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Chaos Theory and the Stock Market

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Are markets random in nature? Neoclassical economists have introduced theories such as the efficient market hypothesis and random walk theory that led to the contemporary passive investing boom. If the stock market returns were indeed random, they would follow a normal distribution. Trader turned author Nassim Taleb calls the application of the bell curve to financial markets “that great intellectual fraud,” and for good reason too. Firstly, the application of a normal distribution and its implied mean, variance, and standard deviation has had disastrous consequences because normal distributions underestimate actual risk in markets. Portfolio insurance in 1987 amplified that year’s flash crash and the implosion of the highly leveraged Long Term Capital Management in 1998 nearly crippled the global financial system. Both relied on underestimated standard deviation as a measure of risk. Secondly, empirical evidence shows that stock market returns do not follow a normal
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On Dalio's "Paradigm Shifts" and the Second Act of Unconventional Monetary Policy

This post analyzes Ray Dalio’s recent article entitled “Paradigm Shifts.” Dalio is a global macro investor that I respect very much for his thoughtfulness and success. Unlike most SA articles or posts on this blog, what follows is more of a stream of consciousness than a structured thesis, point, counterpoint, and conclusion. “Every decade had its own distinctive characteristics, though within all decades there were long-lasting periods (e.g., 1 to 3 years) that had almost the exact opposite characteristics of what typified the decade.” What typified the last ten or so years? Extended stock market gains, global disinflation, stock buybacks, mergers and acquisitions, venture capital, the rise of passive investing, low real GDP growth, low volatility, Quantitative Easing/the expansion of the Fed balance sheet, artificially low interest rates, big tech, and reduced cost of labor.  Nearly all of these are related in one form or another. QE and low interest rates led to stoc
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Why the Stock Market Drives the Economy - Not the Other Way Around

Since its 1977 inception, the Federal Reserve has operated under the mandates to maximize employment, curb inflation, and moderate long-term interest rates. Since the days of the Greenspan put, one can add stabilizing the U.S. stock market to its modus operandi . I would argue that the original mandates have taken a backseat to stock market stabilization. Why? The stock market is the tail that wags the dog due to its effect on U.S. consumption. Here’s what I mean: When breaking down the components of GDP in the U.S., 68% is personal consumption, 17% business investment, 17% government spending, and -3% net exports. According to a 2018 study entitled “Stock Market Returns and Consumption,” the lower 50 th percentile of households in terms of wealth distribution consume 33% of every dollar made in capital gains, demonstrating clearly that rises in capital gains acquired through stocks influences consumer spending. The inverse wealth effect works too on a surprisingly short-term
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The Petro-Yuan, One Belt One Road, and Chinese Economic Grand Strategy

In the global financial balance of power, China is on a collision course with the United States. Unlike the U.S.’s rapid ascension following World Wars I and II, China has taken a slow and methodical approach to surpass U.S. economic influence, mainly through subverting the dollar and creating trade links through the One Belt One Road initiative. The Chinese 30-year plan , with the ultimate goal of becoming a “global leader in terms of composite national strength and international influence,” demands that it challenge nearly a century of U.S. dominance. The question remains, will they choose to play within the western dominated global order or against it? Their deeds indicate the latter. The introduction of the petro-yuan, the One Belt One Road initiative, and smaller projects such as the recent peso-yuan trading facility are clear attempts to de-dollarize global trade and increase China’s economic sphere of influence. The Petro-Yuan In 1974 , President Nixon made an agreem
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