Afternoon T: Traffic Jams, Learned Behavior, & Neon Gazelles

Posted by on Dec 5, 2012 in The T-Report | No Comments

How Traffic Jams Start

One of the favorite bits of research I ever read was in college and it was study on how traffic jams form. I can’t remember the details, as it was my friend’s class not mine, but he test was to randomly hit the brakes and see how many traffic jams you could start. If I remember correctly, a lot of traffic jams could be started that way. The driver behind reacts to you hitting the brakes by hitting their brakes. So does the driver behind them. In the end it is possible to create a traffic jam just by hitting the brakes for no good reason.

So what does this have to do the markets? Maybe nothing. Maybe I am just feeling annoyed at the world.

My short HYG isn’t working so that might be enough, but didn’t like Apple, didn’t love the markets, and liked China and Greece, so that can’t be totally it. I think it is the fact that I struggle to understand what it means to the market to have a name like Apple.

Apple has swung about $40 billion in market cap this week. Starbucks has a market cap of $38 billion. Looking at the S&P 500, about 432 companies have lower market caps than Apple lost this week (and it’s only afternoon tea time on Wednesday).

I am really not sure what that means, and maybe I’m just having a moment, but something about it seems very wrong. I’m not sure the market is in any immediate danger, and I would not be surprised if Apple closed unchanged today, but all that would tell me is we have moved further and further away from valuations and into a world completely driven by stop losses and weak hands.

If that is right, then even credit can do poorly, because if there is an asset class universally loved, it is credit. It is as loved as the yen is despised. I don’t follow FX, but that is another trade where it seems nearly impossible to find someone on the other side. Be careful.

If a traffic jam can be created by one person hitting the brakes for no good reason, it is easy to see how nowadays the same can happen in the stock market, and here there are people looking to tap the brakes to trigger that instant reaction. Each person thinking they are doing what is rational, when in fact it really isn’t.

Human Beings NOT Atoms

I must be really in a bad move as I jump from tangent to tangent, but I think they are related, even if I can’t explain why.

Economics like to pretend they are physicists. They come up with fancy theories and award themselves Nobel prizes. But that is where the similarity stops. Real science is repeatable. It is about the interaction of inanimate objects that react in a predictable manner.

That is not the case for humans. Why would an idea that worked 50 years ago, work today?

In physics, it has to work the same. It doesn’t have to in economics.

Human beings learn over time. Economists would be PhD’s and teach other students if they didn’t learn. But doesn’t that mean we learn and adapt to their policies? If we know how they are going to react, do we not anticipate that action? Over time, the reaction occurs long before the action is taken because people can see it coming. That changes behavior. In medicine it is akin to drug resistant strains of virus’s developing. In the wild it is Darwin’s survival of the fittest.

Why do economists assume that humans haven’t adapted? Is it possible that over time, their medicine no longer helps? Heck, is it possible that knowing the medicine is on its way has changed behavior in a bad way? If smokers knew they could go a new lung tomorrow, would they stop smoking?

Economics is a complex interaction of a variety of components, many of which are sentient (or at least once were) sentient beings. We can’t even model the weather very well and that is a simple system relative to economics.

I can’t help but feel we are applying economic theory that is no longer relevant, because the drivers in the economy have adapted to it, and if anything may be rewarding bad behavior that makes things worse.

I am sure I will feel better later, but right now I can’t help but think that the economists are proudly patting themselves on the back having created a bunch of glow in the dark gazelles, not realizing that in solving their ability to see each other at night, they created a much bigger problem.



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