From: John Conover <john@email.johncon.com>
Subject: Re: News: Futurist: markets, attacks, point to possible depression
Date: 6 Nov 2001 02:30:19 -0000
Obviously, the not very significant odds of an imminent depression
doesn't mean that a depression is not imminent-it might be, and might
not be; such things are unknowable. But it does mean that there are
probably more significant economic things to be concerned about.
In reality, if things are managed correctly, it doesn't make that much
difference, anyhow.
For example, what is the chance of a significant depression, (i.e.,
one lasting at least 3 years, with a GDP decline that is at least a
three standard deviation probability annual event,) happening in the
course of an 80 year lifespan?
Since there is a 77 year window around such an event that would effect
the financial security of someone with an 80 year lifespan, the
chances are (2 * 77) / 526, or about 29.3%-which is not insignificant
odds.
Its a handy number to know, since, under those circumstances, one
should optimally maintain about 60% of one's net wealth in investments
that were relatively immune to fluctuations in the GDP, (i.e., placing
F = 2P - 1, or, 2 * .293 - 1 = 41.4%, at risk of a 50%-100% economic
catastrophe.)
I don't give financial advice, so exactly how to implement such a
strategy will be left to your own ingenuity.
John
BTW, its actually not that easy, and a lot of creativity is usually in
order. For example, many invest about half their net wealth in real
property. However, during the US Great Depression of 1930-1933, asset
values deteriorated an average of 60%-leaving many holding a big debt
bag of insolvency, taking down the US banking system with them; more
recently, there was a similar scenario during the Asian
Contagion.
Savings accounts, treasuries and Munis have a similar vulnerability in
times of high inflation, too, (remember the early 1980's, or the S&L
debacle-which financially ruined many.) Likewise, currencies, (for
example, the yen-dollar ratio was about half what it is now in late
1994-which was disastrous depending on how and when one was moving
money; many wealthy individuals in Latin/South America lost fortunes
moving money from regional collapsing economies to the US currency
haven.) Metals, stones, art, automobiles, etc., all have significant
vulnerability over an 80 year lifespan.
Such risk is what derivatives are all about, (and many run their own
derivative strategy-usually exploiting the fact that standard
deviations of values add root mean square in an investment portfolio,
and risk can be reduced to any acceptable value by spreading asset
allocations over many things, over the planet.) Remember that the
objective is to make about 60% of the portfolio's value as stable,
(i.e., minimal acceptable risk,) as possible, and enhance the
portfolio's value by manipulating the remaining 40%-i.e., "hedge" the
40% against the 60%; always watching to move money in a defensive
fashion.
You will have to make your own decision on how to do that.
John Conover writes:
>
> Always, in times of tribulation, doomsday prognostications capture
> the media's attention.
>
> We might be headed into a depression, and we might not. Whether we
> are, or not, is not knowable.
>
> However, the odds of a depression being imminent are not very
> significant.
>
> The standard deviation of the increments in the US GDP, over the
> 20'th century, was about 10% per year, (0.099733 from 1930-1995.)
>
> During the US Great Depression of 1930-1933, the GDP dropped about
> 50%, (in 1930, it was $96.8 billion, in 1933, it bottomed at $56.8
> billion-the GDPs in the Asian Contagion in the late 1990's did about
> the same.)
>
> The standard deviation of the decrease in the US GDP during a
> depression that lasts at least three years is about sqrt (3) * 0.1 =
> 0.17.
>
> Or, a 50% decrease would be about a 0.5 / 0.17 = 2.887 standard
> deviation incident, which has a chance, on average, of once in 526
> years, or about twice a millennia-quite a rare event, indeed.
>
> John
>
> BTW, assumptions: Black-Scholes paradigm, erf (3) = 1, statistical
> independence in the marginal increments of the US GDP-all reasonable
> first order approximations, (depending on who is telling the story,
> of course.)
>
> Statistical estimate on the standard deviation of marginal increments
> of the US GDP being 10% is about 1 / sqrt (95 - 35), or about 12%, or
> a confidence level of about 88%. Call it a 90% confidence level.
>
> Data references: 1996 US Federal budget,
> gopher://sunny.stat-usa.gov:70/11/BudgetFY96, and the 1997 US Federal
> budget, http://www.doc.gov/BudgetFY97/index.html. Data from Table 1.2,
> "SUMMARY OF RECEIPTS, OUTLAYS, AND SURPLUSES OR DEFICITS(-) AS
> PERCENTAGES OF GDP". Data not adjusted as constant 1987 dollars, nor
> inflation.
>
> So there.
>
> http://www.computeruser.com/news/01/11/05/news15.html
--
John Conover, john@email.johncon.com, http://www.johncon.com/