Beware the rogue waves! A new study to frighten any mariners...
(Edit - from The Daily Reckoning, Friday, July 23, 2004)
Tom Dyson, from Chiswick, underneath London's principal flight path...
- Here at the Daily Reckoning, as regular readers will attest, we love finding different angles from which to view the markets. "We are," said Bill yesterday, "what is known in the profession, derisively, as 'literary economists.' We believe more in words, ideas, metaphors - and what we see with our own eyes - than in the numbers themselves."
- It's no surprise, therefore, that Mother Nature often plays an important part in this analytical process. Whether it's something as simple as using a phrase such as "the storm clouds are a-gathering over Washington" or "today, the sun shone on investors" to describe the market action...or for more spurious applications, like attempting to use the Fibonacci ratio for predicting stock prices. (The Fibonacci sequence is very common in nature. Shells, flowers, pinecones and even the human body are all constructed in Fibonacci ratios. But in finance, it just seems to help one lose money.)
- Just the other day, our favorite perma-bear, Stephen Roach, titled his weekly offering "The perfect storm." He was, of course, referring to the hat-trick of evil forces he sees bearing down on this year's market. More on this nasty weather system, below...
- And yesterday, the cold wind, which has been blowing down Wall Street of late, let up. Or maybe investors just decided that they had already sold enough stocks. Either way, they turned up their collars and pushed the leading averages higher - just. The Dow added a meager 4 points to 10,050 while the S&P mustered up a three-point gain to close at 1,097. The Nasdaq made the best of the weather, gaining 15 points or 0.8% and closing at 1,889.
- The dollar didn't do much yesterday, but overnight, the heat was back on. As of writing, the euro has now been pushed all the way back to $1.125. Before the mayor of E-Z County opened his pie-hole, it was trying to break $1.25.
- "More SIRT (Recall, Stupid Interest Rate Talk)," explains Chuck Butler, editor of the Daily Pfennig, "...And the dollar gets bought...what are these dolts doing? Don't they realize that higher interest rates are only going to shut down the economy? Don't they realize that higher interest rates are being implemented to combat inflation? Don't they realize that higher interest rates are going to make all the Treasuries that Foreign Central Banks own worth less?"
- Still, an avalanche of selling has really battered gold downhill this week. Not only has it broken decisively below key resistance at $400, dropping $17 in the last five sessions, but it has also fallen relative to euros and pounds. The last time we looked, the barbarous relic was trading for $391 an ounce.
- But using nature as an analogy for goings-on in the business world is actually far more appropriate than many would imagine. Look beyond the flashing neon ticker boards in Times Square and the huge trading floors, where flat screen TVs are used like wall-paper. Look beyond the banks of supercomputers, the Brooks Brothers' suits and the neat haircuts. The markets, and even the economy, are actually natural phenomena and are governed by the same laws that drive nature. The important dynamic they share is, of course, randomness, and the way it impacts a large number of independently functioning variables.
- Of all natural manifestations of randomness, waves have a particularly close relationship with the market. Of particular interest, to marine and market scientists alike, is the "rogue wave."
- Rogue waves are defined as monstrous deviations from the normal sea state. They are huge, sometimes as high as ten-story buildings, says an article by AFP. The QEII came across one of these waves in 1995. It was a wall of water that rose 95 feet high. The captain described it as looking like 'the White Cliffs of Dover.' Supertankers and containerships have been sunk by these waves.
- Although there are reams of anecdotal evidence that attest to the existence of these rogue waves, marine scientists have clung to their statistical models that show that, statistically speaking, these waves should only occur on average, once every thousand years.
- But they were wrong. Not satisfied with the stories, the European Space agency decided to use their satellites for something vaguely useful...for three weeks, they monitored the surface of the world's oceans.
- What they found amazed even the most gin-soaked old sea dog. In just three weeks, they spotted 10 different waves at least 80 feet high.
- The waves exist "in higher numbers than anyone expected," said Wolfgang Rosenthal, senior scientist with the GKSS Research Centre in Geesthacht, Germany, who pored over the data. "The next step is to analyze if they can be forecasted."
- We won't hold our breath, Wolfgang. In fact, you'll probably have about as much success as the average Wall Street analyst. Our recommendation: don't bother trying.
- But somewhere in all of this, there is something useful. There's a strong implication for the stock market and more worrying, for America.
- Just ask John Meriwether and the eggheads at Long-Term Capital Management; in 1998 his fully loaded supertanker was hit by a rogue wave and sunk. They knew that waves existed, but they thought that the probabilities of one occurring were so small that they didn't bother building any leeway in their calculations.
- And what about that perfect storm we mentioned earlier? "A nascent recovery in the world economy is now threatened by an ominous confluence of wild cards," says Roach. "Three such forces loom most prominently - surging oil prices, the China slowdown, and the onset of a Fed tightening cycle. A general sense of geopolitical angst is an obvious and important overlay to the economic factors - underscored by the quagmire in Iraq, a related anti-American backlash, and the ongoing threats of global terrorism."
- Ripples, dear reader? Maybe. But the ingredients for a rogue wave or three are certainly present. Translating our rogue wave theory into the language of chief-economists, Roach says, "The risk is that we focus on each of these developments in isolation. It's the interplay, however, that matters most of all."
- The message must be this: don't blindly assume that the gentle waters on which the U.S.A. floats, will always be so gentle. There are many rogue waves out there, far more than you might have imagined. Balance your portfolio accordingly...
from The Daily Reckoning, Friday, July 23, 2004 |
