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Todd Harrison Interviews Robert Prechter: 'When Social Mood Turns, the Fundamentals Will Follow'

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Ahead of the Social Mood conference in Atlanta, the market analyst who invented socionomics explains how his theories are playing out in today's "long top" market.

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BP: Well, I think the ideal world is a free world from one end to the other. So, in my view all policies using force are detrimental. Government is very late in what they do. The Fed, which as a quasi-arm of the government was completely caught unawares by the collapse of 2008, 2009. And in fact there are quotes on record from the Fed chairman and other members of the board in 2006, 2007 that show that they saw nothing but blue skies ahead. We've even been tracking something called The Laughter Index, which is the amount of times that they're bursting out with laughter, the Fed, and that dried up quite a bit in 2008, 2009. So, yes, every branch of the government is reflecting social mood just like everybody else. It's just that some of them have a lot more power than you and I have so they can wave their hands around and create another $1 trillion a year by buying government bonds in one case or deciding to spend $750 billion on infrastructure, which as far as I can tell was just to buy signs saying we're working on the infrastructure. So, yeah, there's a lot of money wasted in bear markets that I think this is just getting us further out on the limb, the amount of debt the government is absorbing and in fact encouraging. They're encouraging $1 trillion worth of new student-loan debt, which by the way you cannot get out from by declaring bankruptcy.

So, what they're doing is they're putting this harness on the next generation that says you're going to be working for nothing for so long. Now, all of these things I think is cumulative. They're the results of social mood and overall long-term darker area right now. And that's going to come home to roost in the fundamentals. Right now the fundamentals, people think, are improving, and they are because they're following the social mood that's been going on for four years. But when that social mood turns back down, the fundamentals will follow as they always do. And I think socionomic theory explains why fundamentals follow the stock market and social mood. In fact, the new studies that came out on Twitter, the new studies by the RAND Corporation and studies showing time and again that the mood changes prior to the events hitting the streets: protests in the streets, riots in the streets. They see the changes in social mood on Twitter and other areas. The only theory that explains that, I think, is socionomics, although there is some time-honored attempts by economists to explain why the stock market is ahead of the economy. I don't really think that they work.

TH: Yeah. And you used one of my favorite words: cumulative, which I think is a very important word and it's a word that we learned the first time in 2007, 2008 and, in fact, I think it's a word that we're going to learn and re-learn again-to incorporate one of my phrases into what I think you just said-until we stop taking drugs that mask the symptoms and start taking medicine that cures the disease. And I think that medicine is time and price, again, separate and apart from trading the stock market intraday. But you mentioned Twitter, and my question is does this new social media landscape-does that offer any predictive value for us as we measure social mood? And if not, what are some of the better measurements of social mood in this new technology digital landscape that we live in?

BP: Well, we can't measure social mood directly because we can't hook up electrodes to people's brains-well, not yet anyway-and follow them around in life. So, the only thing that we can really track is their actions. So, the actions are probably having a bit of a delay. And that's what Johan Bollen found in his study that he thought according to Twitter, anyway, mood changed about two or three days before the stock market did, which is perfectly compatible with what we think is happening. But it's very difficult to quantify, and the other problem is most of the people looking at social mood data are looking at very short-term changes in the way people feel. Now, the stock market is a fractal, and we've been talking about that for the past half an hour, the fact that you can have a long-term trend that's down, but short-term trend that's up and so on. But what they're mostly looking at here is short-term changes.

Now, under socionomic theory, social mood is a fractal construct shared by everyone in society. And we're sharing our moods with each other, and that's the fundamental cause of social action. But we also see upon occasion people have emotional reaction to external events. Social mood is endogenous. It's internally regulated. Sometimes even when the events do occur, people go through a very brief emotional reaction. That's a very different thing. It does show up in the stock market, but only over a few minutes or an hour when people are waiting for some ridiculous number in the morning or something like that. But it immediately melts away, and you're right back to where you would have been without it. And I think this thing is happening in some of the readings that we're seeing on the short-term social media data. So, it's not pure social mood. You're getting a lot of short-term emotional response mixed in, and they are too separate to really understand what you're looking at.

TH: Okay. I understand. So, from one of your subscribers and one of your followers who has been with you over 10 years and this has just come in. They asked the question-they asked me to ask you please-when you talk about recommending maximum short exposure, how does that translate to the average-I know it's different for everybody-but how does that translate into a marketplace where we continue to make new highs every day? How do you measure your risk in this type of environment?

BP: Well, there's no way to directly measure risk. As we all know, the stock market can do just about anything in terms of its quantitative movement. So, you have to look at the results and compare the history. So, that's what we do. We look at the extremes. Now, if you'd asked me in 2010 if I thought that we would see the same extremity of optimism toward stocks that we saw in 2000 and again in 2006, 2007, I would have said, no, it's highly unlikely. If you'd asked me that in 1967 I might have said the same thing, and yet we saw it twice before the final bear market wave took stocks down by 50%. And that was a much smaller corrective degree.

We're talking about a whole new topic here, which is Elliott Wave and stock prices and all that stuff, so kind of getting away from social mood. But when the market is making a top the size of a grand super-cycle the last time we've seen this magnitude was the South Sea Bubble in 1720. And that was a spike high. It went down very quickly; erased virtually the entire thing in two and a half years. This time we're building a very long top, but it does indicate, I think, that the degree of wave structure that A.J. Frost and I talked about way back in 1978 in our book, I was talking about 1976 when I started writing reports, is correct. Normally, if you have just run-of-the-mill top, you might pull back 20% or something like that. But this is a huge top, and so far we've had two very large declines within it. And the extremity is so extreme right now on the positive side tells me there's a real long, big decline coming. I don't think we cleared out any of the excesses.

You just said something very important. You talked about cumulative effects. The cumulative effects, for example, of borrowing for real estate. Now, people were borrowing for real estate from all the government agencies: Fannie Mae, Freddie Mac, Ginnie Mae, the Federal Home Loan Bank, all the way back to the 1930s. So, decades of lending to the point where they're lending out most of 98% of what you needed for the mortgage, was such a cumulative effect that when real estate started to tumble it was tremendous. It's not over yet, too. There's massive inventory to take care of.

I think the entire country-indeed entire globe-is a macrocosm of that real estate picture. We're extended. Cumulative debt's piling on debts. The answer for the government is to go into even more debt and encourage even more debt. This is a cumulative thing that's going to have a very bad result. And that accumulation is the result of a decade's long, super-cycle in positive social mood. People said, "Oh, I can borrow more money. I can pay it back." The lender said, "Oh, I'm happy to lend this person money. I'm sure he'll be able to pay me back." It takes amazing optimism to be able to lend somebody 98% of a mortgage. And now we're slowly seeing results on the other side and we're not done yet.
No positions in stocks mentioned.

Todd Harrison is the founder and Chief Executive Officer of Minyanville. Prior to his current role, Mr. Harrison was President and head trader at a $400 million dollar New York-based hedge fund. Todd welcomes your comments and/or feedback at todd@minyanville.com.

The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

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