Face of FearA talk at the November 1 Junto by Robert Higgs on the importance of fear elicits many thoughts of relevance to markets. Higgs is best knows for his theory of the ratchet effect of crises on government activities. He shows in Crisis and Leviathan that during times of crisis, government powers are increased and that these powers are never reduced.

He started his talk by saying that he wished he had realized many years ago that fear is the foundation for all such increases and that fears are manufactured according to normal production curves subject to the laws of diminishing marginal productivity and depreciation.
He views fear as the key emotion. And believes that fears are invented to create an opportunity for the Leviathan to expand . He groups fears into categories: fear from government itself, fear of real dangers from which government protects us, and spurious fears which are invented so that power can be increased. Planks in his theory deal with the origin of governments in conquest, the alliance between church and state, the tactics of stationary bandits who exert power from a fixed position, the creation of an ideology of fear, the economics of fear, the growth of fear during wartime. He ends with the hope that we can conquer our fears and thus go about our normal humdrum activities in a more productive way.

Against LeviathanI was quite critical of his theories believing for example that many other motivations of human behavior are more important than fear, including the five levels of Maslow's motivations, starting with physiological, safety, love, esteem, and self actualization. Of these hierarchical levels, only the safety level could in any sense be related in part to fear. I felt that much of the support for his theory was based on anecdotal and isolated events such as King Canute's assassination for collecting high taxes. I also questioned whether there was any predictive value in his classification, whether his theories could ever be refuted, the absence of cost benefit calculations in his condemnation of any and all government actions, including its function of providing for internal and external defense, and how it could be differentiated from other theories of power and behavior. I also disagreed with his wholesale condemnation of the use of fear including his condemnation of the United States entering the First and Second World War, after what he decries as false propaganda concerning the evil intentions of our enemies.

Neither Liberty Nor SafetyHiggs' current book Neither Liberty Nor Safety details many of these theories. And needless to say, he believes that the acts that followed 9-11 served mainly to legitimize a wish list of bureaucratic interventions that had been sitting on desks for 15 years, but never were able to see the ligth of day until crisis hit. He believes they did not increase our safety but took away our liberties, and never will vanish even when the need for extra patriotism recedes.

And yet, I found many parallels to the market's fears. There are 1.5 million conjunctions of fear and stock market on the search engines and many of them relate to maintaining the stock market citizen in a state of subjugation, and contribution to the upkeep even greater than that described by Higgs in his many anecdotes, and revision of his crisis and leviathan theory.

I would be interested in your ideas on the influence of fear on markets, the most recent being the fears of recession, the fear of no further rate cuts, the fear of the subprime crisis spreading, the fear of brokerage house bankruptcies and financial liquidations, the decline of the dollar, the spread of epidemics, the comparison to the crises of 1987 and 1998, the increase in volatility and what that portends, the declining earnings growth, et al., the role in fanning fear by former officials recently retired, as well as those who have long predicted Dow 5000 et al.

High on this list would be the typology of fears that have existed each year since the beginning of stock markets, and how this has engendered the 1 million % a century growth which Mr. Ellison has kindly updated here before.

Alston Mabry adds:

Happiness HypothesisIn The Happiness Hypothesis, author John Haidt uses an interesting image our human brain which has developed over vast amounts of time to handle so many tasks: he likens the mind to a rider on an elephant. The rider is our conscious, rational, aware mind - our neocortex. The elephant is everything else and is trained to be pessimistic, defensive, status-conscious, and many other things that might contribute to survival and success, but not necessarily be conducive to happiness. The rider can see farther and is smarter than the elephant, but the elephant often decides where both will go. Haidt then argues that many ancient traditions understand this dichotomy and know that the brain must be disciplined and trained for happiness.

In trading, I find there is a basic division: analysis versus execution. Analysis can seem so sure and easy, when the market is closed and one is simply crunching numbers - the elephant is asleep, as it were, and the rider is alone with his thoughts. But as soon as the market is popping, and one must put real money on the table - as soon as there is *risk* - the elephant awakens. The mind actually changes, perceives and processes the same data differently from the night before.

