Financial Convulsion “Syndrome”
Professional traders often have observed during volatile market conditions that an entire session can see wild fluctuations both up and down, only to arrive back at substantially the same place. Just as this can happen with any security in the course of a given day, so to the same effect can occur over longer periods – a week, a month, or a year. A the world has moved further into the twenty-first century, a series of episodes of volatility have appeared in markets of all types, in all parts of the world, and across a diverse range of asset classes, that have shown in many cases not just volatility, but truly convulsive swings of some 200-400% above and below a historical range.
Already in the first decade of the twenty-first century, an extraordinary set of economic variables have gone through, and in some cases have continued to exhibit, an almost sine-wave shaped pattern. From interest rates copper and rice, a remarkable number of things – financial instruments, commodities, equities, and even foreign exchange rates – have gone through this astonishing and unpredicted roller-coaster ride.
Many professionals, including purchasing managers, corporate treasurers, retail merchandise buyers, bankers, traders and others – have seen swings in basic costs within a two year period that in the twentieth century would have taken an entire career before witnessing anything approaching this range of movement. What does it mean? Will it continue? Is this an emerging pattern of greater volatility, or are each of these areas simply going through a one-time “volatility event”, like some sort of financial tsunami?
These questions frame the state of uncertainty, ambiguity and bewilderment that results from this “sine wave effect”. And yet, mathematically, after all the volatility, in most of these cases we arrive at or near the same place. If something has rapidly increased and then decreased three-fold, yet returned to nearly the starting point, what should be the problem? What prevents us from simply ignoring that it ever made the trip in the first place? There are several reasons.
First, business and markets are, whether rational or not, heavily influenced by emotion. Much of our economic doctrine and governmental policy in the latter decades of the twentieth century had been based on the supposed rationality of market. And yet, evidence suggests that markets respond not only to rationality but also to emotion. The emotions experienced during the sine wave effect’s journey can become gut-wrenching moments of fear, anxiety, dread and self-doubt. During one such period in 2008, Tessie Lim captured these emotions in the Straits Times:
“There are days when fear strangles me so I can hardly breathe. My chest tightens as if dread itself turns the knot, my stomach spasms and my hands become clammy. All I can think of is that I’m not good enough. What if I fall short of my standards, lose control, and default to my core . . . The effort to go forward seems too heavy a burden. I feel dizzy as I see my life teeter on the brink”
What can cause this type of anxiety? How do we, as participants in markets far and wide, alter our behavior, our propensity to buy, sell, borrow or save, based on the sometimes dramatic swings in our collective and personal emotional experience? Despite the legions of analytical tools applied to modern markets, do we have the ability to discern the effects of emotion from the effects of rationality? Can we spot the effects of emotion when they emerge, and begin to hold sway in previously more rational and orderly markets?
Jared Diamond, in his masterful treatment of the interplay between climate, culture and human history “Guns, Germs, and Steel”, describes the first arrivals of Spanish ships in the New World as an event that indigenous people hardly recognized. The sighting of a large ship offshore was nearly akin to the arrival of a flying saucer. It’s not that people did not physically see the ships; it’s that they had no frame of reference with which to process such a thing. Almost without exception, the locals did not marshal their defense, flee, or attempt to scout the true nature of the Spanish ships. They were simply too far outside their own set of known phenomena that they literally could not be processed intellectually. Surely, we are more advanced in our own time. Surely, we have a grasp of nearly all the possible phenomena, patterns and possibilities affecting business. Do we have the ability, in our time, to recognize the completely unanticipated patterns and events while they are still emerging? If we were over-confident in our ability to see hugely divergent, uncharacteristic events as they develop, would we be able to identify our own over-confidence? How would we know?
While the twentieth century in particular saw great strides in the analytical, mathematical and econometric understanding of markets, very few predicted any of these financial convulsions. We have risk management teams, underwriters, securities analysts, think tanks, government economic agencies, independent auditors, and professional investment advisors. And yet with all this talent, very few of these massive oscillations were predicted. It’s as if we had weather forecasting that gave us very high accuracy as to tomorrow’s high temperature, but proved wholly unable to warn us of a once-in-a-lifetime hurricane. Is it simply that these events are “too big”? Are our early-warning systems somehow targeted unintentionally toward those events we know are possible? When the “impossible” happens, is the event “off the charts” literally, because we’ve constructed charts within a range that we know to include what we assume to be the possible outcomes? If these dynamics are at work in our predictive models, then we may indeed have a situation in which the biggest, most potentially damaging events affecting business and our economy are the very events that we are least prepared to see coming.
Generally, business exists in an environment where there is an assumed range of predictability, whether explicit or not, for most of the major variables affecting the enterprise. When a contract for raw materials is signed, management is making a statement about the expected range of prices for that particular input cost. We are accustomed to prices of consumer goods, raw materials and capital purchases like homes and vehicles all operating in a certain range that allows us all to make commitments and decisions with confidence.
