Self Organized Criticality as a Determinant of Systemic failure

During initial conversations with central banking Risk experts in 2024-25, an initial ontological difference emerged regarding the predictability of Economic ending Phase transition events. Crashes. The prevailing institutional view posits that exogenous shocks, such as the COVID-19 pandemic, are inherently unpredictable and thus outside the scope of modeling. However, this perspective overlooks a fundamental principle of complex systems: Systemic State (Status) precedes Systemic Output. (I'm hopeful there is now, an openness to this new ontology, and progress will be made.)

The Theory of Criticality and Fragility The impact of a stochastic exogenous event is governed by the internal configuration of the system at the time of impact. When a complex system—such as a global financial market—self-organizes into a state of "Criticality," it develops an acute susceptibility to minor perturbations. This fragility is not instantaneous; it is an emergent property that evolves over time through internal feedback loops and structural imbalances. While "random events" are constant in any dynamic environment, they only catalyze a "Phase Transition" (crash) when the system has already reached a threshold of instability.

Case Application: Empirical evidence suggests that the global economic system reached a state of criticality long before the viral outbreak of late 2019. This empirical evidence was observable through the lens of AlphaAdder years before.

This long lead time is necessary and invaluable for large institutions.  Allowing time to prepare for, hedge, and even take advantage of Economic cycle ending Phase Transitions.

 

Hong Kong Hang Seng is Further along, and Will Crash Several Months sooner than US market.

HONG KONG:  Any bounces in the Hang Seng within the next several months will be an opportunity to reallocate/diversify away. 

US markets will last several months longer than the Hang Seng.

Japan will go down the same time as Hong Kong, And then again with the USA.

EU will go down approximately same time as US.

If you are close to being a Startup, you might wait for an all clear here.  Cycle ends can kill even the best ideas, best plans, best people and potentially great businesses. 

If you are a Global Asset Allocator - Stop being a dumbass and retain AA.  Importantly, before, within and after the chaos, there were be opportunities to spring ahead of your competition.

In 2008 AND 2020 were you laying off good people.

Were you sending Capital equipment to auctions. Then paying premiums after the turn to retool up.

Were you one of the sheeple on the conference call;  "Well, all of our Peers had the same issue, and didn't do better."

Let me help you prepare, then pounce.  Thrive, and Turn Quicker-Once the All Clear Signal is given by RAA directly to you as a client.

Generally Accepted Economics is Dead.  The revolution is here.  It is Non Gaussian. It is Non Parametric.  It is Non Linear. It is Non Equilibrium. 

It is Reality Based, and Built.  It is documented.  It is successful over multiple cycles.

Market Criticality Alert

Even as the market continues to rally strongly, the underlying system has reached a state of self-organized criticality. While the current momentum remains intact, we are approaching a definitive window where the system’s resilience evaporates.

We will eventually enter a phase where a single exogenous shock—no matter how small—could trigger a total phase transition (market crash), effectively ending this economic cycle.

This specific window of volatility has been identified by the AlphaAdder model and triple-confirmed via non-parametric signal analysis across three independent time series. It is no longer a question of if, but when—and that "when" has now been clearly identified.

9/2019 Actually Did start as AA predicted. FED stepped in with 7-10 Trillion, and burned it in the wind. It merely moved it into 1st Qtr 2020.

 https://alphaadder.blogspot.com/2019/01/2019-view-from-30000-feet-above-china.html

Blast from the past, because its signifigant.

2020 Crash Actually Did start as AA predicted. I even emailed the White House to bring it to their attention Fall 19, no response.  FED stepped with 7-10 Trillion, and burned it in the wind.  It merely moved it into 1st Qtr 2020.

Here is what I wrote back then:Thursday, January 03, 2019

"2019 View from 30,000 feet above. CHINA CHINA CHINA

HIGHLY CONFIDENTIAL NOT TO BE SHARED EXCEPT BY PERMISSION OF AUTHOR

2019 View from 30,000 feet by ALPHAADDER. January 1st, 2019

CHINA  CHINA   CHINA AS IN FXI

The endogenous dynamic driving the markets currently as verified by current and previous Volatility Cluster originates from CHINA.

