The Market Mind Hypothesis, page 2
James Montier
Partner GMO and member of its Asset Allocation team
Author of Behavioural Investing
The “physics-envy” of academic economics has led the discipline down an intellectual cul-de-sac. Messier but more accurate frameworks have been subordinated to cleaner but less accurate ones on the spurious grounds of mathematical tractability. Patrick Schotanus’ ‘big idea’—that markets exhibit characteristics and properties more similar to the human mind than to Newton’s solar system—is an impressive and refreshing attempt to get things back on track. Inspiring stuff.
Dylan Grice
Co-founder Calderwood Capital
The Market Mind Hypothesis (MMH) from Patrick Schotanus helps us move financial market analysis from the simply mechanistic approaches such as CAPM, to well beyond the developments already established through the behavioural economics approach that has gained ground in recent years.
It has long been recognised that ‘Mr Market’ has a mind of its own—and one that often runs counter to/or in advance of what traditional economic and valuation analysis might suggest. This work begins to formalize a framework for thinking about how ‘Mr Market’ works.
Patrick Schotanus builds on his many years of practical investing with leading institutions to interweave a novel theoretical model of how markets function, combining the physical aka ‘the economy’ with the psychological financial economy aka ‘the market’, to show how we can start to better understand this ‘market mind’.
Patrick helps us understand how the ‘market mind’ balances the well-recognized conflict between ‘fear’ and ‘greed’. He shows how rather than markets being ‘neutral observers’ of the dramatic economic market events that have shaped the last three decades such as the LTCM crisis of 1998, and the subsequent blow-up of the Tech bubble, the GFC and the COVID crises, Mr Market is an active participant responding to, and often amplifying, both the risks and returns with its various ‘market moods’, at times shifting rapidly from despair to exuberance.
This is a valuable new insight into the way markets behave and an exciting new lens for both academics and practitioners to view markets and market developments.
Ian Harnett
Co-founder and Chief Investment Strategist Absolute Strategy Research
Every investor is the fruit of his or her own experiences; experiences that create habits, biases and blind-spots. And very rarely, a book comes around to challenge established patterns and encourages the reader to look at markets, the broader economy and even one’s own life through a new lens. This is such a book. The Market Mind Hypothesis offers a different approach to financial markets and economics, one that goes beyond the breakthroughs accomplished by behavioural economists over recent decades, and fully embraces cognitive science, a new multidisciplinary field that includes Artificial Intelligence (AI), neuroscience, philosophy, psychology, and sociology. A must read!
Louis-Vincent Gave
Founding Partner and Chief Executive Officer Gavekal
In this interesting and original book, Dr. Patrick Schotanus takes dead seriously the everyday anthropomorphizing talk about what the market thinks and develops the idea that the market does have a mind, a personality, moods, that emerge collectively from its participants. And after all, what are markets, stock prices, interest rates, volatility, and default rates if not mental rather than physical phenomena?
Emanuel Derman
Professor, Columbia University, and Director of its Financial Engineering Program
Author of My Life as a Quant and Models. Behaving. Badly.
Patrick is an innovative and courageous thinker, rarely swayed by the ‘received wisdom’. In this simultaneously well-researched and unorthodox book, he exposes the fault lines of classical decision-making theory and implores the profession to move beyond even behavioural economics and to consider how cognitive sciences can improve our understanding of economic decision-making.
Larry Hatheway
Co-founder Jackson Hole Economics and former Chief Economist UBS
A must read and a fascinating new way of understanding how economies – and markets – work. If the last few decades have taught us anything, it is that we don’t really understand them. This important book offers new thinking that might help us do better. A deeply necessary addition to the debate.
The economy is all too often treated as a machine. But if all the actors in it have a consciousness, might it not have one of its own? This intriguing new book explains how that mind rules our world.
Merryn Somerset-Webb
Senior Columnist Bloomberg and former Editor in Chief of Moneyweek
As someone who has written about the need for new theories and understandings of cognitive economics I was delighted to read this book, which introduces the Market Mind Hypothesis and sets out an ambitious research agenda. I’m hopeful that we will see a stream of significant work in cognitive economics, not only from economics, but also drawing on insights from other fields, varying from biology and neuroscience to psychology and computer science. The aim should be to show that the workings of ‘invisible hands’ are not something magical but are rather amenable to rigorous analysis.
