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Last year, Nassim Nicholas Taleb wrote a thoughtful editorial in The Wall Street Journal that underscores that investors must learn to live with general disorder and volatility and the frequency of black swans.

In economic life and history more generally, just about everything of consequence comes from black swans; ordinary events have paltry effects in the long term.... Modernity has been obsessed with comfort and cosmetic stability, but by making ourselves too comfortable and eliminating all volatility from our lives, we do to our bodies and souls what Mr. Greenspan did to the U.S. economy: We make them fragile. We must instead learn to gain from disorder.
-- Nassim Nicholas Taleb, " Learning to Love Volatility," The Wall Street Journal (Nov. 17, 2012)

Random market movements may also may be a function of uncertainty -- uncertainty regarding economic and profit growth but also, I think today, uncertainty of what the appropriate P/E multiple is in a setting of artificiality (and difficulty in estimating the life of policy) in which natural price discovery is being masked by the historic liquidity provided by the world's central bankers.


Volatility and disorder are likely a more constant state in a global economy that is experiencing a new normal that remains on tenterhooks, still experiencing the deleveraging and tail issues stemming from the last down cycle and, as a result, only experiencing a fragile trajectory of growth.

Below are Taleb's five rules for prospering in a world in disorder. It is a good list.

Rule No. 1: "Think of the economy as being more like a cat than a washing machine." Policy aimed at stability and the absence of pronounced cycles is misplaced. As Taleb writes, "The state should be there for emergency-room surgery, not nanny-style maintenance and overmedication of the patient -- and it should get better at the former." Cease bailouts and keep safety nets as long as they encourage entrepreneurs and do not increase dependency.

Rule No. 2: "Favor businesses that benefit from their own mistakes, not those whose mistakes percolate into the system." Certain industries -- such as the restaurant business (when their meals are poor in quality, they have to improve the quality in order to survive) or the airline industry (whose safety measures improve after each disaster) -- are anti-fragile. Success should be an outgrowth of adversity. By contrast, each bank failure hurts the entire system.

Rule No. 3: "Small is beautiful, but it is also efficient." Size often increases fragility. The elephant breaks his leg at the slightest fall, but the mouse is unharmed by a steep fall. (This helps to explain, in part, why we have more mice than elephants!) We need an economic system that distributes risk along a wide range of sources.

Rule No. 4: "Trial and error beats academic knowledge." Potential errors should be small; potential gains should be large.

Rule No. 5: "Decision makers must have skin in the game." We ended up in the financial and economic soup in the last cycle because bankers had a "tails I win; heads you lose" compensation system. Whether that compensation includes a large portion of stock or whatever it takes, corporate executives must have a significant and vested interest in the companies they manage. They must be accountable for lack of success and must suffer financially when there is failure to execute.

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