INFLECTION POINT:  2/13/19

INFLECTION POINT: 5/1/19

SUSCEPTIBLE TO EXOGENOUS EVENT:  9/2/19"

NOW LETS LOOK AT USA S&P 500 IN ISOLATION BELOW

THE USA AND CHINA ARE IN LOCKSTEP.  THE DATES ARE NEARLY THE SAME."

Visible on the Horizon, and over the Horizon. Criticality, Inflection point and Phase Transition.

 SystemicRiskConsulting LLC's AlphaAdder can see what is developing On the Horizon, and over the Horizon due to Self Organizing Criticality.

On the Horizon AA has identified a rough patch in 2nd Qtr 2026.

High Volatility expected, but we will not lose auto regressivity, even if "ugly", and will recover.

Over the Horizon, AlphaAdder has identified the "Criticality" time period within the Cap weighted S&P 500, Nasdaq and Tech Sector.  (S&P due to its stealth concentration in tech because of Cap weighting, as opposed to the equal weighted option, which has been, and will continue to outperform)

The time period; "Criticality", where the system has self organized to the point of "Criticality", and will be susceptible to the random exogenous event, causing cascading avalanches of volatility- aka "Crash"

AlphaAdder Banking System Risk Index Update and new AlphaAdder REGIONAL Banking System Risk Update

AlphaAdder Banking System Risk Index is up and running, building it's library. It has already caught notable activity not seen elsewhere.  Of note, unlike the Cleveland FRB SRI, AA is NOT using the KBE.

Additionally proud to announce that at the same time started the AlphaAdder REGIONAL Banking System Risk Index to observe results, and the verdict is in, and its good.  It is up and running, also building its library.

 https://www.linkedin.com/feed/update/urn:li:activity:7333812220969074688/

AlphaAdder US Banking System Risk Index and US Banking System Status Tool Forthcoming.

 "Have been looking at the details of the Systemic Risk Index produced by the Federal Reserve Bank of Cleveland. https://lnkd.in/gKwm8zTA

It is a coincident indicator. It could be much more.
It reflects all currently known information about the ETF KBE, with applied classical and generally accepted methods.
Of course, from a Complexity/Self-Organizing Practitioner's perspective, this has important implications for what it does not and cannot do.
It cannot and does not Identify Self-Organizing towards Criticality, Criticality, or Phase, all of which would be useful to truly identify Banking Systemic Risk. This would allow us to determine when the banking system is truly susceptible to a random unforeseen event, causing a crash, or know that a random unforeseen event won't cause a crash. (AA calls that “System Status”- Is it Susceptible or Not Susceptible to the Random Unforeseen event)
Further, one might do the above on the individual banks in the KBE index to identify company-specific risk.
Systemic Risk Consulting's AlphaAdder has been doing this successfully on the S&P 500 since 2005."

CONVERTING TO LANDING PAGE FOR SRC LLC. Last Time Complexity In Markets Identified Here. AA is under SRC LLC. AA worked well with BTC & 10yr.

 

AlphaAdder has identified Complexity in Current Market. This is last time it will be stated publicly.

Meaningful Self Organizing Confirmation not yet finalized. My suspicion after doing this for almost thirty years, is perhaps, might get it by year end roughly. If so, Event Horizon Narrows, and Future Inflection Points come into focus. To be epistemologically humble, that is still speculative at this moment.

A meaningful Confirmation, should it happen, would be paired with future dates of Market Inflection Points/Turns, and Approximate Date of "Criticality", where System has become Susceptible to an unforeseen exogenous event, causing a Six Sigma or Greater Avalanche of Volatility, aka Crash. Again, Not There Yet, just explaining the potential paths, yet to be determined.

Publicly announcing here that AlphaAdder also worked very well with the 10 Year Treasury exhibiting Complexity and Self Organization prior to 2020 crash and Interest Rate Directional change. Absolutely stunning results with BTC as well, once the necessary data became available with both new BTC Futures and new BTC Options Contracts.

