Fed Policy, Chaos Theory, Shale And Dangerous Miscalculations In The Middle-East

Chaos theory is usually associated with math or physics because those subjects are its origin, but as you’ll see, it goes well beyond that. 

Many years ago, I worked on a project with a bunch of folks at an organization. We’ll just call that organization PJ Gorman to protect their innocence. Anyway, the team I worked with was there to “optimize risk”, and although it was never explicitly stated, we all knew what we were really doing. We were there to see how far the risk envelope could be pushed before we blew up the bank…and yes, to make frighteningly large sums of money so we could then receive a whopping bonus for risking other people’s money. That is if things went as predicted. Sometimes they do…and sometimes…well…they don’t. 

These folks – quants – spend countless hours building complex models for…well everything. Commodities, equities, currencies, bonds…you name it.

Chaos theory rarely features in their investment banking risk models. That’s because there simply are too many permutations to consider. Where the hell do you start?

Now, before we dig into this. If you’re like my wife and any talk about financial markets and technicals causes you to stare blankly and feel that warm shroud of sleep begin to wash over you….hold up! This is important stuff not only for numbers geeks, and I promise I’ll leave numbers mostly out of it today. Chaos theory impacts us well beyond the world of finance…as you’ll see.

James Yorke himself summarizes this theory by saying, “The most successful people are those who are good at plan B”. You have to be ready to change plans at any moment.

“In life, it’s important to be flexible. I don’t plan things. I prefer to discover them.”
-James Yorke, Father of chaos theory-

I was explaining chaos theory to my kids while playing pool a couple months back. It struck me that the breaking of the triangle with the white ball at the beginning of the game provided a wonderful analogy.

When starting a new game, none of us could have figured out where the heck all or even any of the balls would go. There are quite simply far too many permutations. 

Take a look at this. It is the US Federal reserves’ balance sheet which has exploded. The proverbial white ball breaking the triangle of balls.

(Click on image to enlarge)

Actually, I could share with you the Central bank balance sheets of the BOJ, ECB, BOE and a dozen other CBs. They’re like milk bottles. All the bloody same.

The results have been many. An obvious one is that price signals have been distorted. It’s why previously successful asset managers (1980’s through till 2007) have failed in this new environment. Two and two no longer make 4. And when enough folks believe that – why yes, it does actually make 5, or 6 or whatever, then markets begin justifying this. If you want a visual representation in real time I present you with Tesla (TSLA)

(Click on image to enlarge)

Enterprise value closing in on $100 billion. Yes really. Unprofitable, government-subsidized, Fed subsidized and run by a guy who has, and continues to commit fraudulent behavior with zero repercussions. 

As I write this post, this bad boy trades at a P/E of 88!!

Investors are paying $88 in order to receive $1 of earnings. Earnings not profit. Profit? Who needs profits?

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Disclaimer: This is not intended to render investment advice. None of the principles of Capex Administrative Ltd or Chris MacIntosh are licensed as financial professionals, brokers, bankers or even ...

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