Random thoughts on creative destruction, market volatility, chaos theory and psychosis.
Ant colonies, bird flocks, political communities, ecosystems, foreign affairs, the climate and the stock market all have something in common: they are complex adaptive systems. Complex means comprised of many parts which are inter-fused together forming an interdependent whole. Adaptive refers to the fact that all organic systems dynamically adapt to constantly changing environments as the participants strive to survive and thrive. And systems means everything is interconnected, mutually reinforcing and morphing in real time as ‘if guided by an invisible hand.’ This is ‘non-deterministic chaos‘ and it’s an intrinsic part of life.
‘Complexity’ represents the middle area between static order at one end and chaos at the other. Thus complexity is sometimes characterized as ‘the edge of chaos.’ If we think of static order as ice and chaos as water vapor, complexity would be liquid water – always oscillating, always evolving as a function of time and space.
The current stock market wobbles reflect the properties of complex adaptive systems, the myriad ways we move, adapt, survive and thrive or – if our strategies are wrong – die. Hence the ‘rout’, aka, the dynamic re-examining of risk expressed through market price action. The equities and bond markets are complex adaptive systems that have the ability to internalize information, to recursively learn, and to modify their behavior as they adapt to changes in their environments. In other words, they are ‘collective brains’ and act according to sensitive feedback loops. In the modern parlance, markets produce reflexive ‘non-linearities’ and ‘jump diffusion processes.’ Hence, the unnerving, highly-anticipated correction now underway – a market loss of -5% and counting. It’s all good, though.
Basically, the plunge you are observing now on Bloomberg and in various media stems from a confluence of cross-asset, cause-effect sources. They are: 1. A record unwind of levered hedge fund trades 2. Monthly tactical rotation 3. US election uncertainty 4. China’s ongoing contraction/RMB depreciation 5. Rising interest rate expectations 6. Developing economy/Third World stagnation 7. Trump-induced worldwide angst (um, both Kid Rock and Kanye are having lunch with the POTUS today); “A loco FED” as well 8. Exacerbated macro volatility 9. Freaky weather 10. Global supply chain tweaks 11. Margin calls 12. Future deficits and 13. The so-called ‘October Effect.’
When you concatenate these factors, ‘vectorize’ the polynomials, collide their coefficients and multiply their weighted probabilities by their weighted averages, you get spontaneous breakdowns, strange attractors and ‘jerk systems.’ Quants and algos perform these calculations 24/7 giving rise to crazy buy/sell cross-currents and self-organized criticality. Then, bang!, a cathartic flush occurs (massive sell orders!). Margin call time. It’s all … BTFD!
Simply said, the US economy is strong and its capital markets are robust. But the players are a wee bit psychotic (always – esp. now) and their ‘subjective states of mind’ are shifting market sentiment to the downside, generating tipping points, mob madness, panic selling and interesting ‘in-between’ states along the way. At VIVISXN, we view this as an opp. We’re dollar-cost averaging into this drawdown, scooping up the DXY/UUP (Dollar index); the TLT (Treasuries); small caps via the IWM; defense sector stocks; and select regional US banks (KBE) and money-centered financials. Emerging markets (EEM) are starting to look sexy, too, as are beaten down tech stocks and select healthcare. We are staying the f#*k away from all things China (ASHR/FXI) except via puts, shorts and inverse instruments. Energy and oil stocks (via the XLE/OIH) just got cheaper. Watch the NAAIM benchmark for short-term buy signals. VIX should spike again tomorrow. We will be glued to JPM in the morning.
In the financial-economic context of ‘chaos and complexity,’ jitterbugs (by their very nature – ‘jittery’ and angsty) are interacting in a ‘fluxious regime,’ creating an aggregate whole that is freakier than the sum of its parts, with new properties emerging and morphing IRT (spawning ‘butterfly effects’ in the process). This is all just ‘creative destruction’ unfolding in ‘phase space’, guided by interior forces and risk-reward scenarios seen through the prism of machines (‘neural networks’) and humans – pleasure and pain quantified; greed on the way up, fear on the way down; pessimism, skepticism, cynicism and euphoria; time-series convergence/divergence, etc.
As Adam Smith once said, ‘the interactions of firms, freaks, consumers and financial markets produces the modern dynamic capitalist economy, ‘as if guided by an invisible hand.’ And as the great pimp-economist Joseph Schumpeter casually put it, “at the heart of the system is creative destruction.”
Buy select dips here. Brace for more volatility tomorrow. This market is technically and scientifically ‘chaotic’ and that is constructive for your portfolio. Caveat emptor!
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