What is ‘Animal Spirits’ and how can you invest in the theme with us?

What is Animal Spirits?

Animal Spirits is a term coined by economist John Maynard Keynes in his seminal 1936 work ‘The General Theory of Employment, Interest, and Money.’ It describes how emotions, instincts, and confidence levels influence human behaviour, particularly in financial and economic decision-making.

The term comes from the Latin ‘spiritus animalis’ which means ‘the breath that awakens the human mind.’ Prior to Keynes, the Latin term can be traced back to antiquity — where animal spirits applied to the fluid or spirit present in the brain which were argued were the cause behind mental stability. Animal Spirits also appears in literature, referring to courage or exuberance.

Arguably, Keynes predicted the rise in behavioural economics — whereby stocks are arguably moved as much by sentiment as by fundamentals — and rather than relying on objective data, economic decisions are swayed by emotion.

Animal Spirits are often most invoked during periods of high volatility, including euphoric rises and despondent market crashes.

How to invest in Animal Spirits with us

1. Learn more about stocks affected by Animal Spirits
2. Download the IG Invest app or open a share dealing account online
3. Search for Animal Spirits stocks on our app or web platform
4. Choose how many shares you’d like to buy
5. Place your deal and monitor your investment

Investors look to grow their capital through share price returns and dividends - if paid.

But the value of investments can fall as well as rise, past performance is no indicator of future returns, and you could get back less than your original investment.

We also offer many ETFs related to Animal Spirits, including the popular VanEck Vectors Social Sentiment ETF, which comes with a 0.75% total expense ratio — and seeks to track the performance of 75 large cap US stocks which exhibit the highest degree of positive investor sentiment and bullish perception based on content aggregated from online sources including social media, news articles, blog posts and other alternative datasets.

How does Animal Spirits investing Work?

Animal spirits investing is an approach where investors make decisions which are not based entirely on financial data, but also on feelings, emotions, and the mood of the market.

This approach is perhaps unscientific, but takes into account market sentiment, buying when others are optimistic and selling when the mood turns negative. It also considers the wider level investor belief and confidence in growth, in addition to herd mentality — that people may follow trends, sometimes irrationally, because they sense that others are doing the same.

Of course, while this appears to be very subjective, it’s worth noting that many real world economic movements are based on similar subjective criteria. For example, a wave of optimism can send stocks booming into bubble territory — consider the rise of artificial intelligence — to arguably beyond fundamentals. Conversely, widespread fear can cause sharp crashes and panic selling.

Businesses also rely not just on hard data but also on confidence and trust to make decisions about hiring or expanding, particularly when consumer optimism means higher spending might be on the cards. Companies also make decisions based on what their competitors are doing; and sometimes, their competitors may be making irrational decisions.

The bottom line is that Animal Spirits can’t always be predicted by rational financial models, can amplify the boom and bust economic cycle, and can even force governments to intervene to stabilise the markets when they create too much volatility.

While Keynes initially popularised the term, it received mainstream attention when celebrated economists George A. Akerlof and Robert J. Shiller published ‘Animal Spirits: How Human Psychology Drives the Economy, and Why it Matters for Global Capitalism.’

The authors argued that while Animal Spirits are important for growth, a working capitalistic model requires governments to intervene through public policy when spirits get too high. If not, capitalism can get out of hand, resulting in much larger crashes than would otherwise be seen. Akerlof and Shiller include five cognitive and psychological types of Animal Spirits in their work: confidence, corruption, money illusion, fairness and stories.

The theme is perhaps gaining in popularity due to the rise of social media, which can create rapid swings in sentiment — a good example of this may be the GameStop saga.

Animal Spirits vs other investing strategies

An underlying principle of Animal Spirits is that for investment prices to rise and fall based on human emotion rather than intrinsic value. However, proponents of other strategies argue that markets are actually efficient, and that individual irrationality is not relevant to the wider market.

Others consider that bubbles arise not from mass psychology, but from central bank action, fiscal policy and overregulation that can throw markets out of equilibrium.

While Animal Spirits investing is based on psychology, there are many other investing strategies to consider, including:

• Value Investing — Focused on purchasing undervalued assets based on fundamentals such as a company’s price-to-earnings ratio. This approach is rooted in hard data and long-term investment rather than short-term market sentiment
• Growth Investing — Involves investing in companies that are expected to grow at an above sector-average rate. It is more future focused and driven by research into a company's potential, as opposed to the shifting moods of the market
• Momentum Investing — Investors buy assets based on their recent performance, riding the wave of momentum. While this strategy might appear similar to Animal Spirits investing, it relies more on objective technical analysis indicators instead of subjective emotional factors

Examples of Animal Spirits

There are many examples of Animal Spirits in action:

1. 1999 Dotcom Bubble — Many investors were swept up in the excitement around internet companies, leading to irrational investments. Many tech companies, despite having no profits or even a viable business model, saw their stock prices soar, even by something as simple as adding a dotcom to their name. By 2001, most of these dot-com stocks had collapsed.
2. 2008 Financial Crisis — During the lead-up to the financial crisis, there was widespread belief in the stability of financial markets. This led to excessive risk-taking by investors and financial institutions, driven by a false sense of security, which was curtailed by the subprime disaster
3. 2017 Cryptocurrency Boom — The rapid rise in Bitcoin and other cryptocurrencies was partially driven by enthusiasm and the volatile speculative behaviour of investors, ignoring the underlying risks before the alternative asset class entered a ‘crypto winter’.

Pros and cons of Animal Spirits investing

As with all investing strategies, there are advantages and drawbacks to relying on Animal Spirits:

Pros:

• Short-term Opportunities — In certain situations, Animal Spirits can create opportunities for quick trading gains, as market sentiment can sometimes drive assets to reach new highs before a correction.
• Market Efficiency — In volatile periods, collective optimism or pessimism can speed up the price discovery process, especially when new information is incorporated into market prices rapidly.
• Contrarian Opportunities — If you can recognize when Animal Spirits are driving irrational behaviour, you can position your portfolio to profit when the market corrects itself.

Cons:

• Volatility and Risk — Animal Spirits can cause sharp market swings, leading to periods of excessive risk-taking followed by dramatic selloffs. This increases overall market instability, and you can make losses where the market stays irrational for longer than you expect.
• Irrational Decisions — Investors might make poor choices based on emotions, like buying during a market peak or selling during a crash, leading to losses.
• Bubbles and Crashes — Animal Spirits can inflate asset prices beyond their actual value, generating bubbles, and when sentiment changes, it can lead to market crashes and massive financial losses.
• Unpredictability — Since Animal Spirits are driven by emotions, they are inherently difficult to predict. Markets driven by emotions can act in ways that defy traditional models, which can feel unscientific.

Animal Spirits summed up

• Animal Spirits is a term coined by economist John Maynard Keynes in his 1936 work ‘The General Theory of Employment, Interest, and Money’
• It describes how emotions, instincts, and confidence levels influence human behaviour, particularly in financial and economic decision-making. It also considers the wider level investor belief and confidence in growth, in addition to herd mentality
• An underlying principle of Animal Spirits is that for investment prices to rise and fall based on human emotion rather than intrinsic value
• Animal Spirts may have been turbocharged by the rise of social media, which can lead to rapid swings in sentiment