AlphaAdder is under the Umbrella of Systemic Risk Consulting LLC.

If You are a Country, A Central Bank, or a Global Asset Allocator I can be Reached initially at BobK  At SystemicRiskConsulting Dot Com.

Markets don't crash when EVERYONE thinks they will. Neither Bounces, Drops Nor Crashes last forever.

 MARKETS DON'T CRASH WHEN EVERYONE THINKS THEY WILL.

That is what just happened, and why I took some time off.  EVERYONE I spoke to was SURE the market was going to crash.  If that is the case it probably won't. The biggest up moves are within Bear Market rebounds, and we just had one. Key words there are Bear Market.  Yogi has yet to hear the "Fat Lady" sing.

How does that affect AlphaAdder?  Naturally, as in Nature, It has pushed the Crash Out.  It is still out there, it has just moved to the right on the time axis.

Next Pre Crash Peak in volatility is around the end of this month, approximately 8/30/2022.

The Six Sigma event is still on the horizon. I have the approximate date, and other perspectives that will surprise you. 

The Timing of the Six Sigma Volatility Event, and all of my writings going forward are a Service built for Global Asset Allocators. There will be no more entries here.  A Service Not just for Financial Asset Managers, but for the C-suite of Global Entities that understand the immense Power of being able to identify when a large complex dynamic system the company is involved with has reached the point of "Criticality", and headed towards a "Phase Transition" aka Crash, that no other system has shown its efficacy through MULTIPLE economic cycles as Systemic Risk Consulting's AlphaAdder has.

This Service will give you a Competitive advantage over your Peers. Period.  The confidence to step up to the plate, when all others shy away.  The backbone, to pull in your horns, when all your peers have on their rose colored glasses, and are leveraged up. Directly affecting your critical measured performance metrics, as a company, and as an Executive Manager.

Avoid  unseen beneath the surface catastrophic risks with Systemic Risk Consulting's AlphaAdder that has a unique, historic three decade Track Record of doing just that. Unique and Unprecedented Results that are timely, useful and actionable. If you are a Global Asset Allocator, or a C-suite Executive and are Interested Please email me. 

BobK@SystemicRiskConsulting.com

A REVERSE AlphaAdder Perspective on Current Volatility Cluster, its ending and correlation with AA ending. A different tool for decay versus order.

 This is NOT an AlphaAdder Post.  AlphaAdder deals with Self Organizing towards Six sigma events.

This speaks to REVERSE AlphaAdder which deals with Volatility Clusters; their probable decay length, aftershocks, echoes and the diabolical percolating risk that hides unseen during rebounds in this phase. One of Several Pioneering Risk Management tools developed during the Seventeen year Applied Experiment.

Autoregressive behavior like the Efficient Market Hypothesis, works, UNTIL IT DOESN'T, CATOSTROPHICALLY.  Many clever ride that train into the ground, amassing millions, then poof. Every Cycle. Every Cycle. Watched it for thirty years. AlphaAdder helps one disembark the train before it runs off the rails, over the cliff, or into another train.

It speaks to the length of the current cluster, that an unforeseen event can have multiplicative explosive affects.  This despite watching Volatility decompress and markets rebound.  It is much more fragile than you can see on the surface.  This Vol cluster unseen percolating beneath the surface risk lasts until 8/11.  

Should an unforeseen event happen Volatility will explode.  This could morph into the Six Sigma event, or it decompresses, and Six Sigma event is recalculated by AlphaAdder. I, of course would update here.

Don't be walking in front of this steam roller picking up Nickels, you might slip. Risk Reward ratio is immensely upside down.

As it stands right now Inflection Points within the Current Decaying Vol Cluster are:

5/31 which is beginning of Next Week. This weeklong deadcat bounce is ending essentially now.

Next IP  shortly after that 6/16 I expect another brief Deadcat bounce.

Volatility Should Continue Decompressing down into 7/8-12

And be free to explode after that in Mid July- Mid August.  Which Dovetails nicely with the previously mentioned AlphaAdder perspective, which gives me further confidence in my Six Sigma event forecast.