Sir Geoff Mulgan
Professor, University College London, and Editor in Chief, Collective Intelligence (Sage/ACM)
Author of Big Mind; How Collective Intelligence Can Change Our World
To Marilyn, Nimeesha, and Jazzlyn
Acknowledgements
You have no responsibility to live up to what other people think you ought to accomplish. Richard Feynman
This book is the culmination of many years of research, study, and work, including almost 30 years in investment management.1 It’s impossible to retrace the exact origins of its ideas as most of the major philosophies and theories of both cognitive science and economics have left their mark. The numerous quotes and references give you some clues. At the same time, as a Jack of all trades but master of none, I like to invoke Deirdre McCloskey’s excuse: “I must apologize for my amateurish understanding of what is happening in philosophy, mathematics, literary criticism, rhetorical studies, and other places beyond my competence, and ask that practitioners in these fields assist in my further education”. Below I want to express my gratitude more personally to those who did assist and helped shape this book in one way or another.2
My parents—Jan and Diet, who I miss every day—provided the physical and mental foundation for all my creations. My sister Joyce is my pivotal ‘backstop’. I could not have asked for a more sound and stable family grounding, being raised in that unremarkable Dutch city of Almelo, of which local comedian Herman Finkers famously stated:
Een stoplicht springt op rood,
een ander weer op groen.
In Almelo is altijd wat te doen.3
Everything has built up from there, peaking with the joy and pride of my own family—Marilyn, Nimeesha, and Jazzlyn—who supported me during this arduous chase of a dream (despite suffering its consequences). This book is to you, girls. I also cherish the memories of my ‘American family’ in Mill Valley—Alan, Miriam, and the rest of the Burdick-clan—during my extended and transformative stays in the United States.
My teachers—from primary to university—prepared me for my eventual career. A few stood out. Meneer Bonekamp, head-teacher at the St. Stephanus School, and Meneer Welling, math teacher at the Pius X College, were exemplary in being ‘old-school’: clear, fair, and frank. As part of my Dutch MBA I spent my internship in the San Francisco Bay Area where I had the pleasure and privilege to work with Willis Harman. Willis was professor emeritus at Stanford University, a cognitive pioneer, and a visionary futurist. He kindly introduced me in person to numerous other thought leaders—from corporate trailblazers to mind explorers—many of whom I admired as a student, like Fritjof Capra (The Turning Point),4 Gary Zukav (The Dancing Wu Li Masters), and Robert Waterman (co-author of In Search of Excellence). Crucially, Willis influenced my early thinking on consciousness and encouraged me to do my bit in understanding its role in the economy and society at large. I’m also grateful to my University of Groningen academic supervisor Caroline Quispel, a leading expert in business and personal transformation.5 She guided me in my early explorations and helped to arrange this internship. Those first years of my academic life were also greatly shaped by (often sharp-tongued, regularly booze fuelled) discussions with fellow students. I particularly valued the company of Rob ter Brugge, Marcel Gerla, Michiel Goris, Imelda Gorman, Han Hegeman, Dominique Jones, Henk Koezen, Veronique Morat, Jeroen Nijhuis, Maurice van der Putten, Paul Rijk, Cap Sprokel, Roel Teule, Tycho Veenhuizen, Peter Westerink, and Johannes Ziegler.
Much later, during my (part-time) PhD at the University of Essex, I received constructive criticism, encouragement and guidance from my dual-faculty supervisors Roderick Main (psychology) and Andrew Wood (finance), as well as my examiners and several external advisors, including Ralph Acampora and Robin Robertson.
