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Thursday, September 19, 2013

Did the Sensex jump up due to the ‘Butterfly Effect’?

The short answer to that question is: It seems so. For the long answer, a small digression is necessary. The term ‘Butterfly Effect’ is used in ‘Chaos Theory’ to explain why a small change in the initial condition of a complex, non-linear system can lead to a significantly large change in the system subsequently.

In simple English, it means that the flapping of the wings of a butterfly in India can cause a typhoon in the South China Sea. Exaggeration, you say? Apparently not. To test the ‘Butterfly Effect’, a fighter jet formed a ‘figure of 8’ contrail with its exhaust over California. Weather scientists tracked the contrail all the way to Texas – 2200 KM to the east – over the next several weeks. By then, the contrail had turned into a 800 KM long cloud formation!

The US Fed briefly flapped its wing on Sep 18 by maintaining status quo on the QE3 bond-buying programme. After testing global markets with its ‘tapering’ call earlier – which sent FIIs scurrying away from emerging markets – kicking the debt can down the road was taken as a positive surprise by market players.

The liquidity tap shall remain open – probably for another month or two – when every one was expecting at least a $10 Billion cut to the US Fed’s $85 Billion per month bond-buying programme. Bulls celebrated, and the remaining bears capitulated. S&P 500 touched a life-time high. Sensex touched its highest level in 3 years.

Every one seemed to forget that the status quo hinted at a less-than-satisfactory US economic growth. In the short-term, the market acts like a voting machine – and the vote was firmly in favour of bulls. So, what should small investors do now? Jump in? Book profits? Hold for higher levels?

That depends on the state of one’s portfolio and asset allocation plan. Turmoil in the stock market should not determine your investment action. Your asset allocation plan should. If you don’t have a plan, how will you achieve your investment goals? You haven’t set any investment goals yet? Your portfolio is probably giving no returns.

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