Remember I said to reallocate on a bounce? Your chance to rebalance is coming up again.

 I can't leave y'all swinging in the wind, lol.

Volatility Probably peaking here. Roughly. Approximately, over the next several days 5/18ish. Then, Expect a "dead cat" bounce. Risk On assets back on, and Risk Off assets soften again. Bond Principle values at risk again, till next Vol Cluster in two months. 

So If you got caught in this downswing, you will have an opportunity potentially to recover, as I see volatility receding through July.  Whew.  It will draw in the lemmings for the final hammer drop.

Each time AlphaAdder is correct, increases the confidence level on the probability and timing of Six Sigma or greater Volatility events on the Horizon now.

Don't be leveraged IN ANYTHING.  Debt as a percentage of Capitalization is also an important metric now for survivability judgements across all entities.

Review relationships for high debts and leverage.  When "it hits the fan", entities with high debts and leverage fail in avalanches with cascading affects to their partners.

Aside from the short term bounce probable, keep in mind the bigger systemic picture.  The system has self organized to "Criticality" and is susceptible to Six Sigma or greater volatility events, caused by an "unforeseen" event.  This future event will affect markets, it will affect logistics, it will affect everything.

It is the Adaptable that survive.  The flexible, the Non-"Optimized".  As it is in nature, because this is natural.

Important FINAL COMM HERE AS A COURTESY: This Side of the Horizon NOW

 Various Markets Globally are Self Organizing towards Criticality, and will shortly be susceptible to Six Sigma and Greater volatility events aka Crashes. Like many metronomes started separately and randomly, over time, they are coming closer to synchronization. 

I will repeat here what had previously been sent out in direct encrypted comms the past few weeks and months as I watched it develop, and warned that this cycle would be far shorter than the last two.

China's fall peaks Mid May, then US Nasdaq and S&P500 in following months.  Crash(s) It is now on THIS SIDE OF THE HORIZON. That's 50% of Global GDP.

Crypto's still highly correlated to Nasdaq, so any diversification affect is questionable.

Treasuries had a phase transition and have been on an increasing interest rate slope since.  There will be a flight to safety during the crash. Into Dollars and Treasuries. Temporarily.

Gold also had a phase transition and has been on a positive slope since.

The place to be is NOT in Stocks. Any bounces, I would reallocate to a "Protect what ya got" Capital preservation mode.  Rough seas ahead, and few places to hide this time.

After the crash Deep value with Dividends is prudent. Traditional Deep Value, Graham and Dodd and G.A.R.P methodologies usually do well. Commodities and "Things" will do continue to do well this cycle. Increasing interest rates are good for banks.  Industrials, Energy and Commodities might be the winners in this next cycle as well.

Expect crazy volatility in the months ahead.  After the crash there will be a temporary bounce, but then a retest of lows.  Reverse Alpha Adder will be informative on that retest, and the length of the tail.

Lastly, last phase of this twenty four, possible to even look at it as a thirty eight year project is done.  Important parts of AlphaAdder have been codified into software, custom Computers and Live Feeds are integrated and up and running. Not all is in the software though, so even if I'm completely hacked, its Not All There. I always assume I'm hacked.  The unique library grows daily.

Please prepare.  Don't make your "Water dam" to heights equal to previous water line high's. There will always be "New Highs".  Dry and Canned Goods as well.  Hard Cash. Precious Metals on hand. Be prepared for more "High Water Marks" never seen before as the Dutch learned, and do.

Welcome to a Glimpse of Systemic Risk Consulting's AlphaAdder's Fifteen Year Applied Complexity Experiment.

Dear Sir or Madam; 

Thank you very much for your interest.

I have temporarily put SystemicRiskConsulting.com to Public so you can view the relevant  posts related to the original Hypothesis. There are many more, but these are visible to help you hone in on the Important Points. 

The original Hypothesis proven: It was Indeed possible to Identify when the S&P 500 had self organized to the point of criticality and was susceptible to an unforeseen exogenous event causing a Crash. This was done in two different Economic Cycles, in vastly different circumstances, fourteen years apart. 

