If everyone can quantify the risk that the world will burn,
then if it goes up in flames it’s now allowed to count as a black swan (or
blind tail risk) event.
The term black swan,
made famous by Nassim Nicholas Taleb, refers to a phrase from a time London
when they wore funny clothes, and powdered wigs. At the time everyone thought a swan was
white, thus a black swan was viewed as impossible or at least improbable. Without getting too philosophical, the phrase
refers to risk to which the consensus is totally blind, either because their
premise or their process is wrong.
Basically a black swan risk is a huge catastrophic risk not many see
coming - the unknown unknowns (i.e. we don’t know the risk or the outcome).
“Betting against a U.S. financial collapse was a great call. Betting against a Eurozone crash was a great call. Betting against a Chinese hard landing that threatened the whole world was a good call. Betting against a debt ceiling default was the right call.”
Those assessments were totally correct. Further, the risks of those events moving
forward have been substantially diminished; however, those were all known unknowns
(i.e. we knew the risk, but not the outcome).
A common misconception is that risks like the aforementioned are black
swan events: they are not, and the reason is the consensus at the very least
saw these coming head on. On the surface
this seems like a debate in semantics, though it’s more practical to one’s
portfolio than that.
While it’s true those aforementioned risks are now less
likely than before, as the article points out the market has probably priced
that in by now. Thus, our conversations
with clients on risk are shorter, our bullish thesis is stronger, and our asset
allocation observations are lower on conditionals (e.g. stocks will have a good
year if various European countries don’t replay the French Revolution).
Therein lies the issue, investors are now more confident that
those large scale risks are diminished.
This is true for what everyone can see, but can NEVER be true for actual
black swan events. Further, as the known
risks seem to evaporate the probability of being oblivious to a true blind tail
risk event inherently becomes greater.
All of this is a nice way of saying be prepared for
anything, never be too strong in your investment convictions, or dismiss
anything outright. The ways to
accomplish this are through proper diversification, discipline, the use of out-of-the-money
put options, and other prudent risk management techniques. This is also why I have been
bullish, but never omniscient.
The views and opinions
expressed herein are those of the author(s) noted and may or may not represent
the views of Capital Analysts, Inc. or Lincoln Investment. The material presented is provided for
informational purposes only. Nothing contained herein should be construed as a
recommendation to buy or sell any securities. As with all investments, past
performance is no guarantee of future results. No person or system can predict
the market. All investments are subject to risk, including the risk of
principal loss.