Perhaps the discipline of the ancients is the answer. Would Lao Tzu, or Bodhidharma, or the Desert Fathers have been successful in the pits?

Phil McDonnell writes:

MaslowAn alternative approach to Maslow's Hierarchy might be to consider the hormonal make-up of human beings. The two powerful hormones adrenaline and nor-adrenaline control our fight or flight response to potentially dangerous situations.

However they are much more than that. They directly or indirectly influence our heart rate, breathing, blood pressure, serum glucose levels and even our memory. They are a significant factor in motivating us to action. For example researchers have found that after receiving adrenaline human test subjects were more likely to take action in contrived circumstances which potentially involved even physical violence. Humans cannot easily distinguish between true emotions and those induced by adrenaline.

Other research has shown that rats will develop stronger memories when adrenalin is administered. There appears to be a simple physiological basis for this in the neurons. In particular rats that lacked the particular receptor did not develop the stronger memories in the presence of adrenaline. The important point is that memories which are formed or reinforced in the presence of higher adrenaline levels are much stronger that those which are not.

Charles Darwin was the first to study the evolution of emotions in: The Expression of the Emotions in Man and Animals with Photographic and other Illustrations (J. Murray, London, 1872).

Emotions originally developed as a way of avoiding dangerous situations as well as signaling to others the state of a particular individual. For example when an individual is in an emotional state such as extreme anger others may be warned away and learn to avoid confrontation. But when the irrationality of anger is not present others may attempt to reason with the individual. In effect the perception of an emotional state signals to others how an individual might respond in a given situation.

As traders we can turn this knowledge around. Large movements in the markets can induce an emotional reaction in other traders. In particular these movements induce an adrenaline response associated with the fight or flight syndrome. In turn the adrenaline reinforces the memory of the particular gyration in the market. So the memory is stronger and has more immediacy and in a sense more recency. So when a similar event happens again the memory is stronger, generates more adrenaline and is reinforced again.

Each time the effect of the adrenaline is to predispose the trader to action. Traders are more likely to act and act irrationally. Trading volume tends to increase. In effect the market begins to control the emotional actions of traders causing them to think with the more primitive portions of their mind. In the logic of the primitive mind losing money is equated to loss of food and ultimately loss of life. Every drop in the market is met by selling at the worst possible time. Market rises are greeted with herd like buying after the rise has occurred. It is all an emotional dance orchestrated by our own chemistry. orchestrated by our own chemistry.

Micheal Cook remarks:

Yin & YangIt is commonplace to say that two principal drivers of the market are fear and greed. I agree that there are many other higher level motivators, such as Maslow's hierarchy of needs, but the market exhibits crowd behavior, and the crowd is the lowest common denominator of human emotions. The "masses" don't seem to have a hierarchy of needs.

In the context of the market there seem to be two basic fears: fear of loss, and fear of missing out. This latter fear is a form of greed, so maybe fear and greed are two sides of the same coin, the yin and yang of markets.  

I heard a talk recently in which it was said that the market is driven by the irrational emotions of fear and greed, and that rationality consisted in finding the right balance. I found that amusing and ironic, the idea that rationality was finding the optimal mixture of two irrational emotions.
I also find that people seem to spend a lot of time worrying about things that in no way impact any current decision they might make. Things like "will there be a recession," "will the subprime crisis spread?" This strikes me as an expression of free floating anxiety, a channel, a displacement, a sublimation… 

Russ Sears augments:

Perhaps the widest and the true foundation to build on is not "fear" but "pride". Pride that is turned into "us vs them".

Granted that this "patriotism" is often used to create fears to expand powers. When used with fear this can be the most evil and complete expansion.

However, pride or "we are smarter than them" also creates a very stable base to expand love/family to create a counterfeit charitable hand.

That is: the Maslow hierarchy is built upside down to expand government.