To Wit:

1.  Dated and Time Stamped Evidence of Statements of System Criticality Prior to Six Sigma plus Phase Transitions of 2008 and 2020. I wrote these entries for myself, to ensure I wasn't fooling myself. To be Epistemologically humble and transparent over two Economic cycles to observe the efficacy of the hypothesis in a real world application. 

.2. The Original Entry Monday August 22, 2005 is the Original Entry for Context.  It contains bits and pieces of Proprietary paper:  "Stock Market Endogenous Dynamic, 'Noise', and Crash Precursors", written 1998-2005. Inspired by Per Bak, and watching my Quotron melt in 1998 due to LTCM, and noticing similarities with my 1984 work at LANL.

Over the past fifteen years developed a "Very Pioneering" Complete Systemic Risk Management Suite for the S&P 500. "Reverse AlphaAdder". "IP"'s, "S^3", "P^3", "AlphaOmega", "Phase" and other useful non intuitive artifacts that are Distinct Competitive advantages tactically and strategically.

Ended Applied Experiment Successfully with the Correct Call prior to 8-Sigma moves in 2020. 

At the Urging of others I began to apply AA to a Global Pallet of assets where sufficient data was available, (One at a time) and it became evident that it's applicability was far greater than I had comprehended, as I was focused on the S&P500 because of its depth, breadth, and Importance. With the new massive implications of what can be done, I  Stopped Publication, and went back to school for Computers to build Infrastructure necessary to execute on a Global Scale. After School, and Six months in the Field, I, purchased the Global Data Streams, and I am currently designing the System to execute this vision incrementally towards a final goal. The End Result will be as, if not more significant than my work thus far. 

Thank you for your time and Consideration.

Bob Klapetzky 

March 4th 2020 Stating Criticality Call BEFORE 8+ Sigma Event

2019 View from 30,000 feet above. CHINA CHINA CHINA

HIGHLY CONFIDENTIAL NOT TO BE SHARED EXCEPT BY PERMISSION OF AUTHOR

2019 View from 30,000 feet by ALPHAADDER. January 1st, 2019

CHINA  CHINA   CHINA AS IN FXI

The endogenous dynamic driving the markets currently as verified by current and previous Volatility Cluster originates from CHINA.


INFLECTION POINT:  2/13/19

INFLECTION POINT: 5/1/19

SUSCEPTIBLE TO EXOGENOUS EVENT:  9/2/19


NOW LETS LOOK AT USA S&P 500 IN ISOLATION BELOW

THE USA AND CHINA ARE IN LOCKSTEP.  THE DATES ARE NEARLY THE SAME.

Current Phase and Context S&P 500 from 30,000 feet above. Continuing the Wall of Worry, until,,,,,

Textbook Wall of Worry.  You've already forgotten being worried during those dips, haven't you.

As I told you before it started to happen, we are continuing to climb the Wall of Worry.  We dip, you think we are wrong, it turns around and goes back up.  Again, and Again.

As it stands now.  Potential end of cycle contracting Mid 2020. Still.

Activity between now and then either confirms this, or sets up new timing.  Importantly, either way, volatility remains auto-regressive until that time.  Further setting in Anchoring Behavior, and a stronger and stronger feedback loop. Double Edged Sword.

I am reading more and more negative prognostications about impending doom.  This is really healthy, and holds off the Six Sigma Event.  Counterintuitive.

Further;  The signals are NOT as well defined and clear as they were in 2007.  This has direct bearing on the size and distribution of the future event.  Signals in 2007 were terrifyingly clear. Not as much currently- A good thing.

Going forward.  Volatility- Yes.  Expected, and of a an expected degree, that will make you cringe, and question your resolve, but in the end, will be a continued  Climbing of the Wall of Worry with stopping points in the graph above.

