Injecting liquidity into the stock market is a bit like taking an aspirin when one feels sick. It lowers the fever (a short-term relief), sometimes at the expense of long-term recovery.  Could it be that printing money extensively and cutting rates to low levels for too long increases market fragility as well?

Previously, Louis outlined the four asset classes that investors appear to regard as anti-fragile, now that US treasuries no longer fit the bill. With each of these four asset classes enjoying a roaring bull-run, today Louis examines the typical life cycle that lifts an asset class from unloved hell to anti-fragile heaven.

Since the 1980s, OECD government bonds have tended to be negatively correlated with equities, but during the pandemic that relationship seems to have broken down. Given that the Federal Reserve is embracing a new policy framework aimed at juicing up inflation, there are plenty of reasons to think that bonds cannot continue to play an “anti-fragile” role in portfolios. In this first installment of a two-part series looking at what…

As highlighted in Part I, we are witnessing the transition of our world from a ‘Disciplinary Society’ to a ‘Society of Control’. In Part II, we study the structural opportunity to buy the winners, i.e. the FAANMG (Facebook, Amazon, Apple, Netflix, Microsoft, Alphabet) and the likes.

A ‘Society of Control’ requires and therefore favours the mass treatment of information, and is rewarded by a multiplication effect. Today, the FAANGM provide access to computing, communication, internet, social network, gaming, film, music, and e-commerce. In other words, they all leverage the intangible part of value, i.e. information.

The three trillion-dollar hedge fund industry has spent the past decade traversing a barren desert, experiencing disappointing performance and dried up returns. An oasis, however, may be in view!

Balanced investment portfolios intuitively combine fragile assets, such as most equities, and antifragile assets, such as government bonds from developed economies or precious metals, gold or silver. However, how does one choose the right antifragile asset? The answer depends on monetary policy.

In our early letters on “Antifragility Revisited”, we demonstrated evidence of a linear relationship between many financial assets’ excess return and their variance at all probability levels. Such a relationship was conspicuously absent from the considerations of Modern Portfolio Theories. This required a transgression to Professor Taleb’s description of fragility and anti-fragility. But where does this relationship come from? This letter uses physics to explain the concepts of fragility and antifragility from a theoretical standpoint. Fragility and antifragility emerge as a natural consequence of market competition;  they provide a financial variable which discriminates winners and losers in various market regimes. A few simple equations can be used to highlight the theory, and demonstrate how one calculates the physical variables, such as fragility. Readers who are not familiar with mathematics need not worry. The equations are even simpler than the ones used in traditional portfolio theories − that is to say, very simple!

The Theory of Financial Fragility anticipates the behaviour of financial assets in times of stress. Such anticipation not only requires a new conceptual framework regarding market arbitration, but also the help of modern physics and its understanding of energy transfers. “Introduction to Financial Entropy” and “The Energy of a Fragile Asset”, published earlier this year, dealt with the financial interpretation of various forms of energy, such as potential energy associated with expected returns, kinetic energy associated with asset variance and “uncontrollable”, “risky”, or “useless” energy associated with entropy. The Theory of Financial Fragility considers assets as species in an ecological competition vying to access the “useful” part of energy, also known as “free energy”. In other words, finance is no exception. It is governed by physical laws, and by an arbitration principle among strategies competing for survival. Understanding survival strategies is key to identifying potential winners and losers in periods of stress, and to build investment portfolios with heightened robustness. This letter focuses on the conceptual framework: the specifics of self-organized structures that ‘dissipate’ energy, such as planet Earth, living organisms, economic systems, financial markets, and many other systems that shape the evolution of mankind and, to a larger extent, the evolution of the universe, in their own way.

Physics would simply not exist without conservation laws. The conservation of energy in a closed system, for instance, is the first principle of thermodynamics and one of the most important concepts in physics.  Does finance follow similar laws? And what would the “energy” of a fragile asset mean?

The fragility theory might well be the first financial theory providing a rational explanation for critical risks, behavioral irrationality, and market ruptures. In this letter we analyse why “criticality” emerges from fragility, and how to measure it.

The previous publication dealt with providing a formal measure of fragility, shown to be the slope of a return to variance graph. In this letter we analyse why this property is a necessary addition to modern portfolio theories (MPTs). MPTs focus on correlation across assets and on Value-at-Risk. These provide insightful information in calm market phases, but often implode in tails, when they are most needed. The fragility theory introduces a new variable−the fragile or antifragile nature of investment assets−to help capture hidden risks. The missing variable from MPTs is linked to most of the “unexplained” market behaviors described in this publication.

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