Monday, May 27, 2013

Of Butterflys and Bubbles

Butterfly Effect: The name of the effect, coined by Edward Lorenz, is derived from the theoretical example of a hurricane's formation being contingent on whether or not a distant butterfly had flapped its wings several weeks before.


In investing discussion circles, most people talk about bubbles.  I look for butterflys.

Example: Shinzō Abe, the current Prime Minister of Japan. in 2012 introduces "abenomics" or the massive creation of Japanese Yen to fix Japanese overall economy.  This was the butterfly flapping its wings (as opposed to flapping lips - the distinction is important).  In currency war parlance, massive quantitative easing devalues the currency of the country thus making their exports more attractive.  As exports grow, stocks in exporting companies increases due to increased earnings.  In addition, cheap Yen, with no where to go because real interest rates are negative, also goes into the stockmarket driving Japan stocks higher. A double boost!  So if you bought EWJ in December and sold it in May when Japan topped, you would have cleared a >20% return or more 6 months.

What you need to look for is a situation where there is a sensitive dependence on initial conditions, where a small change at one place in a deterministic nonlinear system can result in large differences to a later state.

Let me know if you detect a butterfly.  Help us all make some money. Don't waste your time looking for bubbles and listening to people talk about bubbles-- they can't be saved.

As invetor of the Bulldog method of investing, I now add the Butterfly theorem.  So for your listening pleasure here is a youtube video of "Dog and Butterfly".