“Just So” Snowflakes

Who’s in charge?

Wilson Bently, “Studies Among Snow Crystals.” Source: NOAA

That’s what we often ask about all kinds of complex systems: traffic, language, markets. It often turns out that no one is in charge, that order emerges from the various parts of the system. If you look at any particular automobile, you can’t predict that Route 128 outside of Boston will be bumper-to-bumper at 8:00 am on a snowy Tuesday morning. But if you get a bunch of cars together, work schedules, commuting patterns, and a weather report into the mix, you’ll have a pretty good idea where and when traffic jams will form.

It turns out that in many cases no one is in charge, that things just happen, and they happen the way they do because of how their components are organized – like snowflakes forming crystals and plates, because of water’s hydrogen bonds, dust in the air, turbulence, humidity, and temperature. Systems that develop this way – with no one in charge – are called “emergent” systems. They have their own organizational principles and structure, which can’t be inferred from their constituent parts.

In many ways, our minds are emergent systems. We have sensory zones, autonomous functions, and reflex areas that all interact. Sometimes our brains act more like traffic cops than decision-makers. And yet, we do make decisions. But how?

From studying the reasoning of certain patients, researchers have found that we often decide what we’re doing before we’re even aware of making the decision. Then we develop a narrative to explain it. If I’m hiking on a trail and see a snake, I jump back and tell myself that I jumped because I saw the snake. But the reality is that I jumped back after I saw the snake, but before I was aware of the snake. That is, awareness and the cognitive processing that it requires takes more a lot more time than my initial reaction. So the process goes: I see the snake, I jump back, I process the information, I tell myself a story about the snake.

Photo: Claudia Peters. Source: Pixabay

That’s how things work in markets as well. The market will react to new information before a narrative can form to explain the reaction. We saw this after Election Day in 2016, when stock market futures were down over 5% before reversing themselves and finishing up 1% that day – on their way to a 10% rally. People were initially confused. The narrative hadn’t had a chance to catch up with the markets. A similar thing happened last summer after Britain’s “Brexit” vote.

S&P 500 Futures. Source: Bloomberg

So be careful when you hear explanations about why the market did this or that. Such stories may be helpful, or they may turn out to be post-hoc rationalizations – “just-so” stories we concoct to cope with chaos and uncertainty. In essence, we tell ourselves tales around the campfire to keep out the dark.

But these rationalizations may not hold up in the long run. They may prove as ephemeral as snowflakes in the summer sun.

Douglas R. Tengdin, CFA

By |2017-07-17T12:21:29-04:00February 15th, 2017|Global Market Update|1 Comment

About the Author:

Mr. Tengdin is the Chief Investment Officer at Charter Trust Company and author of “The Global Market Update”. The audio version of each post can be heard on radio stations throughout New England every weekday. Mr. Tengdin graduated from Dartmouth College, Magna Cum Laude. He received his Master of Arts from Trinity Divinity School, Magna Cum Laude and received his Chartered Financial Analyst (CFA) designation in 1992. Mr. Tengdin has been managing investment portfolios for over 30 years, working for Bank of Boston, State Street Global Advisors, Citibank – Tunisia, and Banknorth Group. Throughout his career, Mr. Tengdin has emphasized helping clients manage their financial risks in difficult environments where they can profit from investing in diverse assets in diverse settings. - Leave a comment if you have any questions—I read them all! - And Follow me on Twitter @GlobalMarketUpd

One Comment

  1. Bill Bulkeley February 15, 2017 at 10:13 am - Reply

    When markets rise, commentators always focus on the optimism of buyers. But they could just as well focus on the pessimism of sellers who consider the shares they hold are overvalued. For every optimistic buyer there has to be a pessimistic seller. By the same token, when markets fall, commentators could focus on the glee of buyers who believe they are acquiring undervalued assets. Of course, most trades today are algorithmic and have nothing to do with optimism or pessimism. Nonetheless, we all try to create a narrative around the movement of the Dow,

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