Saturday, May 28, 2022

Non-Linear

 Non-Linear


A 40-year chart of the DJIA obscures an almost infinite number of non-linear events. Judged over time by the eye, stock market volatility looks benign and performance linear. It looks resoundingly positive, and it is, but zooming in on almost any short period reveals intense periods of volatility. How can this be?

Statistically speaking, the long-term stock market performance may be the finest example of linear regression next to species genetics. In many ways there are similar. Multiple non-linear events occurring simultaneously over longer periods of time result in many economic failures, and also several sustaining successes. Consider the private equity world.

In the private equity world (PE for the pros) for every Apple, Facebook, Google, Uber, Amazon, success story there are probably 1,000,000X or perhaps even 1,000,000,000X failures to reach fruition. Put another way, investing works best when you own the survivors. A great example is the S&P 500 Index. 

The companies in an S&P 500 Index are not static; ie losers drop out and off the face of the Earth, while winners survive and populate the index. By default, investors are buying a basket of winners. To be a member of the S&P 500 Index, at this very snapshot moment, you must be a non-linear survivor. The failures by default are members of the S&P 1T failure index...that has a value of zero.

The Navy Seals have many excellent quips, one of my favorites is "It pays to be a winner." You got that right! The all-weather mentality of being in the stock market through thick and thin is a tough one to adhere to when volatility spikes and misery ensues. But being a winner means surviving and thriving, just like a member of the S&P 500.  

By default the longer an investor is in the stock market the greater her fortune should be (as evidenced by the 40-year chart above.)  The danger then becomes one of timing...more to come on that next post.