Feed Your Mind: Black Swan or Just a Bubble?
After a stock market decline of 56.8% from peak to trough in the S&P 500, I heard a lot of people using the term Black Swan. Of course, they are referring to the event described in the book The Black Swan: The Impact of the Highly Improbable by Nassim Nicholas Taleb. When I ask what “black swan” they refer to the fact that they had all of their money in equities because they didn’t see it coming. Or, they talk about now being underwater in their (second) arm interest-only mortgage because they could never imagine house prices falling so much. After all, housing only goes up, right?
Wait, is this a Black Swan? According to Taleb’s definition, a Black Swan is something that is: a surprise, has major impact, and importantly, after the fact, is rationalized in hindsight. It’s this third criteria that is important. After the fact, if a surprising event is rationalized such that we should have expected it, then in fact we don’t sufficiently adjust our behavior to prevent future similar Black Swans.
Interestingly, I think the housing bubble is closer to Black Swan territory. Friends who got caught in this real estate bubble are now lamenting that they should have seen the warning signs (like explicit warnings from me that I can’t remind them of). But during the peak of the bubble, when I was the grand pooper of dinner parties for not thinking real estate only went up, there were numerous times when I asked about affordability and income/purchase ratios, and was told, “but this is different.” Thus, my expectation is that a real estate bubble will form again in surprisingly quick fashion. As for the stock market, I think many people are genuinely surprised by the sharp decline and I’m not hearing as many people voice that they should have seen it. What may happen is a shift toward fewer equities, and more bonds and cash, in investment portfolios. Unfortunately, this would be just in time for inflation.
There’s also a point made in Taleb’s book that is less covered than the surprise factor, and that’s the notion of positive Black Swans or surprises on the upside. Taleb recommends creating more opportunities to take advantage of positive Black Swans. He mentions holding biotech stocks for this reason, since a major disease cure would cause the price to skyrocket. Or perhaps writing a book that is timed with a surprising market move?
