How can one go to bed on Sunday night with markets tame, and wake up the next morning and know that it is going to be a changed world for a long time to come?
There is a school of mathematics called catastrophe theory. This is a model where small changes can lead to dramatic shifts in behavior when there is movement away from one equilibrium point towards another. These dramatic shifts occur as the cusp, or most unstable part of the model is passed through and occur in non linear systems.
I like looking at this stuff as a passing hobby, even though it is unlikely to have any benefit to the short term trader. However, I am willing to bet that the celebrated quants of the past 5 years will increasingly embrace these non linear schools of thought, (i.e. Taleb's lecture in Chicago was sponsered by quant organizations).
I think the market has started going through one of these cusp points the past 24 hours. The shift from bullish sentiment to bearish sentiment over the past three weeks has been so extreme - it surely should not be mistaken for a period where contrarian thinking is called for.
The more dramatic an event, the more likelihood there is of continuation in the direction of that event. The larger the gap, the greater the odds of continuation. The greater the breakdown in a relationship, the greater the odds of continued breakdown in that relationship. When there are moves outside of historical parameters, that is the market's way of telling us something. Take for example, traditional valuation models that compare stocks versus bonds. These models have been screaming that stocks are undervalued relative to what bonds are yielding for the past few years. However, perhaps the real message has been that the underlying assumptions driving the models were not sustainable.
NOT SUSTAINABLE. That is what the market has been saying the past 24 hours about global economies.
We take comfort in the events that occur frequently because we know them and know how they behave and would like to believe that that is how our safe little world will always be. We are not taught how to deal with the uncomfortable aberations that confront us.
Think of it this way: aberations are very powerful messages - don't fight them, be on the same side that they are, and expect continuation in the direction of the aberation. What better indicator could one ask for?
Here is another way to think about it: If 100 year hurricanes start occuring every 5 years, that might be a powerful message that historic weather patterns that were taken for granted are now changing. You would not want to buy beachfront property.
Now is such a time in the markets. It is OK to run for the hills. Retreat, take shelter.....eventually the market will find a new equilibrium level at a much lower level.
It is OK to be philosophical, even downright religeous at these junctures. It is going to be a changed world for a long time to come.