A flock of black swans could soon eat your profits
As I have written before, in mid-2007 the Bank of England saw no chance of the 2007-2008 financial crisis and ensuing recession occurring – even if it was only in a few weeks. Not one of the hundred scenarios modeled by its economists in the Bank’s quarterly “fantail” projection envisaged the crisis.
When it happened, everyone rushed for an explanation – discovering in the process that not only could it have been predicted, but a few soon to be very wealthy investors had done precisely that and were positioning themselves to profit from it. . (Read Michael Lewis The big court to find out who they were.)
And the crash did much to cement the reputation of mathematician, essayist and investor Nassim Nicholas Taleb, who previously published Duped by chanceand just before the crash published The black swan.
“Black Swan events” have now entered the language: extremely improbable events which nevertheless cannot be completely ruled out. They probably have won’t happen – but they might.
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A flock of swans
We have seen several since. Donald Trump as President of the United States, for example. I remember hearing several political pundits say that would never happen. Brexit, for another. Not even the Brexit campaign expected the vote to go their way, it later emerged.
And a global pandemic, for another. Two years later, supply chains and more are still in shambles. As I write, easyJet cancels hundreds of flights – not because of travel bans, but because so many crews are coming down with Covid-19.
Inflation at 10% or more. Electricity prices at exorbitant levels. And now Ukraine. Black swans, every one of them.
My point is not necessarily to avoid losses. The Footsie as I write these words is 7,556 – in other words, higher than it was on February 23, just before the invasion; and higher than it was on 1 January.
It is a larger point. Because investing in individual businesses involves making choices.
And as we’ve seen over the past two years, these choices can involve Black Swan risks.
Pubs, leisure businesses, hospitality businesses and non-essential retail businesses have closed due to the pandemic, for example. Airlines don’t fly and cruise ships don’t sail.
Brexit? Let’s not go.
What will be the impact of a combination of exorbitant inflation, exorbitant fuel and energy costs and an effective ban on doing business with Russia? One way or another, we’re all going to find out.
And I’m certainly not optimistic enough to believe that all my investments will not be affected. What happens to the Footsie is one thing; what happens to individual companies is another. Two years after Covid-19, some of my investments are still not paying dividends, for example.
What to do?
In The black swan, Taleb says we spend too much time trying to predict events. It’s true: day after day, I see dozens of predictions, made by all kinds of people, about all kinds of things. Predicting the future is a very human trait.
But is trying to predict the events of Black Swan worth it, or even sensible?
Taleb argues not. And I tend to agree with him. Far better, according to Taleb, to focus on building resilience: Extremely unlikely events can happen, but their effects don’t have to be catastrophic.
And when it comes to investing, that means a broadly diversified portfolio. Different asset classes, different geographies, different instruments.
It is not too late
Most ordinary investors don’t do that. As I’ve written before, we’re too prone to home country bias, to begin with: a lot of us don’t own foreign stocks, don’t own foreign index trackers, and don’t are not exposed to foreign currency and foreign income streams.
We don’t own enough properties, although the UK stock market is rich in UK and overseas REITs and non-REIT property companies. Ditto for infrastructure companies.
We also tend to hold too much cash and prefer to invest in well-known companies whose products we buy or whose business premises we frequent.
And so on.
If this sounds familiar – if you see yourself in this description, in other words – the good news is that it’s not too late to change your ways.
Because the Black Swans keep coming.