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Divergence
• Phenomenon in Nature and Markets
• Something that needs explaining and can be unexplainable
• Linked with change or rate of change
• Non normal aspect, happens less than normal
• Could indicate change, a potential reversal
• Creates news
• Can be seen in information, data, patterns
• Is studied and researched
• Divergence as a system
• Divergence as strategy
Divergence Cases
• (1723-1790) Adam Smith; Invisible Hand; “What you don’t know?”
• (1848-1923) Vilfredo Pareto; 80% wealth with 20%; “Unequal”
• (1851-1902) Charles Dow; Industrials vs. Transports; “Non confirmation”
• (1871-1948) Ralph N Elliott; “truncation, double extension, throw over”
• (1917 – 2008) Edward Norton Lorenz; “Chaos”
Divergence Cases
• John Murphy; Gold and Dollar; “Intermarket Failure”
• Sam Stovall; Sector Performance; “Varying”
• Robert Shiller; Market vs. Fundamental Value; “Fluctuations”
• Mandelbrot; Fractals; “Extremities”
• Nassim Taleb; Black Swan; “Random”
• Robert Arnott’; Growth and Value; “Cycles”
• Robert Prechter; Social Mood; “Changing”
• Behavioral Finance; Investors; “overreact or underreact”
10
100
1000
10000
1860 1880 1900 1920 1940 1960 1980 2000 2020
Pri
ce
Year
Comparing Actual Real Stock Price with Three Alternative PDVs of Future Real Dividends
Actual Real Stock Price (P)
PDV of Dividends
PDV Dividends
Using Actual
Consumption-Discounted
Dividends, (P*, A=4)
Source: http://www.econ.yale.edu/~shiller/
Divergence Cases Robert Shiller – American Economic Review 1981
Divergence Cyclicality
• John Murphy; Intermarket linkages are cyclical
• Sam Stovall; Sectors cyclically move in and out of performance
• Robert Shiller; Cyclicality in bubble formations
• Mandelbrot; Repeating Extremities
• Nassim Taleb; Recurring random events, Periodic
• Robert Arnott’; Investing out of growth into value and vice versa
• Robert Prechter; Social Mood diverges cyclically
• Behavioral Finance; Investors; Long reversals repeat
Quantifying Divergence
• Power Law
• Exponentiality
• 80-20 visual
• Herbert Simon’s Hierarchical Structures
• Quantifying divergence is about quantifying ‘Time’
• Redefining Mandelbrot’s multi fractals
• Tony Plummer’s Triad
• Kyoto Economics Journal
• SSRN – History of Economics Journal
• Complexity frequently takes the form of Hierarchy
• Hierarchic systems - common properties
• Independent of specific content
• Interrelated systems
• Hierarchical at lower levels – elementary subsystem
• Hierarchical Social Systems
• Chart of social interactions – Hierarchic structure
• Biological, Symbolic, Self reproducing systems
• Complexity had to evolve from simplicity
• Attempt to explain power law distributions
Herbert Simon
Intermarket Cycles
Intermarket Analysis Intermarket Cycles
ASSET B
A/ B RATIO
ASSET A
K K K
ASSET B
A/ B RATIO
ASSET A
FIRST ITERATION
SECOND ITERATION
THIRD ITERATION
• Pair Relative performance
• Rate of Change Triad Iterations
• Are these price or Time Fractals?
• What’s the unit of Relative Performance?
• Could triads can be seen in a ratio?
• Triads in pairs suggest price was never fractalled
• It was always ‘Time’
GE VS CAT intermarket ratio line vs. ROC
Rieki
• How would you rank Spain Euro cup chances 2012 (1-10)?
• Do human’s rank intuitively?
• Is intuition a system?
• What do you prefer, absolute or relative performance?
• Is BRICS, PIGS not about ranking?
• How do we diversify?
• Dow performance is absolute or relative?
• How do investors allocate?
• What is the global competitiveness report?
• What is Euro vs. Dollar?
• Why is yield curve a spread?
• Is it about Charts, Fundamentals, Sentiment, Mathematics?
Questions
• Risk vs. Return
• Demand for cash vs. Demand for assets
• Risk aversion vs. loss aversion
• Pessimism vs. Optimism
• Perceived risk vs. actual risk
• Relative vs. Market Value
• PE vs. Market Value
• Liquidity vs. Solvency
• Supply vs. Demand
• Contango vs. backwardation
• Divergence analysis is a study of Cycles (time)
• Relative performance has no units
• Relative performance studies time
• Every traded asset is a pair
• Ranking/Pairs/Divergence is connected
• Way to comprehend Divergence
A VS. BRelative not Absolute
WHEN
WHEN
WHEN
WHEN
Alpha
• Active - Passive
• Emotion - Skill - Risk
• Active today, passive tomorrow
• Alpha
• Numeric Ranking
• Relative Ranking
• Quantify divergence
• Combining Pairs and Ranking. Why?
• Because larger the divergence better the quantification.
Alpha
• Long India, Short China
• Long Silver, Short Gold
• Long Dow, Short S&P500
• Long Chevron, Short Exxon
• Long Oil, Short Natural Gas
• Long Schatz (2 YR German bonds), Short Bobl (5 yr)
• Long Dollar Index, Short Lero
• Long Dollar, Short Yen
Alpha
• Long Zinc, Short Coffee
• Cross Asset Myth. Time does not differentiate between assets
• Changing benchmarks
Yield curve
-40
-30
-20
-10
0
10
20
30
40
50
2-Apr-08 2-Oct-08 2-Apr-09 2-Oct-09 2-Apr-10
P10: US2 - US30
Long US2Short US30
Short US2Long US30
• Decay expressed by lambda
• ℮-λx
• 1 ~ 25
Time Decay
0
10
20
30
40
50
60
70
80
90
100
1234567891011
0
50000
100000
150000
200000
250000
300000
350000
13579111315171921232527
0
5E+15
1E+16
1.5E+16
2E+16
2.5E+16
1591317212529333741454953576165697377
Summary
• Research focused on identifying divergence rather than quantifying it
• Divergence is not only qualitative but also quantitative
• Divergence is cyclical and is about quantifying Time
• Ranking and relative performance illustrates divergence cyclicality
• Just like divergence even ranking and performance are cyclical
• Performance cyclicality works across assets and across time frames
• Today’s outperformer is tomorrow’s underperformer
• Near perfect hedge does not exist. Time can redefine hedge efficiency.
• Time data exhibits order that is similar to an exponentially class.
• This proves that the divergence seen in nature is more ordered than random.
• Time is fractalled and the reason for power law in nature and markets.
• This order in Time is the reason performance is cyclical.
• Time Index
Where are we?
1930s 2020s1990s1960’s
www.orpheus.asiawww.timetriads.comhttp://econohistory.com