Let’s say you’re an aficionado of two great American pastimes: baseball and stock investing. And, say someone tells you that a set of baseball statistics tracks with the movement of stock indexes. What do you do? You may laugh, snort, roll your eyes, or calmly keep your incredulity to yourself, but the one thing you don’t do is say, “Sure, that makes sense.”
Yet there is difficult-to-assail evidence that just such a relationship exists. That is, increases and decreases in the number of home runs hit by Major League Baseball players year by year bear an imperfect but striking similarity to gains and losses in the Dow Jones Industrial Average, as adjusted by the producer price index (PPI), a measure of inflation.
An even tighter relationship exists when you add annual home runs and strikeouts and compare that sum to DJIA/PPI performance. The evidence for it is detailed in a new report published in the October issue of The Socionomist, a publication devoted to the notion that cyclical “social moods” are the primary influencers of social behavior — in particular, investors’ aggregate propensity to buy or sell stocks. (View an excerpt from the report here.)
The Socionomist is a publication of the Socionomics Institute, which is affiliated with Elliottt Wave International, a market forecasting firm that author and market analyst Robert Prechter has run since the 1970s. In making its forecasts, the firm uses the Elliott Wave principle — which, according to Wikipedia, is “a form of technical analysis that finance traders use to analyze financial market cycles and forecast market trends by identifying extremes in investor psychology, highs and lows in prices, and other collective factors.”
The principle was conceived by Ralph Nelson Elliott, an accountant who in the 1930s proposed that market prices unfold in specific, repeating patterns. Its proponents consider such repetition to be a “fractal,” or a complex pattern that is self-similar across different scales.
Dividing a fractal pattern into smaller and smaller parts reveals very similar, reduced-size copies of the whole. Fractals are widely evident in nature. Examples are found in broccoli, salt flats, mountains, clouds, leaves, canyons, peacock feathers, and the branching patterns seen in trees, lightning, rivers, and the human brain and circulatory system.
Elliott Wave principle proponents say fractal patterns are also evident in human creations, like highways systems and stock markets. “They’re in almost everything we do,” says Alan Hall, author of The Socionomist report.
In fractal-like fashion, the Elliott Wave principle of stock movements is “seemingly [able] to fit any segment of market history down to its most minute fluctuations,” technical analyst and finance professor David Aaronson wrote in The Wall Street Journal in 1993. However, he charged that such applicability was made possible by the method’s alleged “loosely defined rules.” In any event, the validity of the Elliott Wave principle has been and remains a subject of debate.
Is the Connection Real?
Getting back to baseball, average home runs plus strikeouts per game is an indicator that Hall has dubbed SWAT. (It stands for “Swing for the Fences” — “not an exact acronym, but catchy and close enough,” he wrote.)
Here are highlights of the relationship between SWAT and PPI-adjusted DJIA trends. SWAT:
- Rose with the PPI-adjusted stock market in the 1870s and 1880s.
- Rebounded with the market during the post-Depression recovery.
- After World War II, sustained a long rally into 1965, after which it declined into 1981, in both cases trending with the DJIA/PPI while topping and bottoming a year before the market.
- Surged to an all-time high in 1987, again in tandem with the market.
- Declined in parallel with that year’s market crash.
- Soared with stocks during the dot-com mania of the mid-to-late 1990s.
- Corrected in the first decade of the new millennium, as did the market.
- Blasted off in the past few years until, like stocks, it reached its present, new all-time high.
None of that is fantasy. All of it happened. In an interview with CFO, Hall says, without a trace of irony, “We think that if we see a big stock downturn, we’re also going to see a drop in home runs and strikeouts.”
What may be ironic is that Hall, by his own acknowledgement, is no baseball expert. His expectation that stocks and SWAT will continue to move in tandem is rooted in large part in a belief also held by other supporters of the Elliott Wave principal: that social mood — defined as “shared perceptions, primarily about the future, with optimism and pessimism on an aggregate societal scale being primary manifestations” — drives most events and trends.
“When a trend reaches an extreme, people just become ready for a change,” he says. Keeping to the baseball theme, he points to the several-phase expansion of the de facto strike zone starting in 2010, which MLB doesn’t discuss but presumably was done to influence hitters to swing at more pitches and thereby hit more home runs, resulting in a more exciting game.
“But now they’ve reached this peak in home runs and strikeouts, and people are starting to talk about how the game is actually less interesting,” Hall says. “You can see the psychology changing.”
He referred in his article to a 2008 paper by Benjamin Rader and Kenneth Winkle that sought to explain the high-powered offensive production that marked baseball in the mid-and-late 1990s.
“The authors identified several potential contributors to the late 1990s hitting streak, including juiced balls, league expansion, lighter bats, physically stronger hitters, a new hitting style, smaller ballparks, a dilution in pitching talent, a smaller strike zone, and performance-enhancing drugs,” Hall wrote. “To the extent any of these contributors are valid, we would suggest that social mood ultimately influenced the timing of their development.”
Running With the Herd
That would be difficult to prove. But the wider point espoused by the Elliott Wave principle proponents is that, like so many things, stock market results are driven by social mood.
“The media tells everybody every day that events affect the stock market,” Hall tells CFO. “We have written almost to exhaustion demonstrating that events don’t affect the stock market. There are so many examples. Take 9/11. You would have expected that to drive a huge downturn, but it didn’t. It occurred five days from a bottom and right before a six-month rally.
“Events tend to lag the social mood,” he continues. “The Glass-Steagall repeal in 2000 was done to encourage a market rally that had already been happening. We have documented that attacks on leading companies tend to happen near market peaks. That’s when antitrust actions usually occur, too. Then, when the market drops, you get all this regulation designed to prevent what’s already happened.”
Robert Prechter, founder of Elliott Wave International and the Socionomics Institute, has characterized the run-up to current market highs as a “mania” gripping investors. He predicts that a massive correction is coming that could be larger than the crash that preceded the Great Depression. He counsels that investors should put their money into “short-term notes of the least unstable governments” until the correction bottoms out.
It’s easy to be skeptical of such talk. At the same time, corrections of breathtaking magnitude, while infrequent, have occurred with some degree of regularity over the vast expanse of time.
In point of fact, nobody knows when the next market correction will occur or how severe it will be. But regardless of the details, it will be a manifestation of society’s herding nature, according to Hall.
“Basically, we think people are herding to some extent all the time,” he says. “There is tremendous pressure on each of us to do what our fellows are doing. That’s the way you fit in and feel comfortable. It’s really hard to go the opposite way from the entire group, especially when sentiment is extreme.”