The Butterfly Effect and Stock Portfolios

In 1961, pioneering MIT meteorologist Edward Lorenz developed a computer program to simulate weather. In experimenting, he made very minor adjustments to atmospheric conditions which had a huge impact on his long range forecasts. Recognizing that tiny alterations in assumptions can dramatically change results, in 1972 he wrote a paper, “Predictability: Does the Flap of a Butterfly’s Wings in Brazil Set Off a Tornado in Texas?” (Source: Mr. Szuszkowski’s Global Classroom, www.myteacherpages.com).

 Lorenz’s work led to musings centered on the butterfly effect, the idea that seemingly small and unconnected events can have a major impact. That thought resonated relative to an account written by a woman who stepped out of the “rat race” to lead a simpler life. She sold her financial services business because, as she said, “The stress was making me sick despite the money I was making.”

Said she, “My husband and I have learned to live a very simple way of life and it has given me a compassion and understanding that I did not have when finances were not an issue.  We grow food, bake bread, change the oil in our car, and generally have stopped delegating the daily chores of living that we were convinced to do as high wage earners in our previous lives.  Delegating creates dependence and an underlying anxiety knowing you have to earn enough to continue supporting that dependence.  We fortunately owe no one anything and by learning to grow our food, maintain a simple two-room shelter in a climate that requires no fossil fuels or electricity (we are off-grid solar), we live on an amount monthly that we used to spend just on dining out. I think this has been a pretty cool learning experience.”

That works for her and as a financial advisor, I applaud efforts by a stressed out person to change their relationship with money to live a more peaceful life. While her approach is more extreme than most, the crash of 2008 has forced overextended boomers to cut back. Consumers are shedding debt, at a rapid clip, whether involuntary through foreclosure or bankruptcy, or voluntarily.  Savings rates are increasing.

On an individual basis, the trend is healthy. But for Federal Reserve head Ben Bernanke the actions (or lack thereof) of millions of butterflies, a.k.a. consumers, is frustrating efforts to stimulate the economy. Think about the velocity of money. If too many people pull back, save, simplify, and do not spend, the ripple effect depresses profits, jobs, and tax receipts.

If too many people bake their own bread, what happens to the commercial bakers who produce bread, the company that makes the packaging for the bread, the truck drivers who deliver it, the suppliers of fuel to power the trucks, and the neighborhood supermarket that sells the bread? If too many people change their oil, what happens to Jiffy Lube? Jobs dry up, taxes decline, welfare and benefit payments soar, the government runs massive deficits, and the country loses its soul to Chinese lenders.

And so it goes...  As the pain spreads, the economy slows down, and the stock market goes into the tank. This further raises anxieties and consumers pull back even more, and the down cycle is exacerbated. The next thing you know, we are in a depression, and forcing millions, more to bake their own bread and change their own oil. All of this because one woman decided to move to a “little house on the prairie.”

We offer this commentary as a bit of holiday levity, but there is a point. The trend toward savings and decumulation is part of the Age Wave and the privations of the recent recession. For many this is healthy as balance sheets are repaired. Many U.S. multinational companies look to bolster profits in emerging markets where millions of younger and eager consumers are gravitating toward middle class status.  That is why global diversification in portfolios is a must.

Recent data showed that existing home sales are climbing out of the 2008 abyss and builder confidence in the future is at the highest level in three years. Not everyone is clamoring for two-room adobe hacienda, a good thing relative to the velocity of money and the need to spur the economy. Dare we hope that consumers will shop till they drop and spur a Santa Claus stock market rally? It could not hurt!

Lewis Walker is President of Walker Capital Management LLC and Walker Capital Advisory Services, Inc., a Registered Investment Advisor (R.I.A.) Securities and certain advisory services offered through The Strategic Financial Alliance, Inc. (SFA).  Lewis Walker is a registered representative of SFA which is otherwise unaffiliated with the Walker Capital Companies