“The greatest danger in times of turbulence is not the turbulence; it is to act with yesterday’s logic.” – Peter Drucker.
Market turbulence just does not happen. There is a catalyst, which is a surprise turn of events. There are daily investment surprises, the difference between expectations and realized results. A surprise creating market turbulence is more than just a micro surprise associated with a company but is a signal of a macro regime change.
Turbulence is an outlier for the set of relationships across all asset classes. It is not just higher volatility but a change in cross-market correlations and relationships. For example, it could be correlations going to one or a change in monetary policy that signals a macro shift in liquidity. The change occurs at a time of market extreme, as periods of high leverage or market views are tilted in the opposite direction that, causes significant portfolio rebalancing. The time length of the turbulence will depend on how fast the market can adjust portfolio holdings. A more uncertain cause will lead to a more extended period of turbulence. A more radical change will lead to a greater amplitude of turbulence.
A regime change means that the model of yesterday cannot be applied tomorrow. The linkages from the past regime no longer exist. Acting with an old model of reality will only increase the cost of turbulence. Acting with a new model will provide for turbulent profits.
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