Could Market Complexity Trigger The Next Crash?

Tyler Durden's picture

Complex systems are all around us.

By one definition, a complex system is any system that features a large number of interacting components (agents, processes, etc.) whose aggregate activity is nonlinear (not derivable from the summations of the activity of individual components) and typically exhibits hierarchical self-organization under selective pressures.

In today’s infographic from Meraglim we use accumulating snow and an impending avalanche as an example of a complex system – but really, such systems can be found everywhere. Weather is another complex system, and ebb and flow of populations is another example.

Courtesy of: Visual Capitalist

 

MARKETS ARE COMPLEX SYSTEMS

Just like in the avalanche example, where various factors at the top of a mountain (accumulating volumes of snow, weather, temperature, geology, gravity, etc.) make up a complex system that is difficult to predict, Visual Capitalists' Jeff Desjardins notes that markets are similarly complex.

In fact, markets meet all the properties of complex systems, as outlined by scientists:

1. Diverse
System actors have different points of view. (i.e. bullish, bearish, long, short, leveraged, non-leveraged, etc.)

2. Connected
Capital markets are over-connected, and information spreads fast. (i.e. chat rooms, phone calls, emails, Thomson Reuters, Dow Jones, Bloomberg, trading systems, order entry systems, etc.)

3. Interaction
Trillions of dollars of securities are exchanged in transactions every day (i.e. stocks, bonds, currencies, derivatives, etc.)

4. Adaptive Behavior
Actors change their behavior based on the signals they are getting (i.e. making or losing money, etc.)

And like the avalanche example, where a single snowflake can trigger a much bigger event, there are increasing signs that the complexity behind the stock market has also reached a critical state.

MARKETS IN A CRITICAL STATE

Here are just some examples that show how the market has entered into an increasingly critical state:

Record-Low Volatility
The VIX, an index that aims to measure the volatility of the market, hit all-time lows this summer.

Bull Market Length
Meanwhile, the current bull market (2009-present) is the second-longest bull market in modern history at 3,109 days. The only bull market that was longer went from the 1987 crash to the Dot-com bust.

Valuations at Highs
Stock valuations, based on Robert Schiller’s CAPE ratio (which looks at cyclically-adjusted price-to-earnings), are approaching all-time highs as well. Right now, it sits 83.3% higher than the historical mean of 16.8. It was only higher in 1929 and 2000, right before big crashes occurred.

Market Goes Up
Investor overconfidence leads investors to believe the market only goes up, and never goes down. Indeed, in this bull market, markets have gone up 67 of the months (an average gain of 3.3%), and have gone down only 34 months (average drop of -2.6%).

Here are some additional signs of systemic risk that make complex markets less stable:

  • A densely connected network of bank obligations and liabilities
  • Over $70 trillion in debt added since Financial Crisis
  • Over $1 quadrillion in notional value of derivatives
  • Non-bank shadow finance through hedge funds and securitization make risk impossible to measure
  • Increased leverage of banks in some markets
  • Greater concentration of financial assets in fewer companies

In other words, there are legitimate reasons to be concerned about “snow” accumulation – and any such “snowflake” could trigger the avalanche.

In complex dynamic systems that reach the critical state, the most catastrophic event that can occur is an exponential function of scale. This means that if you double the system, you do not double the risk; you increase it by a factor of five or 10

– Jim Rickards, author of Road to Ruin

THE NEXT SNOWFLAKE

What could trigger the next avalanche? It could be anything, including the failure of a major bank, a natural disaster, war, a cyber-financial attack, or any other significant event.

Such “snowflakes” come around every few years:

1987: Black Monday
The Dow fell 508 points (-22.6%) in one day.

1994-95: The Mexican peso crisis
Systemic collapse narrowly avoided when the U.S. government bailed out Mexico using the controversial $20 billion “Exchange Stabilization Fund”.

1997: Asian financial crisis
East Asian currencies fell in value by as much as -38%, and international stocks by as much as -60%.

1998: Long Term Capital Management 
Hedge fund LTCM was in extreme distress, and within hours of shutting down every market in the world.

2000: The Dotcom crash
Nasdaq fell -78% in 30 months after early Dotcom companies crashed and burned.

2008: Lehman Brothers bankruptcy
Morgan Stanley, Goldman Sachs, Bank of America, and J.P. Morgan were days away from same fate until government stepped in.

SHELTER FROM THE AVALANCHE

The Fed and mainstream economists use equilibrium theory, regressions, and correlations to quantify the markets. And while they pay lip-service to black swans, they don’t have a good way of forecasting them or predicting them.

Markets are complex – and only complexity theory and predictive analytics can help to shed light on their next move.

Alternatively, investors can seek shelter from the storm by investing in assets that cannot be digitally frozen (bank accounts, brokerage accounts, etc.) or have their value inflated away (cash, fixed-income). Such assets include land, precious metals, fine art, and private equity.

