It was not just investment gurus, but philosophers and painters who said that simplicity is solved complexity and a powerful investment approach. We also had a Nobel prize awarded to a simple thought that there is no economics without psychology.
Sentiment precedes rationality and human beings are nice and dumb and not profit-maximising smart souls. Crowds are accordingly involved primary with instincts, biological drives, compulsive behaviour and emotions. Hence market success is less about economic but more about psychological competence.
Psychology
Experiments on crowd behaviour prove that individuals, when they become a part of the crowd, abandon logical and rational thought. Solomon Asch of Harvard conducted the matching lines experiment. Individuals and groups were asked to match the length of a line with three other lines. Individuals in isolation made a mistake less than 1 per cent.
However, when placed in a group that had been instructed beforehand to claim the mismatched lines were actually the same, 75 per cent of participants agreed with the majority. This was true even when the actual difference between the lines was very significant. Participants lacked the nerve to disagree with the majority.
Another interesting experiment demonstrating the lack of rational thought was when a group exercise was conducted by Stanley Milgram of Yale. Individuals were ordered to inflict pain on an innocent victim (who was acting) in the interests of an important cause. More than 60 per cent of the subjects were prepared to obey instructions and administer the highest and most lethal dose of electricity, even after the victim was, to all intents and purposes comatose.
Power law
And if all this infliction and pain seem like closed door experiments different from the stock markets, we have numerous mathematicians and scientists proving the simplicity mathematically. It was George Kingsley Zipf, an early twentieth century scientist who revolutionized our understanding of power law and revealed their astonishing presence throughout society and nature.
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Zipf's law states that the most common word used in language is a constant factor (say two times) more common than the second most common, and the second most common word is twice as common as the third etc. in 1955 Herbert Simon sought to unify the observations of Zipf and others by formulating a single common explanatory model for many of the systems displaying power-law behavior, including language, population and wealth. Stock markets around the world also work on a power law.
In 2003 in a paper submitted to Econophysics, Kaushik Matia and I illustrated the Indian price fluctuations exhibiting an intermediate form between power law and Gaussian behavior. This aberration also did not last long when Sitabhra Sinha, re examined the prices in May 2006 finding the price fluctuations exhibiting a power law.
Fractals
Another interesting aspect was that of fractal geometry, published in 1977 when Benoit Mandelbrot, mathematician at Yale proved that fractal geometry was mathematical. His work extended the scope of work of late nineteenth century mathematicians such as Giuseppe Peano who demonstrated the completed inadequacy of the common idea of dimension.
The subject of fractal geometry can not only calculate coastline lengths but is used in seismology and helioseismology and in a host of other scientific applications today. The coast line at marine drive, Mumbai, carries fractal drums to safeguard the coast. It is scientifically proven that rugged fractals are more efficient in saving coastlines than concrete walls. The fractal nature of the web is also behind Google's success.
The worldwide web is in the form of a bow tie with four components, a core, inbound links, outgoing links and the disconnected pages. Anyway you slice the web, geographically, topic specific clusters, organizationally or into groups of pages owned by the same person, the bow tie shape emerges again and again.
This is the same fractal behaviour in nature, societies and price behaviour that connects all of us. The very reason Elliott's wave principle and Dow's theory has survived more than 125 years. Fractal self affinity as Elliott said is fundamental to nature and all human activity leads to a socionomic process.
It follows a law, repeats in time, has a definite number and pattern and covers areas as diverse as gold prices, population movement, price of seats in stock exchanges, patent applications, commodity prices, epidemics, real estate business, politics and the pursuit of pleasure. We have also talked about Malthus population curves redefined by Verhulst as S curves, another form of fractals.
Cycles
And the other interesting part is that all this fractaled nature of economics, nature and universe has a fixed periodicity linked with it i.e. there are cycles running through them.
Edward R Dewey started the Foundation of Cycles in the early 1940's when he realised the uncanny similarity in data cycles found by Hyde Clark in business activity, Benner in industrial prices and Seton in animal population cycles. The 11-year sunspot cycles linked with human excitability and stock markets.
The nine-year cycles linked religion with credit, where rise of deposits every nine years is inversely linked to the rise in people going to church, 25-year volatility cycles, 17-year international battle cycles, dividend cyclicality etc. Interest rate cyclicality is a reality that flies in the face of believed truth that the central banker is in charge.
The current multi-decade cycle is inflationary accompanied by rising interest rates. This is the reason why prices of food, materials and commodities will continue to rise. Though we still see the short-term cycles giving us a multi-month or a year of pause, the long-term trend suggests that commodities might continue to rise till 2012-2015. It will be then when the real depression activities will start.
The hedge funds (the ones that survive) which will create news then will be the one doing Long Water