04 March 2009

The Jimi Hendrix Monterey Pop Portfolio

Last year, the S&P 500 moved 5% on 17 days. Previously, it took from 1956 through 2007 to move 5% a total of 17 days. Put another way, there was as much volatility in 2008 as there was in the 52 years before.

Systems begin to oscillate more when there is feedback in the system. That is, when the system begins to respond to itself rather than just the environment.

There was a time when investments in the stock market might have been based more on actual economic and business conditions. In such a world, stock markets would move more slowly, tracking gradual adjustments in expectations to accord with adjustments in underlying conditions.

But once the game became one of anticipating stock market movements, the game of wondering what other people are wondering, the volatility is less limited. An economy might drop or grow by 2% or 5% in a year. If the stock market tracks this, there is not a great deal of movement. But if the stock market moves with expectations about how much people might speculate about expectations about how much people might speculate ... Well, then it becomes like Hendrix's guitar: a system with feedback that becomes increasingly unstable until some guy is smashing it in bits and lighting it on stage. Which brings me to my 401(k).


ThomasLB said...

Andy Warhol once remarked that a starlette was "famous for being famous." Similarly, there are stocks that are worth a lot of money because they're worth a lot of money.

Anonymous said...

Maybe, the real economy really is collapsing ever more precipitously into a negative feedback loop that really is a virtually uncatchable falling knife. Also, maybe it has something to do with the fact that the investment community is still sitting there not knowing just how many more toxic assets are sitting on the banks' and investment houses' balances sheets, how much more collapsing of asset values are in store, and just how much more unwinding is yet to come of the vast amount of leverage (trillions upon trillions) that was built, layer upon layer of 1st, 2nd and 3ed order derivatives, like a huge ponzi scheme, over the past 20 years of American profligacy.
Look out below!

Anonymous said...

If the earnings on the S&P 500 are $50.00, times a PE of 12, then the Index will be at 600. If the earnings are $30.00, times a PE of 8, the Index will be 240. Today, it is at 682.55.