WIH: What follows is a brief summary of a paper that Peter has written on the current world financial crisis, it's causes and the actions needed to resolve the problem. It's very long, highly technical and, in places, incomprehensible for those of us who never went beyond the potato graphs of Economics 101. For anyone who wants to read the entire study, drop me an email with your snail mail address and either Peter or I will get a copy to you. (Peter and I have had problems sending it; some of the graphs have failed to transmit.)

Peter mentions three books he had just received. Perhaps he'll be able to recommend the best of them with a short précis. The last with its "reader friendly manner" sounds the most promising, but the second with advice on "how we can protect ourselves" may be the most practical.


Current World Crisis

Peter Kirkham: 22 Feb 09



Last Fall, recognizing my need to understand the current world economic crisis, and its implications, for our investment portfolio, I did an analysis, documented in a paper. The paper is too long to post on this web site, but I suggested to Bill that if some classmates wished to read this material, perhaps we could find a creative way to make it available to them.

In the paper, I concluded that, while the sub-prime mortgage activity was a facilitating factor in our current economic mess, it was not the primary source of these difficulties.

The primary cause arose from the build up of capital imbalances of world flows of funds (between countries), primarily in oil exporting countries (from high oil prices), and in the East Asian countries, especially China (from persistent trade surpluses). These funds, seeking investment opportunities, found banks around the world, and Wall Street, only too happy to facilitate such investments, through “collateral debt obligations (CDOs)”, underpinned by US sub-prime mortgages.

Recognizing this situation, I focused on what all this means for our investments. I use Canada as a specific example. This is the primary focus of the paper. (The conclusions apply more broadly. That we now have 75% cash in our personal portfolios, perhaps, captures the summary conclusion of my assessment).

The current world economy will eventually re-stabilize, but unless the structural aspects of the world economy, giving rise to these capital imbalances, are re-designed, we will find ourselves in this situation again, down the road. (This is a subject of the up-coming meeting of G-20).

Three books (that I received 2 days ago) deal with various aspects of this situation:

1.    Fixing Global Finance, by Martin Wolf, identifies the cause to be the same as I did. His book focuses on how to fix this problem.

2.    Contagion, by John R Talbott, is primarily concerned with how we can protect ourselves (and our investments) in this situation. His conclusions are the same as mine, although more expansive.

3.    The Return Of Depression Economics, by Paul Krugman, discusses, in a reader friendly manner, the broader environment in which we now find ourselves.


So you are offered three choices:

  1. the above 3 books, with great external credibility, involving some 600 pages (about 200 each);
  2. my paper, with no external credibility, but only some 80 pages;
  3. ignore all of the above, and go on leading your own happy lives, without external intrusion.


Bill Campbell and John Plant, I believe, have read at least some of the paper. You can ask Bill and John (privately, or on this web page) whether it is worth an investment of your time. ( Bill/John: I won’t be offended by your feedback, whatever you say. I am studying “Emptiness”, and have reached a stage where I do not take offense at anything or anybody, any more).



Peter Kirkham: 22 Feb 09

Some people have asked me to elaborate on my "approach" in the paper, and explain why I am taking the approach I have. Attached is a short note, designed to answer this request. Hope it is helpful.



  1. I look on the stock market as a complex, turbulent, chaotic, non-linear, dynamic system. This implies that you cannot forecast “price”. What you can do is control risk, to a degree. My approach recognizes this situation, and is geared to deal with it.
  2. Econophysicists ( Sante Fe Institute) are most directly working on these problems. A good summary of their progress is in “Why Markets Crash” by Didier Sornette.

This work has not progressed to the point where its results can easily be used, directly, in stock market analysis at this point.

