This note was originally published at 8am this morning, October 27, 2010. INVESTOR and RISK MANAGER SUBSCRIBERS have access to the EARLY LOOK (published by 8am every trading day) and PORTFOLIO IDEAS in real-time.
“Clouds are not spheres, mountains are not cones, coastlines are not circles, and bark is not smooth, nor does lightning travel in a straight line.”
To say Benoît Mandelbrot lived a great life would be an understatement. The recently deceased Sterling Professor of Mathematial Sciences at Yale University had the opportunity to follow and study his passion his entire life and, as a result, his contributions to the field of mathematics were vast.
Most interesting to our Hedgeyes was Mandelbrot’s work on fractals, which underscore many of our own market models. In fact, Mandelbrot actually coined the term fractal in his consummate work, The Fracatal Geometry of Nature. He also did what many academics actually have a hard time doing, he extended his academic studies into the more practical areas. According to our friends at Wikipedia:
“Although Mandelbrot coined the term fractal, some of the mathematical objects he presented in The Fractal Geometry of Nature had been described by other mathematicians. Before Mandelbrot, they had been regarded as isolated curiosities with unnatural and non-intuitive properties. Mandelbrot brought these objects together for the first time and turned them into essential tools for the long-stalled effort to extend the scope of science to non-smooth objects in the real world. He highlighted their common properties, such as self-similarity (linear, non-linear, or statistical), scale invariance, and a (usually) non-integer Hausdorff dimension.”
Mandelobrot passed away at the age of 84 years after more than 60 years of pursuing his passion. He was one of the most celebrated mathematicians of the last 50 years and won innumerable awards for his work, including: the Wolf Prize for Physics in 1993, the Lewis Fry Richardson Prize of the European Geophysical Society in 2000, the Japan Prize in 2003, and the Einstein Lectureship of the American Mathematical Society in 2006. Most interestingly of his awards was perhaps that fact that he has an asteroid named after him: 27,500 Mandelbrot.
As it relates to financial markets, his primary contribution was determining that price changes in “financial markets did not follow a Gaussian distribution, but rather Lévy stable distributions having theoretically infinite variance.” In addition to his study of financial markets, he also had an idiosyncratic character that was near and dear to our hearts. So much so in fact, that he actually gave himself his own middle initial, “B”, which actually did not stand for anything.
So in memory of Professor Mandelbrot and chaos theorists everywhere (especially our Harvard friend at a well known money management firm in Canada), we are going to focus on only 3 important global macro events this morning as it relates to managing risk, which are as follows:
1. The Election – As many of our subscribers know elections are near and dear to our hearts and the upcoming midterm election is one we’ve been very focused on. (If you would like to trial our research and to see some of proprietary election analysis, please email email@example.com.) In fact, we are on record saying that we are more bullish for Republican chances than our friend Karl Rove. For us, though, it is not about politics, but is simply math. As the math stands now, and excluding races that are “too close to call”, the Republicans will win 233 seats in the house (a majority) and will win 45 seats in the Senate. We believe that turnout could be the wildcard and slide many of the “too close to calls” to the Republicans as many poll internals show a highly motivated Republican base. The primary implication of this is that the Republicans will likely implement immediate budget cuts, which, according to reports this morning, could be as much as $100BN as soon as January. While in the short term a decline in government spending may hurt GDP, in the longer term deficit reductions will put the U.S. economy on a more stable path of growth.
2. Greek Deficits – If you don’t think that government numbers can be wrong or revised lower, well now you know. Greek deficits this morning were revised higher to 15% of GDP as, shockingly, tax revenues were worse than expected. As we’ve been saying for months, sovereign debt issues in Europe will rear their ugly heads again and obviously Greece is at the forefront of that again this morning. We’ve highlighted this point of Interconnected Global Risk in the Chart of the Day below, which highlights that credit default swaps in Europe are making higher lows. As these CDS spreads increase, we are likely to see equity markets act inversely to those spreads widening.
3. U.S. Dollar – The U.S. dollar is appreciating this morning (not a sentence we have been used to typing over the last few months) on the back of Wall Street Journal reports that while Quantitative Guessing will likely be implemented on some level, it won’t be the “shock and awe” type that many proponents of Krugman Kryptonite were hoping would be implemented. It seems Chairman Bernanke may actually be listening to some of his colleagues at the Fed like Thomas Hoenig, president of the Federal Reserve Bank of Kansas City, who said Monday that more expansive monetary policy was a "bargain with the devil." Indeed. The most immediate term impact of a stronger dollar is likely a correction in those commodities that are priced in dollars.
Just like Mandelbrot, many of the fine folks at Hedgeye have left higher paying jobs to pursue their passion. This passion is the art and process of producing objective and real-time investment research, which we believe is Hedgeye’s core competency. We aren’t always right and we aren’t always popular, but we passionately believe in what we do and we thank you for your support.
Yours in risk management,
Daryl G. Jones