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The Count's picture

simplified version: a mound of bull shite

YUNOSELL's picture

Although the Central Bankers are doing a good job lately in making the markets a lot less complex -- soon there will just be a handful of players that make up the market

dead hobo's picture

James Bullard will appear on CNBC and tell the world about the new possibility of thinking about more QE and lowering of rates again. He will save the markets. Yellen will agree by remaining silent or hinting everything is flexible over time. The S&P will hit new highs shortly after this. Fed doves may make more speeches to assist. 

MillionDollarButter's picture

Complexity has coupled everything together in such a way, nothing can change without having drastic unforeseen side-effects.  There is no clean separation between anything anymore.  The markets are more fragile than a gender studies major on election night.  And who understands the interconnections?  Why the algos, of course.  Meanwhile, the PPT takes us higher and higher up the high-dive ladder, because moving down the ladder, or the natural next step in the business cycle is now unthinkable.  Disaster is baked in.

skbull44's picture

And as archaeologist Joseph Tainter has argued in The Collapse of Complex Societies, increasing complexity requires greater and greater energy (e.g. resources, money, credit, etc.) all the while experiencing diminishing returns until the entire edifice collapses...

 

https://olduvai.ca

GUS100CORRINA's picture

Could Market Complexity Trigger The Next Crash?

My response: HELL YES!!!!!!!!!!!!!!!!! We are looking down into the ABYSS unless our leaders and bankers stop the tomfoolery.

What a tattered WEB we WEAVE.

peddling-fiction's picture

market complexity = excuse for zionist bankers and the gnomes in Zurich (Basel).

Come on ZH, you can do much better than this.

skbull44's picture

Great topic to follow up with: https://en.m.wikipedia.org/wiki/Abelian_sandpile_model

And, I would argue complex systems are NOT predictable. Not with all the various feedback loops and emergent phenomena.

thisisallnonsense's picture

Japan is the perfect case study

MFL5591's picture

If Market Complexity equals TRIBAL criminality then the answer is yes!

Fake Trump's picture

Japan will become irrelevant when Kim strikes them.

Buck Johnson's picture

Exactly, exactly.  Everyone knows the next one is going to hurt and hurt badly but they are trying everything they can to whistle through the graveyard.  When this time it implodes there won't be anything to save the US market.  They used up all the bullets.

 

Cash2Riches's picture

The markets are growing increasingly unstable by the day. The fact that they are nearly completely run by algorithms makes them not safer, but even more dangerous. There is a reason why gold is sounding the alarm right now.

grasha87's picture

I have created a free market currency that helps alleviate unemployment and recessions that the Fed creates, and it's based on Say's law: https://bunky1787.wordpress.com/2017/09/06/the-wallark-neo-scrip/

grasha87's picture

I have created a free market currency that helps alleviate unemployment and recessions that the Fed creates, and it's based on Say's law: https://bunky1787.wordpress.com/2017/09/06/the-wallark-neo-scrip/

HRClinton's picture

Looks like James Rickards and his Complexity Theory finally got to the Visual Capitalists. 

Whereas Rickards' audience can grasp his descriptions verbally, the VC audience needs pictograms.

Yo, bro, I gets it now! 

So Close's picture

Did Shaggy smoke pot?

DontFollowMyAdviceImaDummy's picture

of course he did and those Scooby Snacks were drugs too

me123me's picture

There will be no crash in the foreseeable future. Crashes dont happen when everyone is waiting for it. 

Racer's picture

Now ZH is putting out another article for a crash, cue market to hit new highs for days/weeks

OverTheHedge's picture

I just searched zh for " markets crash". Only 12,400 returns. Quite restrained, when you think about it.

Http://www.zerohedge.com/search/apachesolr_search/markets%20crash

 

buzzsaw99's picture

does janet have ample liquidity in her diaper?

Fake Trump's picture

Only when she is having an orgasm.

Michigander's picture

Written by Jim Rickards...

Cardinal Fang's picture

"All models are wrong, but some are useful."

https://en.wikipedia.org/wiki/George_E._P._Box

Complexity is not the issue. Criminal conspiracy is.

In all this nonsense about complexity, they do not discuss 'optimization'...

https://en.wikipedia.org/wiki/Heuristic_(computer_science)

I could go on and on, but I have some complexity to manage...

https://en.wikipedia.org/wiki/Complexity_management

buzzsaw99's picture

all of the above cited events were buying opportunities not things to fear.

Ink Pusher's picture

 

"Could Market Complexity Trigger The Next Crash?"

I am of the opinion that "market simplicity" will lead to the inevitable demise.

The simplistic reality that an unsecured debt can be securitized as an asset based upon or backed by alleged future receivables, will without any doubt destroy the entire system under the weight of its own eventually fully realized and now compounded debt.

 

grasha87's picture

I have created a free market currency that helps alleviate unemployment and recessions that the Fed creates, and it's based on Say's law: https://bunky1787.wordpress.com/2017/09/06/the-wallark-neo-scrip/

spanish inquisition's picture

Don't worry. Any potential market crash will be off set by infinite PPT leverage.

