OK: Another tranquil week to describe. The Chinese authorities have had another pop at one of their big industries, this time, gambling companies in Macau. That caused their share prices to plummet and further dented sentiment about the wider Chinese market. In contrast, Japanese shares, perhaps benefiting from flattery by comparison, had another good week. Other than that; all quiet on the markets front.
But, much as I say not much happened, for all we know, maybe it did. Markets have a lot in common with other complex phenomena, such as earthquakes or forest fires. Much as we think they should be predictable, they constantly confound humanity’s best attempts to forecast them.
This is because earthquakes and forest fires happen far more frequently than we assume. In the case of earthquakes, they’re happening all the time. But almost all tremors are so tiny we don’t feel them, so we don’t obsess about trying to predict them.
However, although the overwhelming majority amount to nothing, any one of these tremors could trigger others, which then trigger even more, and so on until we have a major quake (almost like the first tremor has “gone viral”). As Mark Buchanan put it in his excellent book – ‘Ubiquity’; “when it starts, an earthquake doesn’t know how big it will get.” This is why they’re impossible to predict.
And so it is with market sell-offs, which share the same mathematical signature as earthquakes and forest fires, and even wars. That’s something called a ‘power law’, which roughly means that there are exponentially fewer big wars/earthquakes/market crashes than there are medium ones and exponentially fewer medium ones than there are tiddlers.
Put another way, we see market sell-offs hundreds of times every day, we just don’t care because they’re tiny. But, like earthquakes, when a sell-off starts it doesn’t know how big it will get. So China causing investors to sell Casino shares might mean they have to sell other shares too, which causes even more investors to pull out, which then ripples out to a global crash. Or it might spark a rally in Japanese shares. Or it could just peter out to nothing. We won’t know until we know.
Taken the wrong way, this could be scary: We like to think our world is predictable, even if, deep down, we know it isn’t. But markets have always been this way. That’s why we use tried and trusted safety measures like diversification. Concentrating our money in just one company, market, or asset class makes us more vulnerable to unforeseen events. But using a selection of diversified funds and asset classes as we do (you hold, for example, a modest amount of Chinese and Japanese shares), we’re confident we can survive the small, medium or large tremors, and bounce back stronger afterwards too.
For now though, all is quiet. So you can forget markets – and earthquakes – and enjoy your weekend.
Simon Evan-Cook
(On Behalf of Raymond James Barbican)
With investing, your capital is at risk. The value of investments and the income from them can go down as well as up and you may not recover the amount of your initial investment. Certain investments carry a higher degree of risk than others and are, therefore, unsuitable for some investors.