Black Swans and Grey Rhinos
King Solomon wore a ring with the inscription, “this too shall pass”. The coronavirus has been declared a global pandemic and the financial markets are reacting with distress. What is driving the correction is uncertainty and fear more than objective fundamental assessments. Panic is a natural reaction to fear of the unknown. At Global Asset Management, we believe that the best antidote to panic is understanding what is happening. Investors who do so, and stay calm for the next few months, will be in good shape. As we witnessed firsthand in Seoul, the calm, measured actions of South Korea are the best way to navigate a crisis.
The widely accepted assessment of the current situation is that it’s a Black Swan event. By definition, Black Swans are rare, unpredictable and extremely chaotic. They arrive by surprise, create a major impact, and are explainable in hindsight. Statistically speaking, they are outliers. This makes them impossible to predict, even using advance computer models and metadata.
Black Swan investment theory is attributed to Nassim Nicholas Taleb, a historian and former options trader. The expression actually dates back to 16th century London, as a metaphor for impossibility. Europeans assumed swans were all white. Since that’s all they had ever seen, they considered the existence of black swans to be impossible. In 1697, Dutch explorers travelling in Australia saw black swans for the first time, and were shocked. Since then, the term has been a metaphor for the concept that something previously considered to be impossible could in fact occur. The term Black Swan has been used to describe World War One, the creation of the Internet, the fall of the Soviet Union and the terrorist attacks of September 11, 2001.
Others say that the correct metaphor for the current crisis is a Gray Rhino. Linguists use this term to refer to highly probably but overlooked threats that cause a massive impact. U.S. author and policy analyst Michelle Wucker coined the term. She introduced the concept at Davos after the Greek financial crisis in 2012. In contrast to a Black Swan, a Gray Rhino is a “highly probable, high impact yet neglected threat…grey rhinos are not random surprises, but occur after a series of warnings and visible evidence”.
Wucker considers the current crisis predictable, since the likelihood of global pandemics is known. Scientists certainly know that high impact outbreaks are highly probable. Now that this one has occurred, she argues that we should have known it would. But this goes back to the third aspect of a Black Swan event: explainable in hindsight. Whether this is a Black Swan or a Grey Rhino is immaterial. There is chaos in the market, and Global Asset Management investors need to make objective decisions of how best to handle their decision making.
When the stock market drops sharply, investors get distressed. People have been lulled into complacency by the incredible bull run over the last few years. The current crisis is challenging. Not only is it impossible to predict what is unpredictable, but people are concerned about their health as well as their financial security. Panicking also makes people more vulnerable to a scam. Certain things, however, are within our control:
- Establish a formal investment plan with a Global Asset Management advisor for objectivity
- Ensure adequate diversification in your investment portfolio to lower risk
- Identify opportunities within the chaos to turn a black swan white
As the great Warren Buffett said, ‘Be greedy when others are fearful and fearful when others are greedy.’ Fear and greed drive stock markets. It’s important to remember that panicking is the best way to lose money. Losses are only on paper unless you sell and realize them. Looking at things from another angle, every transaction involves a seller and a buyer. The fact that the market hasn’t dropped to zero means people are buying stock right now. Who is buying? The Pros. For example, when Delta Air Lines crashed at the end of February, none other than Buffett himself was buying. Berkshire Hathaway picked up just shy of a million shares at $45-$47, down from $62 less than a month earlier. Buffett knows how to turn a black swan white.
What Will This Correction Look Like?
This is the question. GAM advisors know timing markets is a fool’s game. It’s impossible to predict the length or depth of a stock market drop with any certainty. One thing we know is that market corrections are normal, and they always reverse themselves. The bellwether S&P 500 has, on average since 1950, had a 5% decline 3x per year, 10% pullback every 16 months, and 20% correction every seven years. It’s normal.
Stock markets dislike uncertainty. But we’ve seen Black Swans before, and what we do know is they pass. Over the long term, the stock market goes up. One of the worst stock market crises was the September 11th terror attacks. In anticipation of major panic, they shut down the NYSE and the Nasdaq for the longest period since 1933. When the markets finally opened, the NYSE experience its largest drop in history. The S&P was off 11.6% and the Dow Jones Industrial Average dropped over 14%. And yet. One month later, the stock market had regained all of those losses. Several sectors were even up – defense, communications and pharmaceutical stocks.
The Global Asset Management team in Seoul, Korea remains optimistic about the future. We invite anyone interested in finding shelter in this storm, and even profiting in these markets, to give us a call.