Chaos, Weather, and Markets

A core tenant of Chaos theory explains, "A butterfly flapping its wings in Brazil could set off a tornado in Texas." While widely used as an explainer for economic phenomena, it is usually misapplied. General Stanley McChrystal clarifies, "The idea of a small thing that has a big impact, with the implication that, like a lever, it can be manipulated to a desired end. This misses the point of Lorenz's insight." Instead, a small thing in a complex system may or may not have an effect. If it does have an impact, it could be a massive one or of little consequence [McChrystal 2015]. 

To understand an event's effect on an extensive system, one must first understand the cause-and-effect relationships involved [Dalio 2021]. For example, a two-year drought in Spain led to thefts in Greece and a meteoric rise in olive oil prices [Gatopoulos 2023]. Gangs are sneaking into olive groves and chopping off heavily laden branches to cash in on the soaring price. Most nefarious are the groups chopping down trees. As a result, growers are selling before maturity to protect their groves.

Record-high temperatures for two years have caused a long-running drought in Spain. As drought becomes more severe, the remaining water becomes concentrated with containments. If the dry conditions continue, Spain risks encroachment by deserts within this century [Chandler 2023]. Also at risk is the country's GDP, which relies on agriculture—a potential cascade of misfortunes brought about by abnormally high temperatures.

Hurricanes, Floods, and Wildfires

According to the National Oceanic and Atmospheric Administration (NOAA), the cost of the average hurricane is $22.8 billion. For example, Risk Analysis at UBS recently calculated the cost of Hurricane Idalia, the 2023 category III storm that made landfall in Florida and pushed heavy rain into Georgia and the Carolinas, at $18 to $20 billion dollars [Luscombe 2023].

NASA declared that July 2023 was the hottest month in Earth's history. While there is no way to confirm that, we can agree that the historically high temperatures experienced around the globe were warmer than those in recorded history. With these blazing temperatures came wildfires, storms, and foods with a price tag of over $38 billion in loss. The aftermath of these calamities will likely carry costs into preceding years with a figure much higher than currently realized.

Complex to Simple

Before the 20th century, many believed that the events that changed the world were massive in scope. However, a simple shortcut by meteorologist and mathematician Edward Lorenz changed everything during the 1960s. While working on a weather model, he entered 0.506 instead of the complete 0.506127 to simplify the calculations. The result of the fractional difference was enormous to the long-term forecast. From this, Lorenz concluded that a tiny change in the initial conditions had considerable long-term implications.

In science, whenever a phenomenon is encountered that seems complex, it is assumed that it must result from an underlying mechanism that is also complex. However, this is not always the case. The opposite is realized through scientific experiments with simple rules creating complex results [Wolfram 2002]. Called automata, this new science created by Physicist Stephen Wolfram explains how the intricate patterns of snowflakes are produced from the freezing of water.

Wolfram started with a computer program that replaced the pre-built algorithm or series of instructions with simple rules. The result is something not wholly random or predictable. For example, a loop of 1 million iterations does one thing if the number is odd, another if it is even, and another if a specific condition is met.

Markets and Weather

At its core, markets are chaotic systems influenced by numerous tiny changes while simultaneously bound to larger predictable cycles [Dalio 2021]. Like the weather, markets are far more complicated than most realize. Mathematician Benoit Mandelbrot, the father of fractals, proved modern economic assumptions wrong by applying physical statistics. Instead of a familiar bell curve, price histories show independence distributions within short time frames and long-term dependence over large timeframes [Mandelbrot 2004].

These short-term complexities, followed by long-term predictability, mirror weather patterns. Billionaire investor Ray Dalio concludes, "To see the big picture, you can't focus on the details." A fact Wolfram discovered in his computer lab. It is the tiny changes over time that compound into significant changes. This is how the world works. A few hot days in June followed by continued heat during the rainy season, and an entire country is on the brink of disaster. The same is true for markets where a missed earnings call followed by an unflattering story in the press with a slam on social media all combine to a boycott and eventually delisting of a once fruitful company.

Conclusion

Weather and associated natural phenomena have resulted in more harm throughout history than war [Dalio 2021]. Catastrophic weather has even unset empires and ended dynasties. The same holds for markets, as both are related in more ways than we realize.

All aspects of the world are based on long-term cycles with short-term chaos. Cycles occur, such as improved education periods leading to higher incomes and greater GDP. They also happen when something is in decline. Be it a country, company, market, or person. These cycles reinforce each other and build like a giant snowball [Dalio 2021].

Prepare for disaster because they are a certainty in life. King Solomon wrote in Proverbs 22:3, "The prudent see danger and take refuge, but the simple keep going and pay the penalty." The Ancient Chinese explain, "a smart rabbit has three-burrows." However, do so with the knowledge of everything that could go wrong.  

References:

• Chandler, R. (2023) A Glimpse Into Spain’s Future, Where Water Comes by Truck, Not Tap. New York Times. https://www.nytimes.com/2023/10/22/world/europe/spain-drought-water.html

• Dalio, R. (2021) Principles for Dealing with The Changing World Order. Avid Reader Press

• Gatopoulos, D. (2023) The price of olive oil soars, and thieves go after century-old trees in the Mediterranean. Associated Press

• Luscombe, R. (2023) Hurricane Idalia could become 2023’s costliest climate disaster for the US. The Guardian. https://www.theguardian.com/us-news/2023/aug/31/hurricane-idalia-cost-update-category-3-florida-georgia

• Mandelbrot, B. (2004) The (MIS)Behavior Of Markets: A Fractal View of Financial Turbulence. Basic Books

• McChrystal, S. (2015) Team of Teams: New Rules for Engagement in a Complex World. Penguin Random House LLC

• NOAA (2023) Hurricane Costs. https://coast.noaa.gov/states/fast-facts/hurricane-costs.html

• Wolfram, S. (2002) The Foundations For a New Kind of Science. Wolfram Media, Inc.