Blog written on January 12-th, 2015.
In a recent article “Why The Next Stock Market Crash Will Happen Any Day Now” it is claimed that a massive stock market crash (down by 50%) will happen any day now. Based on past crash patterns it is said that we are on the verge of another huge collapse.
Crashes (of systems) are triggered by destabilizing events (natural disasters, conflicts, defaults of systemic corporations or banks, etc.). However, in order for a crash to actually happen a given system must be fragile. Evidently, a weak system will suffer attacks more than a resilient one. Like many other systems, global finance is a system. With one difference. It is huge – it engulfs our entire globe, the whole economy – and its dynamics are neither understood nor under control. The current state of the global economy provides eloquent proof.
The next big stock market crash needs, therefore, two conditions to materialize at the same time: a destabilizing event of sufficient intensity and a fragile global financial system. While the triggering event may not happen, as for fragility, we’re very close to dangerously low levels. In fact, systems with resilience equal to or less than 50% are candidates for collapse. Again, low resilience (high fragility) is not a sufficient condition for collapse but it is a necessary one. The evolution of resilience of the Global Financial Resilience Index over the past 110 trading days is indicated below (the present blog written on January 12-th, 2015).
The first drop in resilience, observed approximately 100 trading days ago was relatively mild. The one we witnessed 10 days ago is abrupt and there are no evident signs of recovery. The global financial system is, today, very fragile – 54%. The longer it stays so low the greater the danger. The interdependency is also quite high – 43% – favoring fast propagation of shocks and contagion. The most likely contagion paths may be deduced from the Complexity Map of the Global Financial System (indicated below) with the help of particular software tools.
(click here to view above map in interactive mode).
However, the effects will in any event propagate at internet speed so that it doesn’t really matter what mode of failure the system selects. What is important is what the result will look like, i.e. where will the system settle after a potential collapse.
What is important in conditions of market collapse is to have as resilient asset portfolios as possible, so as to (potentially) minimize the consequences. This is accomplished by designing low-complexity portfolios using a newly developed technique. Click for details.