  1. My approach below is an adaptation, designed to immediately use this type of approach. It represents “ad-hoc pragmatism”.
  2. First, we must recognize that the stock market, irrespective of whether it incorporates all information in price immediately, or not, is not predictable, is not a continuous process, and is periodically marked by “gapping” (where we can get big drops, or ascent), or sharp discontinuities.
  3. The “power function”, encompassing many possible statistical distributions (depending upon the value of the exponent in the function), to our knowledge, best captures the “generating function(s)”, but we do not know why, or when, these generating functions suddenly switch, from one to the other. (think of a generating function as being like a lottery container, holding balls, and the spinning of the container spits out balls). Our statistical distributions do the same, spitting out “prices” in the market (we don’t know how they do it, but each statistical distribution approximates a process).
  4. Now, during benign times, the log normal distribution does a pretty good job of approximating “price generation”. I use it to get a “trend” rate of growth for the market (or individual stocks).
  5. We know that the rate of growth of the stock market is going to approximate the rate of growth of GDP ( growth of wealth). We could expand on this point, but this is the summary position. Thus, I just “don’t” accept the “trend growth number” the statistical process “spits” out, but rather ensure it “fits” this larger model, in terms of value. (I did not accept the shorter term estimates in my paper, 2003 to 2007, because the “values” did not fit this larger model. It indicated we were in the middle of a business cycle, where we started with unused capacity and so could exceed the wealth growth constraints for a short period, but not for any reasonably chosen longer term).
  6. Similarly, sub sectors of the Index, must (on a weighted average basis) fit the overall growth of the Index. And individual stocks must fit the sub sector indexes constraints, in order to be meaningful.
  7. Now as we monitor the Index (or individual stocks) through time, the actual values can deviate from these trend growth rates. However, in the context of the larger model, the actual prices must always “regress to mean”. Through “experience, research, and contemplation”, which when it becomes “second nature”, meaning “internally familiar” (some call this “intuition”), starts to tell me when (hopefully) we are going to get a “change in the generating function”. Most changes in generating functions are marked by “major gapping”, or “minor gapping”. (in the paper I have referred to these “gappings” as “draw downs”).  When the market “gaps”, we don’t know what “generating function” is applicable. (this is where a lot of the research is concentrated; trying to find out when we are going to gap, and what generating function will result).
  8. I have found that when the actual price deviates from trend, we are starting to create the conditions for “gapping”.  Remember, I don’t expect to be able to predict “price”. But I can do something about “risk”.
  9. So when the conditions for “gapping” start to materialize (I don’t know whether, or when, a gap is going to happen) I start to take action to control “risk”. This may mean reducing an investment position ( in the case of “minor gapping”). If conditions are starting to develop where I think a “major gapping” might happen, the safest action is to go to “cash”. This is what I have done under current conditions, now holding 70% cash.
  10. When we have a “major gapping”, the price is going to open lower, when the market settles down (becomes benign, and again can again be approximated by a normal distribution). But before getting back into the market after such a situation, I need to know where the “appropriate level” of price should be to start the “new statistical series of price”. This is why I am interested in “net worth, and price to book”, they being my attempt to find the “level of price” again. I would use anything to do this, including “fundamental analysis” if it would help. All I am trying to do is get the new starting point in the “statistical price series” going forward.
  11. Now my use of the equation p=e x (p/e) is not used for “forecasting”, which I don’t believe we can do. Rather it is used to “distribute the “price variation” between “earnings” (controlled by the firm), “p/e ratio” (market determined), and exogenous factors (generated from outside the market system). Although I cannot forecast price, I can learn how much variation in price (on average over time) seems to be generated by the “firm behaviour”, versus the “market behaviour”.
  12. I feel much more comfortable knowing that the price seems to be using (in its generating function), more of the “firm influence” and less of the “sentiment of the crowd”. It is with this focus that I am interested in finding out the percentage influences on price ( by e, by p/e, and by exogenous factors).
  13. I could elaborate on all of these points, and others Norm, but hopefully, the above explanation convinces you that I am not basing my methodology on either the  “efficient market hypotheses, or “fundamental analysis”.
  14. Glad to continue this discussion if you wish.

Peter Kirkham

1 February, 2009


1. A good critique of the  “modern portfolio theory approach” to market analysis, portfolio construction, and the efficient market hypothesis, is found in Benoit Mandelbrot ( and Richard L. Hudson), entitled “The (Mis) Behavior Of Markets”, Basic Books, 2004. This publication, more helpfully, articulates a “new methodological approach”(This new approach is still in the theoretical development stage, and not easily available for,  direct application in the  market, by market professionals). The book is written in plain English, making it accessible to most readers. As I stated above, my approach, described herein, can be seen as an “ad -hoc adaptation” of a sub-set of the ideas expressed in this book (designed for immediate use in the market).

Peter Kirkham: 23 Feb 09

Contagion is the book that I feel most classmates would get the most from reading. It explains many dimensions of the current crisis, with excellent examples, and then bridges from these explanations to suggest what we might expect going forward in the next few years.He then suggests an investment portfolio for these times. It consists primarily of cash, RRBs (real return bonds), and gold( I believe). The author advises extreme caution in investment positions.I liked the book, and got something out of it. It costs about $27 Canadian.