In 2006, investment analyst John Mauldin wrote an article, “Fingers of Instability.” The original article is currently only available embedded in someone else’s article. I strongly recommend reading the whole thing.
Here’s a snip:
To find out why [such unpredictability] should show up in their [computer-generated] sand pile game, Bak and colleagues next played a trick with their computer. Imagine peering down on the pile from above, and coloring it in according to its steepness. Where it is relatively flat and stable, color it green; where steep and, in avalanche terms, ‘ready to go,’ color it red. What do you see? They found that at the outset the pile looked mostly green, but that, as the pile grew, the green became infiltrated with ever more red. With more grains, the scattering of red danger spots grew until a dense skeleton of instability ran through the pile.
“Here then was a clue to its peculiar behavior: a grain falling on a red spot can, by domino-like action, cause sliding at other nearby red spots. If the red network was sparse, and all trouble spots were well isolated one from the other, then a single grain could have only limited repercussions. But when the red spots come to riddle the pile, the consequences of the next grain become fiendishly unpredictable. It might trigger only a few tumblings, or it might instead set off a cataclysmic chain reaction involving millions. The sand pile seemed to have configured itself into a hypersensitive and peculiarly unstable condition in which the next falling grain could trigger a response of any size whatsoever.”
Something only a math nerd could love? Scientists refer to this as a critical state. The term critical state can mean the point at which water would go to ice or steam, or the moment that critical mass induces a nuclear reaction, etc. It is the point at which something triggers a change in the basic nature or character of the object or group. Thus (and very casually for all you physicists), we refer to something being in a critical state (or use the term critical mass) when there is the opportunity for significant change…
So what happens in our game? “… after the pile evolves into a critical state, many grains rest just on the verge of tumbling, and these grains link up into ‘fingers of instability’ of all possible lengths. While many are short, others slice through the pile from one end to the other. So the chain reaction triggered by a single grain might lead to an avalanche of any size whatsoever, depending on whether that grain fell on a short, intermediate, or long finger of instability.”
Now, we come to a critical point in our discussion of the critical state. Again, read this with the markets in mind (again, emphasis mine):
“In this simplified setting of the sand pile, the power law also points to something else: the surprising conclusion that even the greatest of events have no special or exceptional causes. After all, every avalanche large or small starts out the same way, when a single grain falls and makes the pile just slightly too steep at one point. What makes one avalanche much larger than another has nothing to do with its original cause, and nothing to do with some special situation in the pile just before it starts. Rather, it has to do with the perpetually unstable organization of the critical state, which makes it always possible for the next grain to trigger an avalanche of any size.”…
Relating this to our sand pile, the longer that a critical state builds up in an economy, or in other words, the more “fingers of instability” that are allowed to develop a connection to other fingers of instability, the greater the potential for a serious “avalanche.”… [end quote]
Of all the many wise and insightful observations that John Mauldin has shared over the years the “Fingers of Instability” article is particularly brilliant. Mauldin himself revisited the subject several times.
I was strongly reminded of the Fingers of Instability earlier this week, prompted by a Wall Street Journal Article that showed the deeply intertwined business deals among the major AI companies.
https://discussion.fool.com/t/ai-investments-vs-en…
I’m not the only once concerned about the dangers of circular financing in the AI space. Patrick Boyle made a video about it.
URL: http://www.youtube.com/watch?v=NbL7yZCF-6Q
The stock market partied last week because the CPI was 3% which was “lower than expected.” I wrote about this – no point repeating myself. It’s way above the Federal Reserve’s target rate and certainly not improving.
https://discussion.fool.com/t/inflation-less-than-…
I don’t see how inflation can improve considering the tariffs on imports, the dramatic increases in insurance costs and groceries and many other factors impacting households.
The Atlanta Fed’s GDPNow model estimate for real GDP growth (seasonally adjusted annual rate) in the third quarter of 2025 was 3.9 percent on October 17. This is strong growth. The combination of high inflation and strong growth should inhibit the Federal Reserve from cutting the fed funds rate but the options market expects two more 0.25% fed funds rate cuts in 2025.
The Chicago Fed’s National Financial Conditions Index (NFCI), which provides a comprehensive weekly update on U.S. financial conditions in money markets, debt and equity markets, and the traditional and “shadow” banking systems, shows that financial conditions are very loose already. Coupled with fed funds rate cuts the loose money is supporting the stock market bubble and the bond market. Whether this will impact consumer price inflation depends on how much of the money will get into consumer hands.
Consumer sentiment is weak, largely due to higher prices. The Personal Savings Rate is falling (from 5.7% in April 2025 to 4.6% in August). Consumer Debt Service Payments as a Percent of Disposable Personal Income has dropped over the same time and is lower than the pre-Covid average.
Bond yields are falling. The Treasury yield curve has dropped along its entire duration. The 10 year Treasury yield is 4.0% and actually fell below that last week.
The last two cycles of fed funds rate cuts caused the interest paid by savings accounts and money markets to decline in parallel until the yields were close to zero. It’s important to maintain an emergency fund in cash. But it’s worth thinking about building a bond ladder to lock in today’s relatively high yields. The value of bonds will rise if prevailing yields fall. These can be sold on the secondary market for a capital gain if the cash is needed.
Caveat: the markets are still predicting long-term inflation of 2.3%. If inflation expectations rise then long-term bond yields will also rise to compensate investors. Also, the government is running huge deficits so the yield curve may steepen.
Stock indexes soared to another record high. The trade moved back toward risk-on. The Price-to-earnings ratio is based on average inflation-adjusted earnings from the previous 10 years, known as the Cyclically Adjusted PE Ratio (CAPE Ratio), is over 40 (compared to a long-term median of 16).
The Fear & Greed Index is still in Fear. The demand for Treasuries and USD is a move toward safe haven.
Top U.S. and Chinese negotiators sounded a positive note on weekend trade talks, hailing what they called constructive discussions ahead of a meeting between President Trump and Chinese leader Xi Jinping planned for this week. But of course Trump is unpredictable and could shoot the whole game out of the water even if the trade negotiators worked up a fair deal.
https://www.wsj.com/world/china/bessent-sounds-con…
The METAR for next week is sunny. As always, the METAR is a short-term forecast. The Fingers of Instability build up gradually. It’s impossible to say when the avalanche will trigger.
Wendy
https://www.atlantafed.org/cqer/research/gdpnow
https://www.cmegroup.com/markets/interest-rates/cm…
https://www.chicagofed.org/research/data/nfci/curr…
https://stockcharts.com/freecharts/candleglance.ht…
https://stockcharts.com/freecharts/candleglance.ht…
https://stockcharts.com/freecharts/candleglance.ht…
https://stockcharts.com/freecharts/yieldcurve.php
https://www.cnn.com/markets/fear-and-greed
https://www.multpl.com/shiller-pe
https://data.sca.isr.umich.edu/get-chart.php?y=202…