching its final high and then declining into a bear market.

    In the last bull market 2002-2007 there was only one 10% correction, but there were four during 1990-2000. (There were 6 correction between 1974-1980 – the seventies being a lens to view today).

    The Dow experienced a 13.2% correction last year; while so far the present correction is 15.6%.

    I am still sticking with the severe stage of the next Great Depression occurring during the next US presidential term.

    Reply
  5. Interesting thing about “emotional . . decisions” is that yesterday the decisions followed a time-phased reaction around the globe, starting in Aus Stock Market.
    If one overlays the market reactions (10Aug11) of Aus, UK & US markets (down 4-5% in first few hours then up 5-6% to close at 1% up on day) then there is a remarkable resemblence.
    What are the chances of that being a coincindence?
    Word zero comes to mind.

    Reply

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