Solio's picture

What is complex about "the masses must pay infinitely." ?

riskon.then.riskoff's picture

Complexity of market is true, but don't forget the massive liquidity injection we have experienced, this is new era,we cannot think like in the past

DontFollowMyAdviceImaDummy's picture

my 500 shares of SPXS sure could use one of those complex cascading crashes right about now

grasha87's picture

I have created a free market currency that helps alleviate unemployment and recessions that the Fed creates, and it's based on Say's law: https://bunky1787.wordpress.com/2017/09/06/the-wallark-neo-scrip/

Hkan's picture

Complexity smokescreens is killing us. 

Fake Trump's picture

2017. Bitcoin crash.

IDESofMARCH's picture

All market crashes will be bought by the FED. When it's a bad day and the news, missles, earnings paint the candlesticks red the FED JUMPs ! /\ in and buys the market up.  Look at size of last minutes Candlestick and the amount of green paint.  The fed does not buy red paint. The FED only buys green paint from HD. FED has a million more gallons of green paint on order from HD.

Radical Marijuana's picture

Another euphemistic presentation of the problem being "complexity."

As a couple of previous comments already indicated what is complex?

The existing political economy is based on the powers of public governments enforcing frauds by private banks. Moreover, about exponentially advancing technologies have enabled that to become about exponentially more fraudulent. Since being able to back up legalized lies with legalized violence never stops those lies from still being fundamentally false, what is getting hyper-complex are those abilities to continue to grow an exponentially increasing fraudulence.

The language generally used to discuss "economics" is based on taking for granted the banksters' bullshit, which was derived from the history of the biggest bullies' bullshit making and maintaining Neolithic Civilization for thousands of years, to have become the currently Globalized Neolithic Civilization. "Money" made out of nothing as debts has been used to "pay" for strip-mining the natural resources of the planet. The underlying causes of the collapses will be running into diminishing returns due to the limits of the exponential growth of the strip-mining of the planet.

That is NOT going to merely be another little reset due to a pyramid scheme over-extending itself. Rather, the globalization of the electronic "money" made out of of nothing as debts does NOT have any practically viable frontier to move on to in real time. Although there are theoretically the resources of the Solar System to move into strip-mining, Spaceship Earth is being trashed too fast to actually allow such developments, due to everything having already been done through fundamentally fraudulent financial accounting systems, too much, for too long ...

To better understand the "complexity,"  one should include consideration of the murder systems that backed up the money systems. The final "snowflake," or straw that breaks the camels back, shall NOT merely trigger some monetary system corrections, but rather, the runaway debt insanities will trigger death insanities. Economic "complexity"  was driven by the ruling classes becoming increasingly psychotic psychopaths, while those they ruled over mostly became increasingly incompetent political idiots. The emerging "complex"  systems are WAY MORE COMPLEX  than the article above indicates, because of the degree to which such an article deliberately does NOT include the evolution of the human ecologies through the history of warfare, as the actual basis for globalized political economy based on public governments enforcing frauds by private banks, in ways which are becoming exponentially more fraudulent.

Electronic "money" made out of nothing as debts was enabled to continue to grow exponentially by the threat of force from weapons of mass destruction which simultaneously became trillions of times more powerful than anything which previously existed in human history. Thus, the "complexity" of MAD Money As Debt, backed by MAD Mutual Assured Destruction, is far more precarious than the article above indicates. Rather, that article was another example of the superficial use of analogies between human and natural energy systems, which does NOT go through sufficient series of intellectual scientific revolutions and profound paradigm shifts, such as those already achieved in some areas of applied mathematical physics.

Globalized electronic monkey money frauds, backed by the threat of force from apes with atomic weapons, are WAY TOO "COMPLEX"  for anyone to fully understand anymore, especially because almost everyone attempting to do so still tries to shoehorn their thoughts into the world views of the biggest bullies, who became the banksters. The REAL political economy is based on EXPONENTIALLY INCREASING ENFORCED FRAUDS, which can not be adequately comprehended by anyone who does not appreciate the degree to which MONEY IS MEASUREMENT BACKED BY MURDER. Therefore, the excessive complexity of the money systems is surpassed by the excessive complexity of the murder systems, both of which developed in ways which have maximized maliciousness!

south40_dreams's picture

I thought it was started by a butterfly in the amazon rainforest?

Let it Go's picture

The current economy is becoming more of a conundrum every day. The global economy is like a Rube Goldberg machine, these machines are contraptions built in a ridiculously complicated way to perform what would normally be a simple task. Unfortunately, nothing is simple when it comes to economics.

It is best not to have a great deal of faith in our economic system because it is severely flawed. Central banks can stack the deck but when it gets too high and begins to fall they may not be able to control the direction or who it will crush. More on this subject in the article below.

http://brucewilds.blogspot.com/2017/03/understanding-economics-as-rube.html