By Matthew Unterman & Thomas Crowley
My supervisor, Thomas Crowley, and I go to lunch early, around 11:30 A.M. every morning to try and beat the deluge of students and background noise that flood the lounge around noon time. This daily ritual is in fact an ongoing blog... anything is fair game. We tend to talk about what we have read in the news for the morning, or how god awfully slow I have become in writing up scientific papers... but then there are sometimes moments we just sit in silence, enjoying the 20 or so minutes of tranquility within the University before chaos ensues and its back to the salt mines and my super computer...
There was one time however that we began discussing how it seemed the Dow Jones (DJI) was wiggling about wildly... almost chaotic... a time of increased variability within the stock market… and then it hit. My supervisor recently published a paper in Nature ((Nature 456, 226-230 (13 November 2008)), he and a coauthor conjectured that rapid changes in past climate could sometimes be explained by some "nonlinear" (*) feature of the climate system. They suggested that increasing variability might be one predictor of an abrupt climate change, and that the high variability in climate of the last few hundred thousand years might be an indicator of some future transition to a different, more stable, climate state - permanent midlatitude northern hemisphere glaciation. Consequently our early morning tradition became a time to speculate that perhaps changes in the DJI might also be examined this way... but without the glaciers.
I was able to acquire a long daily time-series of the DJI extending back into the 1920’s from Yahoo Finance and a communication with my father… who happens to be a Wall Street Lawyer… but I digress. Analysis of the variability in the DJI led to ambiguous findings (Fig. 1) - yes there has been a lot of variability lately, but high variability has occurred at other times also just as one would discuss natural variability in the climate system - such as the sharp drop in 1987, when the market recovered fairly quickly. So we just started looking at the raw DJI back to 1927 (Fig. 2) and later, compared the more recent 2007-2008 changes to what happened in 1929. Interestingly, we found that the DJI went through several transitions after 1929, and did not bottom out until 1933 - almost four years later. It is also interesting to point out that the DJI is a perfect proxy for historic events, even in the smaller, less noticeable wiggles in variability (for instance the battle of Shanghai in 1937 is clearly visible and potentially even the battle of Marco Polo Bridge).
Not counting the one day bash of 1987 the magnitude of variability has not been seen since the Great Depression and the years following it.
We noticed that after each of the drops there was a period of stability that we called "backing and filling" and that after a few months of this the 1929-1933 went through another drop. These "stagger steps" did not seem to be a feature of other market drops (Fig 2, Fig 3 - enlarged version of last 15 years), so it could be unique feature of more fundamental market shifts… but this is only speculation.
You can see that we made a prediction back in November on the "Next Transition"...
Thomas’s interpretation of these "back and fill" events is “that the economic shock of the preceding drop takes a while to work its way through the system and may even be countered somewhat by some investors betting that the market has bottomed out. Whatever, in the UK there has been a steady flow of bad news doled out in daily doses over the last couple of months of business closings and unemployment figures. These continued unabated, weakening the already weak banking structure. The recent clustering of bad news from the much-overrated Royal Bank of Scotland, Halifax Bank of Scotland, and AIG were the immediate factors precipitating the next phase of drops, but those big number drops reported by RBS, HBOS, and AIG might not have happened if there had not been a steady stream of smaller bad news preceding. In this respect it is very much like climate theory, where major transitions can be precipitated by small incremental changes crossing "threshold levels", after which there is a big response.”
We therefore tried an experimental forecast approach on November 6 2008, sending the forecast only to my father (refer to dated figure) and trying an experimental forecast* of the next transition, if it were to occur, based on the average time of stability in both the 1929 and 2008 time series (Fig. 4). We predicted a transition, if it were to occur, in the timeframe 1 Feb-Apr 1 2009…. Which, if you are not one of my kitchen flies, is a relatively good prediction thinking of the “now” (Fig. 5). Obviously this agreement by no means indicates proof of the method - but is “better” than failing! Though I wish we were wrong of course…
With at least one forecast to our credit we therefore thought it might be useful to post this information for others to contemplate. Again, caveat emptor.
We will issue another forecast soon, after a little more data are collected - probably end of March early April time frame.
In the meantime, one of us (Thomas Crowley) feels emboldened to state his personal suspicions what is going to transpire:
“There will not be a recovery after the next drop, as many economists are forecasting. Tom thinks this is as much "group think" and wishful thinking as much as anything, as we really don't have other experience (other than the Great Depression) of the market dropping to below 50% of its value. If analysis of abrupt transitions (see above) has any bearing with respect to the future of the DJI, then my experience would be to conjecture that the system has passed the point of no return and will descend into a depression within the next year or year and a half. Beyond that I do not believe that anyone can make any predictions on when the market will recover. I should note that it took the DJI nearly 25 years to surpass the 10 October 1929 peak (Sept 17, 1954), so let us hope that is not a predictor of the future.”
And honestly, I have to agree. It is almost like any news is bad news in the media and that regardless of the trillions of US Dollars being funneled into the system the downward trend might not halt. Was it wise to toss hundreds of billions back into the market to attempt a fix? I’m not sure… I honestly cannot think that I would sit around and do nothing… so I guess something needs to be done. Are we passed the point of no return? Our prediction basically points us in that direction. Yet I am allowed to hope we are wrong… kind of makes me want to scream “stop selling people!” all at once… but then again I don’t want to enforce a motion of no confidence…maybe it takes a catastrophe to make it all better anyway…
More to come…
*TC: A more specific prediction, and even more conjectural, comes from my 1.5 years of living in the UK (I am a US citizen). I personally think the UK is the weak link in the entire global financial market, and that it will be the weak link (not Iceland or Ukraine - something bigger) that is critical rather than the largest economies (US and China). I just do not believe the UK has enough resources to bolster banks much more and that at some point in the next year they are going to collapse on their own weight. Then the walls of Jericho will truly comes tumbling down
*Matthew's background is in computer science and paleoclimate modeling. Application of a 3-day, 5-day, and 10-day basic variability algorithm was applied to the DJI daily average to determine the degrees of variation within the time series.
* This term comes from climate science - Crowley's background, and originated more than 25 years ago with winter forecasts made by the National Weather Service on 1 December of each year. These forecasts have now been more routinely updated and use more numerical methods (rather than primarily vast experience of the forecaster), but the concept is the same - they are experimental forecasts, they are not predictions, and they are by no means at the state where one would want to bet their life savings on. This is for information only, with the "user" taking full responsibility for any actions taken because of the forecast.
