Niklas Hageback - The Mystery of Market Movements: An Archetypal Approach to Investment Forecasting and Modelling

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I wish to express my gratitude to Cherry Cheng Ka-Wing and Daniel Kongo Hedblom for their contributions to the background research.

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Experience teaches us no less clearly than reason, that men believe themselves free, simply because they are conscious of their actions, and unconscious of the causes whereby those actions are determined.

Baruch Spinoza, Part III: On the Origin and Nature of the Emotions; Postulates (Proposition II, Note) from R. H. M. Elwes, trans., The Ethics, 1955, p. 54 (original work published 1677)

In the wake of the dot-com crash and the collapse of the US housing bubble, it is clear that non-rational impulses, such as the mania at the height of these bubbles and the subsequent panics that followed in the downturns, play a major part in collective human investment behaviour. These irrational sentiments, which have the capacity to greatly influence asset prices and at times feed financial bubbles that threaten to trigger great social unrest, have been given many names. The founding father of fundamental analysis, Ben Graham, and later his most famous disciple, the investor Warren Buffett, named them the manic-depressive Mr. Market; the economist J. M. Keynes referred to animal spirits; and the former US Federal Reserve chairman Alan Greenspan talked about irrational exuberance.

The inability of conventional economics to account for human irrationality renders the commonly accepted economic and financial theories void. Economists adhering to these conformist thoughts are at a loss as to how to adapt their theories to account for collective human behaviour that does not follow the rational man assumption. To date no one has been able to pinpoint and explain the mechanics of these forces, other than relating to them in anecdotal fashion or quickly glossing them over as an unknown variable. Consequently, interest is, and has been, growing in developing alternative approaches to economic theory, such as behavioural finance. However, these newer concepts have proved uneven at best in predicting and explaining financial bubbles. They all fail to answer the two key questions: When and why are financial bubbles likely to form?

Given the dramatic impact such irrational fluctuations can have on asset prices, and on society at large, and the recognised, but generally overlooked, inability of fundamental valuation models to factor them in, it is vital that we identify the underlying drivers. Existing theory has proved incapable of doing so, but there is a way. However, to understand it, we must first delve into psychology and explore the collective unconscious and its archetypesinnate mental images that exist unconsciously in us all and affect our behaviour and judgment without our being consciously aware of it.

Recent developments in neuroscience have brought greater understanding of the workings of the brain and how it relates to the much more elusive concept of the mind. There has been a fundamental shift from the position that nurture is basically responsible for human development and behaviour, in other words, everyone is starting with a blank slate, to an acceptance and understanding of the powerful influence nature holds. Modern research supports the existence of an unconscious, with a part operating at a collective level, impacting societal movements, whether in fashion, political trends, even social unrest and revolutionsand the financial markets. Individually or collectively, human choices, including investment decisions, are affected to a large degree by the prevailing social mood or zeitgeist. The collective unconscious plays an important role in creating and directing these social mood swings.

The term collective unconscious was coined by the Swiss psychologist Carl Gustav Jung (18751961) early in the twentieth century during a period in which he was collaborating with his Austrian contemporary Sigmund Freud (18561939). Jung's thinking on the collective unconscious and its archetypes came over time to gain broad acceptance among the psychology profession and academics. Jung incorporated Freud's model of the unconscious, what Jung called the personal unconscious, but he proposed the existence of a second, far deeper form of the unconscious lying under the personalthe collective unconscious, where the archetypes reside. The personal unconscious comprises an individual's experiences that have been forgotten or suppressed into the unconscious. It is unique to each person. The collective unconscious, on the other hand, contains psychic materialthe archetypescommon to mankind and therefore universal and impersonal throughout time and regardless of cultural context.