The world is comprised of systems. Layers upon layers of systems. Systems within systems.
Pioneering scientist Donella Meadows, author of Thinking in Systems, defined a system as "an interconnected set of elements that is coherently organized in a way that achieves something."
Accordingly, a system must consist of three things: elements, interconnections, and function or purpose (purpose is to function what man is to machine).
Humans. Schools. Governments. Economies. Weather patterns. Families. Businesses. Oceans. Communities. Automobiles. Political movements. Elections. The stock market. Each and every one, a system.
Some systems are simple, like checkers. Others are complex, like political systems, or the human body. But each and every one has the opportunity to learn from, and so improve upon, the means by which its elements interact in the completion of its function or purpose.
These learning processes are called feedback loops. Through feedback loops, systems change over time. Usually, becoming more efficient in its function or purpose. In other words, as systems function over time, and feedback loops provide better information as to the proper affectation of the system's purpose or function, the elements learn to better interconnect. The result? A more efficient system.
Consider your child's football team. Beginning of the season? A whining, inefficient mass of self-obsessed, hyperactive units. End of season? A well-oiled machine.
Yet, there are many systems we work within and are affected by that are anything but efficient. Government. The public school system. College football's Bowl Championship Series. But, each of these complex systems happens to share one commonality-the elements involve human beings. Human beings harbor special interests, which affect our abilities to effectively interconnect.
If the circulatory system worked in the same fashion as the public school system, the result would likely be a mass extinction event. There is a reason that the body, and the body politic, are not symbiotic.
Government. Education. The economy. Darwin recognized that, when empowered to act without the interference of artificial stimuli, the strongest systems improve and survive.
These systems are not broken, just complex. Meaning, the feedback loops take longer to provide the information flow needed to properly affect the outcomes. Perhaps time and a greater set of data flow provided via the feedback loops are required before these complex systems involving human special interests may enhance themselves.
One must assume that, eventually, that which is best for most will win out. Sometimes this process requires decades. Centuries. Minutes. But eventually, open-ended systems like capitalism and democracy will get it right. Barring too much government intervention, that is.
Take our forests. Viewers shudder when, on occasion, we see the beautiful green canopy of a forest in flames, and the burning mass races over the landscape towards the communities within their midst. Yet, the problem here is not the forest fire. Forest fires have occurred long before the dawn of man. Lightning strikes have lit up the countryside long before we built communities anywhere near it. Nature's way of purging the disease, bacteria and impurities that build up over time. The forest may take 300 years to take root and grow.
Nature is patient. Human beings? Not so much. When our human versions of forest fires arise to clean burn clear the impurities in the system, like in 2008, we can't help ourselves. We step in to put out the fire. Leaving the bacteria, disease and impurities to prosper, and pollute the system far longer than it should have.
Any system that is forced out of equilibrium, like a dense, overgrown forest will eventually take matters into its own hands. Economies are no different.
The U.S. economic system remains one of the most efficient the world has ever seen. The U.S. has maintained its status as one of the world's most productive nations, even as one of its largest, and most populous. The American economy is a wunderkind that will survive its unfettered and artificial tampering by those serving their unique agendas. The economy will overcome the vilification by those touting circumstances of their own creation and beyond their own control.
So too is the stock market a system. An amazing one that enables the efficient allocation of capital to growing areas of the economy. It is a system that, when left unfettered, rewards intelligent risk taking, and punishes stupidity.
Publicly traded companies utilize the capital afforded by the system to conduct business. The contribution to society made by this system, through all of its individual elements-companies, employees, investors, service providers, etc., is immeasurable.
In addition to transferring capital to areas of need, the market also serves as a pricing mechanism whereby the proper valuation for each company is determined by what investors are willing to pay. Over time, investors consume enough information to make a reasonably educated decision as to whether a particular company represents a sound investment.
As additional data and revelations spill forth from the political, economic and financial arenas (all of them symbiotic), investors continue to develop their opinions, and buy, sell or hold. Along the way, the feedback loops occurring throughout the price determination process call forth every range of human emotion. Greed. Fear. Panic. Joy. Often simultaneously. Like a high school mixer.
Eventually, the market settles on an acceptable valuation, at which point a critical mass of voters (investors), will agree with the system's outcome (current pricing) by allocating capital. Often, the market will overshoot the mark, dropping much lower or rising much higher than the eventual price determination. However, that is a facet to every market-be it oil, housing or grocery.
The system is efficient. Self-enhancing. And beautiful. Some of the elements are not. Some have a lack of patience for feedback loops. They are prone to panic. Ignorance. Poor decisions.
Market valuations have no True North. They occur when the largest number of voters meet the most favored level of pricing. Conversely, when the largest amount of voters determines that the pricing has become too rich, they stop buying, or even begin selling. The result? A falling knife.
Risk and reward. Flight or flight. When the system settles at a price at which investors feel is worthy of the placing investment capital at risk, they join the fight. When investors perceive that the system has reached a point of diminishing returns, they flee. Some investors are right. Some investors are wrong. Always, and at the same time. Because for every buyer, there must be a seller. Thus, the system rewards some, while punishing others.
Yet, for those who accept feedback, become more efficient, avoid past mistakes and hone a methodology, there is reward. For those who approach investing like an evening at the improv, punishment.
Those who think in systems are systematically better thinkers. Einstein. Lincoln. Jobs. Jefferson. Systematic thinkers, each.
Unfortunately, one only need to watch the machinations in D.C. to realize that most of today's policy makers are not systematic thinkers.
A successful investor need not know exactly when the system is accurate or inaccurate. But to have a proper amount of respect for how the system works. Like any system, be it a mountain system, an ecosystem, or the legal system, one either operates within the system, or is punished by the system. So say the laws of nature.
Effective systems eventually get it right. But, not all pigs are patient. Some can be astute. They learn. Build homes of brick. Yet, others are impatient. Take shortcuts. Eventually, they are systematically eaten by the wolves at the door. Stay tuned.