The book was “The (Mis)Behavior of Markets,” by Benoit Mandelbrot, co-written by Richard L. Hudson (Basic Books).
Mandelbrot’s message: “Like the weather, markets are turbulent. We must learn to recognize that, and better cope.” In other words, investment markets can be more unstable and treacherous than many of us suspect.
Mandelbrot, 83, is Sterling professor of mathematical sciences emeritus at Yale and the creator of “fractal” geometry, which studies the regularities in various irregular systems, from wind tunnels to coastlines.
In his book, he argued that most of the leading financial theories we accept today are badly flawed. Investment markets are not peaceful but turbulent. (Think of the bear markets of 1987, 1997, and 2000.)
Too many people, Mandelbrot argued, believe that the “bell curve” is found everywhere in nature—that most things congregate in the middle, and that the relatively few exceptions peter out on the left and the right. (Hence, the shape of a bell.)
But the bell curve doesn’t apply to the stock market, the cotton market, or to markets in general, Mandelbrot claimed. “The seemingly improbable happens all the time in financial markets,” he wrote. “Extreme price swings are the norm in financial markets—not aberrations that can be ignored.”
Financial advisers may urge Americans to keep 45% of their portfolios in stocks, he went on, but some people are dubious. The Japanese keep barely 8% in stocks, he wrote. Europeans keep 13% in stocks.
So, maybe we Americans shouldn’t have been, and shouldn’t be, as optimistic about stock-market investments as we have been. Remember the book “Stocks for the Long Run,” by Jeremy Siegel, which argued that the stock market was where the big money was to be made?
The trouble with exceedingly turbulent markets, it seems to me, is that (1) we may desperately need money when the markets are in the pits, (2) we may succumb to despair and panic while waiting for the markets to revive—and sell, and (3) it may take a long, long time for such markets to revive.
Lord Keynes put it nicely: Markets can remain irrational longer than we can remain solvent.