Self actualization: what separates "We" from "Them" is "we" are the only ones with a true "need to know" the truth. We here is defined broad, to include all but "them"

Esteem: "We are smart enough to rule everybody's life". "We" here is defined narrowly as those of "us" that are in the government. Everybody else should follow the yellow brick road to see the wizard.

Love/family: "It takes a village" government will replace the dysfunctional family, which is all of "them"

Finally, the expansion into safety: government will protect "us" from "them".

From this view fear is the roof, or exterior, not the foundation. The expansion of government occurs with each level, not simply fear.

This can of course can be seen as a clear pattern in doomsdayist prophecies. "We" are the only ones smart enough to seek the truth, at all cost. Tomorrow is bleak without "us" to warn you and turn bad on its head and into good.

It is a good exercise for the reader to read many of the recent credit crunch articles with this view,  as current propaganda. This of course can be expanded beyond the markets and political readings, even into such areas as religion and popular pseudo science such as Dawkins for instance.

Tom Ryan enumerates:

The influence of fear:

1. The reliance on social proof rather than logic (looking to the herd for confirmation)

2. The tendency to extrapolate past events out into the future

3. The tendency to respond to contrasts more than absolutes

4. The tendency to non-linear weighting of probability (Kahneman & Tversky)

6. Emotional reaction to loss tends to exceed that of gain (Prospect Theory)

7. The tendency towards being consistent in one's behavior despite the financial pain in order to avoid the mental pain (fear of regret)

8. Overreaction to scarcity (scarcity programming - as one who has gone bust before I have this in full measure)

9. Strategic conventionality ("no one ever got fired for buying IBM")

Larry Williams contributes:

Fear is the greatest enemy of long term investors as it kicks them off track, off their game plan… that, coupled with short term 'gain-greed' seems to be why there are few truly long term investors.

Where does the fear come from?

Deep within our hearts and minds I postulate there is a fear mechanism—for our survival—but those fires are fanned, now, twenty four hours a day by media. Media= Negativity (fear)= Subscribers/Viewers.

Solution? Best I've heard comes from John Prine, "Blow up your TV, eat a lot of peaches, ya gotta find Jesus on your own"





Speak your mind

6 Comments so far

  1. apk on November 3, 2007 11:19 pm

    Looking at Victor’s example of market fears, one might assume that all fear is the fear of loss, and serves only to depress the market. But the fear of missing an opportunity is, given the long-term upward bias of key markets, even more powerful. (How many market participants are driven by the fear that the underlying will rally, squeezing their shorts or outperforming lower-risk positions?)

    One can clarify this discussion by discarding “fear,” and other emotionally charged words, in favor of “uncertainty” or “information,” which, it can be argued is what people are really trading–or at lest what smart, emotionally disciplined money is trading.

    As to how well Lao Tzu et al. would have done in the pits, Herman Hesse offered an answer. Siddartha, fresh from asceticism and deep in his “ride” mind, apprentices to a merchant, who says of him: “This Brahman is no proper merchant and will never be one, there is never any passion in his soul when he conducts our business. But he has that mysterious quality of those people to whom success will come all by itself…He always seems to be merely playing with our business affairs, they never fully become part of him…he is never afraid of failure, he is never upset loss.”

    So without fear, of loss or of gain, there is no volatility to the market. Said another way, the hope of gain can only exist in apposition to the fear of loss. In financial markets, the edge may well belong to those participants who can dynamically mix elephant and rider according to the situation. To be 100% rider, an enlightened mind, is not enough. Think of Soros’s _Alchemy of Finance_, wherein he recounts *becoming* his portfolio; trading in and out of positions according to his physical health. That said, in the market of happiness, the edge goes to the enlightened (dispassionate?) mind, which cannot be exploited. We can now view Leviathan as that which rides the elephant-minded masses with the goad of fear.

    (A postscript for the curious: After further immersion in the red dust, Siddartha lost his detachment and was ultimately crushed under the onus of worldly success and desire. After this loss, he traded his life as a merchant for one as a boatman and student of enlightenment.)

