Tag: Black Swan

  • The Black Swan Event – Is it Coronavirus?

    The Black Swan Event – Is it Coronavirus?

    The Black Swan Event
    No one can predict the Black Swan event, but this coronavirus is a danger in many ways.

    The question could coronavirus be the Black Swan event for the stock market, started with the increasing number of infected people. But this reason isn’t the only one that generates this question. Numerous companies temporarily shut down their operations in China. According to CNBC, General Motors’s spokesman sent an email that stated the company said to its employees that it will keep its factories in the country shut through Feb. 9. General Motors is the largest U.S. automaker in China. Also, Starbucks temporarily shut down almost half of the existing locations in the same country. Moreover, if the infection progresses, the company will close more without hesitation, said its CEO, Kevin Johnson. Google is another large company that temporarily closed its offices, and Microsoft employees in China will work from home until Feb. 9. Amazon and Google have restricted employees to travel to China. Also, many airline companies slashed or stopped their flights to China. All due to government-imposed travel bans in China.

    Markets reaction

    Markets are reacting to the potential consequence of the coronavirus blast.
    Global markets sold off on Monday but started to stabilize on Tuesday. The stocks are still close to record highs reached recently. But the comparisons with the 2003 SARS is out the question. Though, everyone makes them. 

    Could coronavirus be the Black Swan event for the markets?

    Let’s say this, in 2003 China growth was reduced by 1 percentage point. But the growth rate of China’s economy since 2003 increased and China has a bigger role in the worldwide markets today. Maybe the markets shouldn’t be so careless this time.

    The coronavirus could have a far more serious impact on the world economy than the SARS epidemic in 2003. At the end of 2002, the Chinese GDP was estimated at around $1.5 trillion, 4% of global GDP. In 2019, the Chinese GDP was $14.3 trillion and above 16% of global GDP. In the time of the SARS epidemic, China just joined the World Trade Organization. That’s the main difference.

    Influence on the global economy

    According to some estimates, today even a small downturn in the Chinese economy can cause volatility in the global oil market and global trade, for example.
    Firstly, the number of tourist and business trips to China is already declining. Further, China’s GDP growth rate could decline by 0.5% to 5.6 percent this year, as a result of the outbreak of the virus corona epidemic, according to some experts.
    As we can see, the coronavirus has already impacted the world’s commodity markets, including the oil market. 

    The price of Brent crude oil has fallen 14% since the beginning of this year, largely due to news from China and continues to decrease.

    But could it be a Black Swan event?

    The coronavirus is an understandable concern to stock market investors. Since the stock market is overbought and in such a condition, it can be extremely unsafe and vulnerable. Some investors are convinced that the coronavirus epidemic could cause the Black Swan event in the markets. Moreover, they started to buy on dips thinking that this event is temporary and will not live for a long time.

    We all hope so since medical science has dramatically advanced and the virus could be contained. But who can predict what is going to happen in the markets? The Black Swan event could happen or not. There is a 50/50 chance, in fact.

    Investors should be realistic. The coronavirus can be a seasonal event and by spring it can be contained. But as we said, even such a small and short-term event may cause changes in the stock prices. Of course, when the number of cases is increasing, the stock market is decreasing. The main problem to the market is that this virus appeared in the time of bullishness in the stock market. This is a critical point.

    It can be the Black Swan event for the Asian market

    Asian markets fell Thursday, January 30. The reported number of coronavirus infected increases every minute. That makes difficulties for the global economy. Hong Kong’s Hang Seng Index (HSI) had its worst day since August this year on Wednesday, January 29. The index lost 2.1% and it already has fallen over 5% in January. 

    Japan’s Nikkei 225 sunk by almost 2% on Wednesday. South Korea’s Kospi fell 1.5%. But Taiwan is the biggest loser among the Asian markets, Taiex fell 5.5%.

    So, the virus can really disrupt China’s and Asian economy. How far it will spread? Will it affect the global markets? 

    Several circumstances could lead coronavirus to affect asset prices on a global level. On Monday, January 27, the US stocks dropped significantly gaining a new low record since October last year. The fear is rising. Investors are moving their holdings from risky stocks to safe havens. The coronavirus affected the global markets. Is it a Black Swan event? The risk is high and also the possibility. The influence of coronavirus on global stock markets is than SARS could ever do. 

    How is it possible the coronavirus affects markets so quickly?

    First of all, the news is spreading very fast creating reasons for turbulent market moves. The virus’ is spreading over the world fast and leads to market downswings. The global supply chains are interconnected tighter than ever. The trade networks are complex and, at the same time, vulnerable. So, some kind of domino-effect is very possible. If the coronavirus spread extensively that will influence the companies based in China. 

    Also, if the coronavirus continues to spread, it could reflect in stock prices. Well, one of the biggest global economies is affected already.
    JPMorgan decreased its  GDP estimate for China on Wednesday, indicating a “demand-side shock” caused by the coronavirus. 

    Thus, the positive 2020 economic predictions can be undone very easily due to coronavirus.

  • Black Swan Investing Strategy To Reduce The Risk

    Black Swan Investing Strategy To Reduce The Risk

    Black Swan Investing Strategy
    Predicting when the next black swan event will happen is the mission impossible. But you can create a portfolio created to reduce the risks related to black swans.

