As some of my readers know, I am out of town for the next two weeks delivering a series of lectures onboard a Celebrity Line cruise ship. As such, this week’s column will reiterate one of my favorite themes from the past.
Until they are caught up in the maelstrom, few realize how a relatively insignificant news event, often unrelated to Wall Street, can trigger significant gains or losses in the equity markets. These oscillations reflect what is popularly referred to as the butterfly effect. Specifically, the belief that a butterfly flapping its wings in one part of the world could potentially disrupt the weather 1,000 miles away.
The name butterfly effect, coined by Edward Lorenz back in 1961, is derived from the metaphorical example of the constructs of a hurricane being influenced by minor unrelated perturbations, such as the flapping of the wings of a distant butterfly several weeks earlier.
It seems that Lorenz was using a numerical computer model to rerun a weather prediction when he entered 0.506 instead of entering the full number 0.506127. The result was a completely different weather scenario. The key point is that even a seemingly inconsequential change in an initial condition will create a significantly different outcome.
Consider the randomness of throwing dice. On each throw, the outcome is dependent on small differences in the initial conditions, such as the precise direction, thrust and orientation of the throw. The result is significantly different dice paths and, subsequently, the numerical outcome of the toss. That is why it is virtually impossible to throw dice the same way twice, much to the relief of Las Vegas.
So how can you determine what will happen in the financial markets when you have no hope of reconstituting the initial conditions of the past and when even a small, random change in the initial conditions will dramatically affect the outcome? The answer is you cannot.
At the same time, maintaining a pragmatic financial vista should not imply any lesser degree of attentiveness on your part. Let the Street’s woeful antics be an opportunity for financial gain; take advantage of the opportunities created by those irrational, panicked flows of capital.
Investment timing is important only to the timid or inexperienced investor. This is an investor who often enters the market at a time of extreme exuberance, only to become disillusioned when the market declines and paper losses occur. The antidote, per Warren Buffett, is to accumulate shares and never sell when the news is bad and stocks are well off their highs.
Buffett once wrote, “Why would I sell off stocks that are small participations in wonderful businesses? True, any one of them might eventually disappoint, but as a group, they are certain to do well. Could anyone really believe the earth is going to swallow up the incredible productive assets and unlimited human ingenuity existing in America?”
Moreover, listening to market predictions is a waste of time. As Buffett repeatedly points out, doing so may blur your vision of the important facts. To Buffett, when news commentators glibly opine on what the market will do next, it reminds him of legendary slugger Mickey Mantle’s scathing comment, “You don’t know how easy this game is until you get into that broadcasting booth.”
Finally, Buffett maintains that much of what he learned came from Benjamin Graham’s book, “The Intelligent Investor,” which he bought in 1949. Buffett writes, “My financial life changed with that purchase. For me, the key points were laid out in what later editions labeled Chapters 8 and 20. These points guide my investing decisions today. Of all the investments I ever made, buying Ben’s book was the best.”
Note to readers: I will teach Investment Redux, an eight-session course that will stress such topics as the role the economy plays in investment selections at 9 a.m. Mondays, beginning March 5, for Ringling’s Lifelong Learning Academy. Call 941-309-5111 to register.
Lauren Rudd is president of Rudd International, an asset management firm. Neither Lauren Rudd nor his employees hold any shares discussed or have plans to buy them within 30 days, nor is there any intended inducement to buy or sell any security. You can write to Lauren Rudd at Lauren.Rudd@RuddInternational.com or call him at 941-706-3449. For back columns, go to www.ruddreport.com. Lauren Rudd offers commentary Thursdays on SNN News 6 during the 5:30 p.m. live newscast.
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