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The Physics of Financial Catastrophe

Slight, soft-spoken Didier Sornette is a master of disaster, a scientist who has made the forecasting of catastrophes in space, on land, in cities and in the market his life's work.

He started two decades ago in France with seminal work on the predictability of rocket-engine ruptures and failures, then earned a professorship in geophysics at UCLA by applying his complex-systems research to the more grounded task of predicting waves of tectonic ruptures that lead to earthquakes. Next week, he meets with the Dutch government to explain how his models predict the sort of societal ruptures that result in waves of urban criminality.

But all of those efforts are child's play next to the work he has undertaken on behalf of investors. In a new book, Why Stock Markets Crash, the polymathic physicist proposes that complex-system theory can explain and predict both the emergence of financial bubbles as well as their rupture and path of recovery.

So far, so good. The book was just published this month, but Sornette has been issuing papers in academic journals that have quietly made accurate financial predictions, ranging from the 1999 resurgence of the Japanese stock market and its follow-on decline, as well as much of the U.S. market action last year. His latest predictions, made without reliance on any of the usual technical, seasonal or economic indicators in vogue on Wall Street, suggested in August that U.S. stocks would sink into October, but then rally sharply into the start of 2003.

Sornette's fractal model suggests that the current rally will stall shortly and that prices will subsequently retreat much lower over the next 12 months to 18 months, punctuated from time to time by strong countertrend rallies. After the S&P 500 index reaches the low- to mid-600s from its current perch at around 925, his model predicts a multiyear period of convalescence for U.S. stocks before a new bull phase pushes prices back toward and beyond their 2000 highs. He promises to provide a monthly update on his prediction at his UCLA faculty Web site.

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