More recently, this book has greatly benefited from conversations, discussions, and other exchanges with several pre-eminent cognitive scientists (some of whom already acted as the other external advisors to my PhD). Among them are the ‘cognitive’ speakers and moderators of our May 2022 symposium in Panmure House, of which I’d like to name a few: Vivienne Brown, Christel Fricke, Gerd Gigerenzer, Sam Johnson, Julian Kiverstein, Geoff Mulgan, Sören Overgaard, Shannon Vallor, and (especially) Karl Friston and Scott Kelso. I’m particularly grateful to the MMH’s earliest line-up of brilliant advisors and collaborators: Ron Chrisley, Andy Clark, Duncan Pritchard, Dave Ward, and Aaron Schurger. I would also like to thank Harald Atmanspacher, Uziel Awret, Richard Baker, Charles Card, David Laveman, Thomas Metzinger, Robert Prentner, Michael Silberstein, Bill Seager, and the other fellow members of the Society of Mind Matter Research (SMMR). Comments in private conversations and correspondence by David Chalmers, Antonio Damasio, Stanislas Dehaene, Vittorio Gallese, Christof Koch, Orestis Palermos, Jaak Panksepp, Anil Seth, and Giulio Tononi are gratefully acknowledged. I hope this book will refresh and intensify those.
In similar vein, a large number of academics in economics and finance have tried to educate me over the years. I especially appreciate the efforts by the outstanding faculty of the Master of Financial Engineering (MFE) program at UC Berkeley, in particular Mark Rubinstein, Rich Lyons, Terry Odean, Francis Longstaff, Philippe Jorion, Hayne Leland, Jonathan Berk and Nils Hakansson. I have fond memories of and thoroughly enjoyed collaborating with my fellow MFE students: Robert Bentson, Albert Chan, Jim Gilliland, Karim-Patrick Khiar, Chulki Kim, Ed Lee, Jun Leng, Ben Meng, Alex Pabon, Michael Surowiecki, and the rest of ‘Rubinstein’s guinea pigs’ in that eclectic (and now somewhat notorious) inaugural class. I thank the MFE’s former director, Linda Kreitzman, for allowing me in (despite having been a technical analyst).
I also received support, during various phases, from a few expert advisors, in particular Richard Meese (my MFE-internship boss and former head of Barclays Global Investors’ FX division), and Hank Pruden (my mentor in technical analysis). Other academics and policy makers—for example as participants in our symposium or as proof-readers—generously shared their macro, micro, finance, and policy views: Tobias Adrian, Robert Axtell, Jo Danbolt, Sheila Dow, Andy Haldane, Andrew Hauser, Eddie Jones, John Kay, Robbie Mochrie, Adair Turner, Mervyn King, and Bill White.
Over the years I met many investment professionals, both on the buy and sell side. For practitioners it is arguably easier to accept the concept of the market’s mind. I’ll mention a few of them who have kindly offered both supportive and critical comments on my views, for example expressed during our 2022 symposium: Evangelos Assimakos, David Bowers, David Bowie, Guy Cameron, Juan Ramón Caridad, James Clunie, Emanuel Derman, Louis-Vincent Gave, Alastair Gill, Duncan McInnes, Andrew Milligan, Gareth Murphy, Jim Grant, Dylan Grice, Elwin de Groot, Hal Haig, Ian Harnett, Larry Hatheway, Anatole Kaletsky, Will Kinlaw, David Long, James Montier, John Normand, and Keith Skeoch. I am especially grateful to three living investment legends: Howard Marks, Kiril Sokoloff, and George Soros. But most of all, I want to thank Russell Napier who has been my staunchest advocate and my brother-in-arms for new enlightenment in economics. He is best known for his cult (investment) classic Anatomy of the Bear (2005) and his course A Practical History of Financial Markets (which I attended many years ago).
My day-to-day interactions with former colleagues and other investment professionals—be it by co-managing portfolios, creating models, or generally discussing investment themes—have been very instructive and have enhanced my understanding of the market. Other colleagues with backgrounds in cognitive science raised my understanding of our mentality. All helped to make a Dutchman feel at home, wherever that was. I’d particularly like to thank some of those international colleagues and fellow expats over the years: Rogier van Aart, Evan Agapitou, David Brown, Roberto Carulli, Jaco Cebula, Elaine Crichton, Bill Dinning, Colin Dryburgh, Bettina Edmondston, Andrew Fleming, Scott Fleming, Wink Franklin, Stuart Fraser, Gareth Gettinby, Simon Holman, Tom Hurley, Sander van Ittersum, Anchalika Kijkanakorn, Debbie King, Margaret Livingston, Kirstie MacGillivray, Vincent McEntegart, Innes McKeand, John McNeill, Pauline McPhersson, Phil Milburn, Cédric Phounpadrith, Paul Reading, David Roberts, Stuart Rowan, Gregory Turnbull-Schwartz and Mohammed Zeineddine. In the Netherlands, it was a pleasure to work with some exceptional individuals at Van Lanschot Bank (a.k.a. “FvL”): Rob van der Aa, Arno Barens, Jean-Paul van Bavel, Joost Buchner, Glaucia Canabrava, Desiree Claassen-van Dooren, Clara van der Elst, René van Geffen, Frank Kamsteeg, Rob Labadie, Reginald Melchers, Patrick Rutten, Raoul Sprangers, Michel van der Stee, Dirk Verbiezen, Ruurd Verdam, Cees de Vries, and Eric Wening.