If I continue publishing, I will do it without the timing component you have seen here.  It is a distinct competitive edge/advantage that I will no longer keep in any computer.  I am applying solely within my proprietary trading going forward.  If I continue to publish here, I will clarify Phase, and Context.
Current Phase/Context:  Self Organizing towards Criticality, and will become Susceptible to an exogenous event causing a large Volatility Event in the intermediate future.  We are nearing the end of this second record long market run.  Enjoy the Runup to the end-DO NOT GET ATTACHED.  DO NOT ANCHOR.  BE AGILE.  PROTECT YOUR BALANCE SHEET.  DO NOT FOOL YOURSELF INTO THINKING YOU KNOW WHAT THE UNFORSEEN EVENT WILL BE, THAT TRIGGERS THE CASCADE.
Cheers!
Bob K

The Hidden Hand of Contextual Temporal Value Systems, and Perceived Priorities

     6/27/2018 Wall of Worry.  Asset Prices Extended by many measures
Doesn't matter at this point, (for a while) Adam Smith's Hidden Hand
is in charge.  Asset Prices are Temporal, Contextual and based on
Perceived Priorities-Review 8/22/05 Entry
     People, AND NOW MACHINES, are being conditioned.  Everybody is riding the predictable churn of autoregressive behavior by the market.  As it always does, it will work, until it doesn't, Catostrophically.  Of course, the other side of the coin is the old admonition to Short Sellers; That the market can stay irrational longer than you can stay solvent.
     The dearth of liquidity is being caused by the increasing integration of A.I. into High Frequency Systems, and its corresponding increasing rapidity of stepping away from the market.  This increases frequency of "Flash Crashes", from which we recover.  My concern is what will happen the next time the System has again Self Organized to the point of Criticality, and is Susceptible to a Six Sigma Volatility event, and the Machine Firepower is potentially overwhelming combined with the normal endogenous phase transition forces.

Return to current Endogenous Dynamic Slope.

I CHALLENGE YOU:  IS THERE ANY OTHER ENTITY OUT THERE WITH THESE RESULTS?  

Effects of China Cluster End Done. Despite Stretched Valuations we return to "Crawling wall of Worry"

China Dipped as predicted. Affected us as predicted. Change around 4/21

Right Again, which gives confirming info about future potential events.

Told you in 2007 what was going to happen in 2008.
Told you 2016 what was going to happen in 2017, and in 17 for 18. Jan for rest of year.
Added China in January 2018, and told you in advance how it would affect the US in Febuary through May.  (Halfway there)

2018 View from 30,000 ft. Both China and USA

China end of Vol Cluster. 2/10 Susceptible to exogenous event.  IF NO EXOGENOUS EVENT, THEN NO PHASE TRANSITION.

Close to our Inflection Point, not an ending point for us necessarily-a ways off.

Buy Vol shortly before 2/10 related to CHINA FXI (with greater than 30 day expiration to remove time decay risk.)

THE INFLECTION POINTS IN CHINA AND THE USA ARE DIFFERENT.  THE INFLECTION POINT IN CHINA IS AN END OF VOLATILITY CLUSTER.

We have an inflection point around 4/21, but it is not an end of cluster point.  It is a point, of a change of direction.  If China starts to pull us down starting around 2/10, we will have a persistency to go down also until around 4/21, at which time there will be a change of direction/persistency to flat, and or up.

If accurate than it gives confirmation of when we will have a Six Sigma Volatility event in the future.  I am keeping that to myself, for now.

UPDATE: Moving up timetable. Inflection point is around 8/21

Stumble into September, dragging Uber Smart Bears along longer

Many "Bears" are among the "Smartest" among us.  Their education, analytical skills and research are top notch. They bring to light things we did not see, fundamentally. In fact, they are correct most of the time regarding the issues that will be our downfall--- eventually, after a while.  Problem is they are a tiny, tiny minority in relation to the "Hidden Hand" of the masses, that are naturally more optimistic.  The Bears will be right eventually, but the opportunity cost is high waiting for the masses to flip. Wasted money on untimely unnecessary hedging.  Missed returns due to not being allocated correctly. It will not be a straight line, could be quite volatile as we continue to climb the "Wall of Worry".