    Black Swan investing isn’t quite a strategy, it is more a trading philosophy. Actually, it is a method of predicting the occurrence of black swans. The black swan is an unplanned, unexpected event in the markets. Such events come as a sudden blow and may influence the market. But black swan also can have both a positive and negative impact and we are going to discuss them here.

    An example of a negative black swan is the crisis of 2008.

    Black Swan investing is a trading philosophy based completely on the probability that some accidental event will hit the markets. To avoid losses caused by a black swan, traders who are trading based on black swan strategy always are buying options, never sell. They never estimate will the market go in one or another direction, up or down, they are buying. These traders are actually betting on the chance the market will move both up and down.

    Protection of investments 

    Behind that behavior is investors’ need for insurance for their portfolio to protect against another black swan event like it was financial crisis 2007-2009.

    They are afraid of is losing money as they did at the time of the crash. But losing money is a risk that you have and can determine. The black swan is a risk that you can not determine or predict. How can you plan some sudden and hidden events ahead? Hence, we can’t hedge out the risk of secret and unknown events. All we can do is analyzing past events.

    The black swan investing theory is based on an old saying that presumed black swans did not exist. Nassim Nicholas Taleb developed black swan theory but in his book The Black Swan he also recommended traders to fire their advisors claiming that they don’t know enough or know a bit about investing. Brave claim indeed. His belief in the incompetence of financial advisors is based on their disregard for Black Swans.

    Is it possible to predict the next event?

    It sounds like an impossible task because it is. As we said, how can you predict something unknown? But what you can do is to build a well-diversified portfolio to reduce the risks. Also, now you have this tool to determine when to exit your trade and avoid money losses. Moreover, you can determine when to do that in profit. 

    Yes, your portfolio can be structured to reduce risks linked to black swans.

    Positive or negative black swans

    Okay, you would like to know how to invest for positive or negative black swans. So, first of all, you have to understand how not to depend on catastrophic predictions. Let’s say, you invested with the belief that the stocks will grow forever. Also, you are pretty much sure that the financial crisis will never come, or the company will never bankrupt. Well, something has to be changed in your beliefs. The truth can be very painful for you at this very moment. Stocks will not rise all the time. Not even in the next 20 years or even five. They will go up and down.

    The main point of black swan investing is to profit from unpredictability. But such events come suddenly, they are surprising, so how can we invest in it? We cannot do it directly. All we can do is to be ready for them, meaning to be exposed to such exceptional but extremely impactful events.

    How to expose to a positive black swan

    How to do that? How to take advantage?

    If you follow Taleb’s definition it is quite clear what to do to positive events. If you can seek exposure to something you can not predict,  then seek out exposure that is unrestricted to the upside. Well, there is no need to know will some event come or not, or when it is going to happen. All you have to do is to detect exposures that have the potential to blast if meet the proper conditions.

    Exposure to positive black swans may sound a bit esoteric. Some investors that are practicing a black swan strategy like to say that it is necessary to build a portfolio that is able to “invite” positive events, amazing and unexpected. We don’t have material proof that it works. 

    Their idea is to give a portfolio a chance by setting up limited sums of money or scale it up. If it works, it’s okay. If it doesn’t work, just give up and risk later. 

    This stands in firm contrast to traditional investing advice.

    Behind this idea

    For any trader who wants to implement the black swan investing strategy, it is necessary to create a barbell portfolio. This kind of portfolio was created by bond traders. This strategy requires owing safe short-bonds on one side of the barbell, and on another side to balance the weight of investments, riskier long-dated bonds.

    By building a barbell portfolio, you’ll have very safe investments on one end and notably risky investments on the other end. The safe investments virtually don’t have risk. They will survive even a black Swan. The risky side of the portfolio opens it up to the endless upside. This kind of portfolio advances despite any circumstances in the market. That’s according to Taleb.

    Black Swan investing 

    Since black swan traders never sell and they are counting on the crash, they are buying out-of-the-money options.

    But one question arises. Can any empirical evidence account for black swans? We are afraid the answer is no. So, we cannot predict the market. Why there are still people trying that? Because we all need progress in this field. Yes, we have algos, AIs, learning machines, automated trading, etc. But yet, no one can predict the market. And it is a great challenge. By fair, that moment isn’t so far from us. One day someone will find some formula for that. Frankly, how many people were able to predict all possibilities of the internet? A very small number. Today it is part of our daily lives. 

    Yes, we truly believe that one day, somewhere, someone will find a way to predict market movements. Meanwhile, there is no need to give up from investing because of the lack of unreachable knowledge. Just work with what you have and know. That would be enough. At last, it was enough for the past 200 years.

    Pro tip: Develop an efficient portfolio on a demo account first; (1) Examine how well it guards you from random Black Swans (2) optimize (3) only then risk real funds.

    Bottom line

    Banks are a negative black swan business. The upside is inadequate and the downside is complete. The examples of positive black swan investing biotechnology stocks, venture capital, publishing, etc.

    The venture investor that invested in Uber in its beginning was exposed to a positive black swan, but today would be more exposed to a negative black swan with the same investment.

    The key principle in black swan investing is to find extremely aggressive as unreasonable as possible assets. Hence, when you find that chance, take it.