During my investment career I kept mostly quiet about my secret versatile modelling tool, Amibroker (with its plug-ins for, among others, Bloomberg, Datastream, and R), because it offered me a competitive edge. For example, it helped me to build an early risk-factor investing model, long before it became popular. I thank its developer Tomasz Janeczko (the best programmer I know) and the Amibroker community for their advice and support.
Others who provided valuable feedback and support include Mazviita Chirimuuta, Flavia Cymbalista, Stuart Leckie, Jay Pocklington, Cris Sheridan, Merryn Somerset-Webb, Monica Tamariz, Gillian Tett, and Peter Westerink (my “best man”).
Completing this book and getting it published wouldn’t have been possible without Jaime Marshall and my editor Suzanne Ebel. I’m indebted to Russell Napier, Scott Kelso, and Julian Kiverstein for writing, respectively, the foreword, intermezzo, and afterword. I thank the professional team of De Gruyter Publishers, especially Jaya Dalal, Stefan Giesen, Steve Hardman, and Anne Stroka (Integra) for their belief in this project and for getting the book out there. It benefitted from the following additional commentators who took the time and effort to read (parts of) the manuscript: Uzi Awret, James Clunie, Bill Dinning, Madeleine Kemna, Alastair Lees, Robert Prentner, and Danilo Spinola.
Without a home institution, while promoting a very heterodox theory, I must confess that my switch from investment management to academia has been difficult. I am thus grateful for the backing I did receive. My research as a pracademic, trying to bridge industry and academia, has been made possible by the generous support of Walter Scott Partners (headed by Jane Henderson and Roy Leckie) and especially the Didasko Educational Company (founded by Russell Napier, chaired by Tony Foster, and led by David Clarke). I thank Adam Dewar and Meg Tulloch for creating and maintaining the marketmind.org website, as well as for making the symposium such a success. Similarly I thank Duncan Pritchard for arranging, and Dave Ward for renewing my visiting scholarship at the University of Edinburgh. Ron Chrisley did the same for my affiliation with the Centre for Cognitive Science (COGS) at the University of Sussex, as did Heather MacGregor and Robbie Mochrie for my visiting professorship at Heriot-Watt University. I also like to thank the Edinburgh Futures Institute, represented by Owen Kelly and Douglas Graham who have been ambassadors for the MMH within the University of Edinburgh community, eventually resulting in me being awarded EFI’s research grant. On a growing number of occasions I have been kindly invited to introduce the MMH and share our insights, including at events organised by the CFA Society UK, the Mercatus Center (George Mason University), and McGill University.
Finally I thank Mr Market, the ultimate teacher. He regularly inflicted pain on me but it now, and in turn, pains me to see his fragile state due to long-term abuse.
The usual caveats apply. If you think you should have been mentioned here, my apologies. The fact that my memory failed does not necessarily mean that you are forgotten (just send me a gentle reminder, if only for the next edition).
Foreword
Price holds up a mirror to reality. Price reflects, in the form of data, what we think of reality and thus it reflects, at least, our consciousness. As a practitioner in financial markets, for over thirty years, I have peered at such reflections on a daily basis. Many economists have told me in the past (though fewer nowadays) that what I see gazing back at me is only the so-called ‘rational economic man’—a pared down version of consciousness at best. It was the predictability of the ‘rational’ actions of this ‘man’ that allowed a seeming greater certainty in economic understanding that was key to pushing the discipline along the spectrum from a ‘mere’ social science towards the ‘hard’ science which is still seen as a goal by many economists. While some academics still cannot see past the rational economic man most now recognise some behavioural anomalies in our thinking, which are also reflected in the mirror of price.