One last time. Thank You to Dr. Robert Engle's Volatility Institute

First, Thank you to Dr. Robert Engle's Volatility Institute at Stern Business School NYU and its supporters, for allowing me this venue, and the ability to interact with my academic friends during meetings I attended there and at the NY Fed.  Wonderful experiences and people.  Keep up the great work.

S and P 500 sideways to up from here, approaching recent highs.

Look what showed up in the Bradbury Museum in Los Alamos. I honor my late father A.J. Klapetzky

If you would, please kindly allow me this one time, to deviate from the market. This is BEAR, as it was leaving Los Alamos National Laboratory on its way to White Sands Missile Range. It is now I understand at the Bradbury Museum back home in Los Alamos.  It was shot into space, tested and recovered.  A "Star Wars" Strategic Defense Initiative project from Los Alamos National Laboratory.  At its core is a  particle beam device that I watched my father tinker with in his Lab at LAMPF, and eventually get to work- to everyone's surprise. He was deservedly proud of this accomplishment, and I of him.  Never thought I'd be able to talk about it. Strange coincidence that I found this out the same day I found out that Voyager 1 is about to leave our Solar System.  Data from Voyager was what I was looking at as an 17 year old intern in the Astrophysics division at LANL at the same time (1984).  A cosmic yin yang it seems.  73-s Dad.

I TOLD YOU SO... i told you so. 12/1/08

Volatility incredibly high. It will end in the near future. There will be a relief ralley of sorts, then we will have a sucker punch come out of left field seemingly. That will be the end of the phase transition; and we will have a new market with new leaders, and the rational optimizers will be in charge for a while.

1/7/08 System "Critical" and susceptible to six sigma event.

As I said volatility was expensive and there would be an explosive move. It happened, a head fake ralley and volatility cheapened. Well the New Year arrived, and volatility has once again increased, and the system is critical.

The market is susceptible to a six sigma crash currently, at any time from some unforseen event. The biggest risk is the unforseen risk, as always. Interesting times globally. Cash is king in my book, even if it is a weak dollar.

SECOND PHASE PEAKING. ITS A HEAD FAKE.

SECOND PHASE PEAKING AS I ORIGINALLY DESCRIBED THE CHAIN EVENTS IN PREVIOUS POSTS.

SHORT TERM REVERSAL COMING UP. ITS A HEAD FAKE. THE LEMMINGS WILL BE DRAWN IN AGAIN FOR THE SIX SIGMA EVENT AHEAD.

IT IS THE FINAL REVERSAL BEFORE THE CRASH. TIME NOT DETERMINABLE, BUT IT IS TIME TO SHIFT THE RISK TO OTHERS. VOLATILITY AT THIS POINT IS EXPENSIVE. THAT WILL CHANGE IN A RAPID VIOLENT MANNER.

Even a unforeseen surprise , will not surprise.

Volatility to continue, within slightly elevated levels. Not a high degree of correlation with participants. "Rational Optimizers" in charge of this market. The real estate market here in Florida is another issue. LOL! It is funny to watch how people chase returns after the fact, and leverage up with an asset that has already run up. Sound familiar? Reasonably valued Cash generating assets, with good balance sheets are king. Find cash flows that you can quantifiably confirm have the fundamentals beneath them to confidently, and consistently generate expected cash returns.

I am not excited about indices, but even at this point we are not in a "phase" that would be susceptible for a large catastrophic avalanche of volatility. No six sigma or greater events on the horizon within the S&P 500.

Short Term Volatility within expected bounds

Yesterday Dow down 140+. This morning futures down big. To be expected with current news. Market will absorb it and behave within expected volatility parameters; system is not critical and will not "crash" at this point.

I repeat, remember the ABC's that I mentioned earlier. A rigorous application of traditional deep value metrics is, and will be the way to go.

Clarification: Nobody will ever be able to say with certainty that a complex dynamic system will have a six sigma or larger event in a specific time period; the best one can do is understand if the system has reached a point of "self organized criticality" and is then susceptible to a large event. The latter in of itself is of great value as you can hedge, and in parallel the system has reached a point of diminishing returns and decisions regarding asset allocation can be made more effective.

