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