  2. Greg Rehmke on November 3, 2007 11:50 pm

    This year’s national homeschool debate topic calls for immigration reform. Fear drives anti-immigration advocates. Fear of immigrants being terrorists, criminals, infectious, pushing wages down, crowding public schools, emergency rooms and highways. Virtually none of these fears are backed by empirical data. Welfare programs are costly, wasteful, distorting and debilitating whether provided to illegal immigrants or citizens. But economic data on immigration is powerful and positive for the American economy.

    Why then so much fear regarding immigration? Nativists fear the influence of foreign cultures today, just as they did in the early 1900s when Eastern and Southern Europeans arrived in large numbers. And as they feared Chinese and Japanese immigrants on the west coast in the late 1800s.

    People apparently fear jobs that might be lost, diseases that might be unleashed upon society, “exploding” crime, prisons overcrowded with illegal immigrants, and “overpopulation” (Google “gumballs immigration” to find the YouTube video of a misleading talk on this last topic).

    Yet immigration is the great driver of economic growth. Immigrants launch high-tech firms or fill key positions, creating thousands of jobs at firms like Google, Yahoo, eBay, and many others. At the low-skills end, immigrants from rural Mexico and Central America fill millions of positions in agricultural, meat-packing, landscaping, and construction, freeing up higher trained U.S. citizens for other jobs.

    Immigrants, legal and illegal, pay rent and some taxes, purchase goods and services, and create wealth through productive work.

    Anyway, the key question is the role fear continues to play in the migration market, and why so many who otherwise want limited government seem to approve governments century of failed efforts to micromanage immigration numbers and policy.

  3. Ronald Weber on November 5, 2007 6:00 pm

    Random Thoughts on Fears and the Market

    Fear is naturally present with any irreversible decisions that carry high stakes, and making investment decisions is probably the most dramatic example.

    Markets fear news more during periods of doubt than during a bull market. You won’t get much attention nowadays if you argue that oil could get back to 20 or Gold to 200 nowadays, but you will get eyeballs if you talk about a housing meltdown. It just seems like the logical continuation of a process.

    Also, for many independent small newsletters and authors, playing with market fears is a better way to get attention and to differentiate against the Street, as most bank analysts tend to be “bullishly” aligned in their views. So by playing the “downer” you will right maybe 10% of the time but at least you will be noticed during this time, even if you are wrong 90% of the time.

    Finally, I can’t help to make a parallel between market fears and religion, as the call of the “last judgment”, “redemption” or the “apocalypse” has been a leitmotiv since the dawn of humanity. Post-bubble periods are the best examples: we are reminded of our “sins” for having fallen for “greed” and “they” (the bears) knew it all along and have all the answers.

  4. Bill aka NO DooDahs! on November 6, 2007 10:27 am

    “physiological, safety, love, esteem, and self actualization. Of these hierarchical levels, only the safety level could in any sense be related in part to fear.”

  5. Eric Blumenschein on November 6, 2007 5:26 pm

    If you are trading the ES and you are up 8 points but only cash in 3, that experience is like late rains that dampen the harvest yields. You can knock yourself about mis-reading the weather because you wanted those grains to fatten up a little more but you still put something into the bank.

    If you in fact lose 3 points, that is like you not only lost your harvest but you are losing your seed and question if you will be able to plant next year and who really wants to think about that.

    Fear and Greed — How do you rise above those emotions?

  6. Ali Anani on March 2, 2010 1:50 am

    This is a fantastic reading as it challenges our assumptions mindfully. I have myself questioned the validity of Maslow’s pyramid of needs in two recent presentations:

    Surprisingly, literature on the emotional swing of markets show fear progressing into despair during downturn of the markets, but shows no greed on the upturning market. Possibly, anticipation is linked to greed, And yet the literature always refer to balancing the two even with the greed word not showing on the graphs!!!!

    I strongly recommend that ach investor should read these articles before investing.


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