Last night saw a – 7.32% move in the Nikkei. Big day.
What does a 7% move in the market mean, for Japan this was a six sigma event, in other words the range of the movement was six times greater than its normal daily movement.
Why is this important, because the asset management industry is built around the (flawed) concept that market returns follow a normal distribution for statistical purposes. (They don’t.). The consequence of that is why can say great lines like the S&P 500, has returned 8% with a 16% standard deviation – that means that 95% of the calender return lies within two standard deviations.
If the markets followed a normal distribution, last nights movement in the Nikkei, should occur once every 2,500,000 days, or once every 6,849 years. Why does a once in a “who knows what” event occur with an absurd frequency?
Just because we can measure something doesn’t mean we should. The global financial markets have become a monstrously complex system. The dilemma of a complex system is that it becomes increasingly fragile and less robust, so the slightest twinge can have sudden and unexpected consequences.
As the world is becoming more fragile events like last nights decline in the Nikkei will increase in probability and should be expected. The world is awash in debt, central banks are overly involved, corporate revenues are declining and profit margins are at record highs.
I choose to invest based upon the data that I see not try to fit the data into a model that I am desperate to hope is true.
Bye for now.