Complex Adaptive Systems & Investing
Let me start this post with a statement that some or many might not agree with.
Real Investing is Boring…Yes, it’s Super Boring.
On the other hand, our environment is complex and dynamic. Things change all the time.
In fact, there is even a term for this one.
Complex Adaptive Systems.
In the 1994 book “Complexity” by Mitchell Waldrop, there is insightful coverage of complex adaptive systems based on the research done by Santa Fe Institute.
The author writes “In the natural world such ecosystems (complex adaptive systems) included brains, immune systems, cells, developing embryos and ant colonies. In the human world, they included cultural and social systems such as political parties or scientific communities. Once you learned how to recognize them, in fact, these systems were everywhere.” He also refers to the economy as a prime example of the complex adaptive system.
These systems have a few properties. I reproduce them from the book “Complexity“.
1. Each of these systems is a network of many agents acting in parallel.
In the brain, the agents are nerve cells. In an economy, the agents might be individuals or households. Or if you were looking at business cycles, the agents might be firms. And if you were looking at international trade, the agents might be whole nations. But regardless of how you define them, each agent finds itself in an environment produced by its interactions with the other agents in the systems. It is constantly acting and reacting to what other agents are doing. And because of that nothing in its environment is fixed.
Yes, nothing in the environment is fixed.
Remember how oil prices went below even zero briefly last year. Where are they today? This is because nothing truly in that ecosystem is fixed.
2. The control of a complex adaptive system tends to be dispersed.
There is no master neuron in the brain. Similarly, there is no master control of the world economy or stock markets. Not Even US or China.
Several weeks and months back, everything cantered around Evergrande, today it is inflation, tomorrow it could be some president or prime minister of one country joining hands with another.
The fact is that the overall behaviour of the economy is still the result of myriad economic decisions made every day by millions of individual people, businesses and governments.
3. A complex adaptive system has many levels of organization, with agents at one level serving as the building blocks for agents at a higher level.
For example, a group of individual workers will compose a department, a group of departments will compose a division, and so on through companies, economic sectors, national economies and finally the world economy.
Additionally, complex adaptive systems are constantly revising and rearranging their building blocks as they gain experience. A firm will promote individuals who do well and (more rarely) will reshuffle its organizational chart for greater efficiency. Countries will make new trading agreements or realign themselves into whole new alliances. Just 16 hours ago, Prime Minister Narendra Modi said in the 21st Indo Russian Summit, “Our strategic ties continue to grow stronger”. Will this have some reactions from the US and in what form or severity?
Who knows? Maybe or Maybe Not.
4. All complex adaptive systems anticipate the future.
The anticipation of an extended recession, for example, may lead individuals to defer buying a car or taking an expensive vacation- thereby helping guarantee that the recession will be extended. The anticipation of an oil shortage can likewise send shockwaves of buying and selling throughout the oil markets- whether the shortage ever comes to pass.
Peter Lynch had said these wonderful words that perfectly complement the above statements “More people have lost money waiting for corrections than in actual corrections.”
Isn’t this what we have witnessed in the last 20 months and what are we witnessing now?
In investing, the stock market too is a perfect example of this (a complex adaptive system). In our daily lives, it’s traffic (and I had written about traffic earlier).
Can you ever predict traffic?
Google Maps will give you a sense today, but can you really predict the behaviours of millions of drivers on the road and how they interact with each other?
Likewise, can you ever predict the movement of stock markets in the short run?
There are millions and millions of events, and interactions that are happening. A small event has the ability to shake global markets in the short run.
Thus, we cannot predict what will happen in the short run.
However, we crave certainty in an uncertain world. There is a deep instinct to make predictions, and to be proven right (or rather not wanting to be wrong or look foolish). Thus, we tend to predict or look for people who can predict. This approach gets us to commit costly mistakes.
The key to success is all about action without prediction. Thus, we must rely on a Process and Not Prediction (or Speculation) when it comes to real investing.
What are you relying on “a Process or Prediction?”
To be Continued Part 2.