The large complex dynamic system we call the Stock Market is not self-organizing at this point. The system is far from critical. Value has done well as I said it would, and it will continue to do so for as far as I can see. There is no danger of a catastrophic >six sigma failure. A large unforeseen event even equivalent to 9-11 would not have the same effect.

As far as the stock market. Traditional valuation metrics with a priority placed on strong balance sheets and strong cash flows, enabling one to buy a future dollar at a discount today are, and will be the way to go. Stay away from momentum/greater fool concepts.

Taking this into account, passive diversified low expense ETF's come to mind also, if they are exposed to above mentioned parameters. I will be more specific shortly.

Stock Market endogenous dynamic.

Empirical observations of the U.S. stock market and of agent based models show catostrophic “avalanches” of volatility that could not be explained by existing financial models. - J.P. Bouchaud

1963,97- B. Mandelbrot
“The variation of certain speculative prices”
“Fractals and Scaling in Finance”
Stock price changes have fat tails deviating from the Gaussian distribution.

1989- R. Shiller
“Market Volatility
Fat tails correspond to avalanches of volatility that could not be explained by fundamental economics.

1994 - P. Bak and M. Paczuski
“Complexity, contingency, and criticality”:
Large dynamical systems tend “to organize themselves into a critical state, with avalanches” of all sizes.
“biology, history, and economics can be viewed as dynamical systems”
“In the critical state, events which would otherwise be uncoupled become correlated”.
“General equilibrium theory” has not been explicitly formulated for biology”, and this is why the avalanches of volatility could not be explained.
a non-equilibrium theory of economics can be constructed and it “will not be beautiful; it trivializes all the nuances and details that make complex systems exciting for humans”

1997 - P. Bak, M. Paczuski and M. Shubik
“Price Variations in a Stock Market with Many Agents”:
“rational optimizer” behavior is driven from economic analysis.
“noise traders” behavior is driven by market dynamics.
When the RELATIVE number of rational traders is small, “bubbles” often occur.
When the number of rational traders is larger, the market price is generally locked within the price range they define.

1999 - P. Bak, S. F. Norrelykke, and M. Shubik
“The Dynamics of Money”:
“in reality, agents usually make decisions locally and sequentially”
“money stores value between transactions”
“money is essentially a dynamical phenomenon, since it is intimately related to the temporal sequence of events.”
“Thus, the value of money is a “strategic variable”, that the agent in principle is free to choose as he pleases.

2005 - Albert-Laszlo Barabasi in
“The origin of bursts and heavy tails in human dynamics”
human nature is bursty
“a consequence of a decision based queuing process”.
“when individuals execute tasks based on some perceived priority, the timing of the tasks will be heavy tailed”

People do not behave in a random manner. 8/22/2005 RGK

People with the emotional self-discipline to consistently and effectively execute a “rational optimizer” strategy are the minority, whereas a noise trader’s barrier to entry is much less. Seeds are planted by “rational optimizers”, but “noise traders”, and their market driven perception of their stored value within the market drive bubbles and crashes.

Stocks are a temporary store of value.

Stock value is a PERCEIVED value; local, temporal and transitional based on market dynamics. PERCEIVED priority is greed/gain or fear/loss.

Greed drives the market up and out of control of the “rational optimizers”, and attracting ever more “noise traders”, self organizing until critical, highly correlated, and highly susceptible to a perceived shift in value and hence a fear driven crash.

A complex dynamic system self- organizing towards criticality. At criticality, events that during “rational optimizers” time in charge would be uncorrelated become highly correlated.

The complex dynamic system self-organizing is not the market.

The market is a derivative of what is self-organizing; noise traders. Greed or fear is their perceived priority; driven by a perceived, temporal, transitional, market dynamic value.

The biggest risk is the unforseen risk. (In finance) The same event in two different time frames can have dramatically different consequences. Literally a six sigma event, or larger, or not.
COPYRIGHT 2005