Money & Markets: The randomness of markets

Markets are random, even if the players can’t accept that it’s all based on probability. However, there is a non-random noise component that engineers will be familiar with.

Markets are said to be random by regulators and theoreticians, but none of the practitioners agree. They laugh at the thought that markets are random, all the while ignoring the fact that markets like the huge equity options complex are based on equations with probabilistic distributions at their heart.

With practitioner laughter ringing in your ears, you can go dig the data and what do you know, the time series are random. Now as most don’t know, there are many shapes of random and almost obviously market prices are bounded. While oil can go into negative values, it cannot go to a billion dollars a barrel. I wrote that with conviction then realised it wouldn’t take too much Weimar-style inflation for it to do just that, but even hyperinflation hits the buffers after a dozen or so zeros finally get printed on banknotes. It’s a good point, however, for how random market prices can and can’t be, but ultimately there are limits to the range of price randomness in markets.

The noise is also not pure. There is a non-random component in markets like a very weak radio signal from far away snuffed out by noise. This signal is generally so small the mechanism that would wipe it out, pre-emption, simply can’t get to it either through the cost of doing so or the available time to capture it. So if it costs 2c to make 1c from a non-random market feature, that profit potential will still be in the time series because it can’t be traded away. Rest assured, however, if there is potential to make money, there will be people putting themselves through contortions trying to find a way to get to it and in time they will.

Apart from edge cases, the markets, at least the important ones that trade in economy-moulding volumes, are for all intents and purposes random. This random noise can be loud or quiet, and right now it is loud because to put it simply no one knows how the current economic situation is going to pan out. This leaves the participants running hither and thither with money sloshing from one asset to the other with little anchor to create stability. Volatility is noise and noise is uncertainty and uncertainty is high.

It was not so long ago when people said that the monetary interventions sparked by Covid would not cause inflation. I hope you recall I called for high inflation to come. Then inflation was going to be ‘transitory’ to which I said nay. So here we are exactly where I suggested we would end up. So against a background of random howling noise and rampant uncertainty I may as well have a crack at guessing what is up next and what to do about it.

Now there has been a crash in the US market, surreally everyone is expecting a crash in the US market. Having got significantly poorer because of the lockdowns of Covid, people see instead an unconnected cost-of-living crisis which is actually the comeuppance from a lack of economic activity in 2020/2021.

I would summarise that the accident people are fearing has already happened, the economy we are living in was baked in 2020 and 2021. If anything we are in a recovery, with the pain we are suffering now simply a result of the previous injuries.

There are of course plenty of ways to slow that recovery, but it is under way.

So predictions are that we are in for a recession, and that may be true as there is a large economic crater to be filled to get the economy back to where it was in 2019, and that is probably two to three years of struggle. There is not going to be a meltdown. This is a key conjecture. It’s going to be a rough period but not the worst ever.

I received a recent email saying nice things about an article I wrote ten years ago, on how to prosper in hard economic times, so I went back and read what a younger, slimmer me thought was the way to get ahead in tough times. The following seemed to me to be key: “Keep a positive mental attitude.”

The following is obvious: 1) Most people are confused; 2) Many are very fearful; 3) A lot of people are not even paying attention. As such, one person’s recession is another person’s land of opportunity.

The markets and the economy will be nursed along in the coming years with elevated inflation. That should be a conducive environment for the fast and light actors in the economy. The many grumpy souls expecting and hoping that flocks of chickens will come back to roost on their pet peeves are going to be disappointed.

Instead now is the start of a new era, and the time to jump on the next big thing. It doesn’t matter how bad the market gets, how dire the economy, how bad the situation is in various places, somewhere there is always a party going on.

The trouble is you don’t know where it is and you do not have an RSVP.

Rather than quivering at the prospect of a recession, we all need to be looking for that party invite because it’s out there and we just need to get it.

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