In less than five minutes, world markets were literally shaken to their knees once again by a “black swan,” Nassim Nicholas Taleb’s term for an unexpected and disruptive event. But we’ve had quite a few of these lately. Are these rare birds growing more common, and what can you do about them? MoneyShow.com editor-at-large Howard R. Gold explains.
It hasn’t been the greatest week for investors.
Global markets, already unnerved by rising oil prices and the looming threat of inflation, were sent reeling by the massive 9.0-rated earthquake and tsunami that hit Japan—and then the alarming accident at the Fukushima Daiichi nuclear power plant, 140 miles northeast of Tokyo.
As I write this, explosions have damaged four buildings at the site, and fears were mounting about core meltdowns and the dangers of radiation release.
The S&P 500 index is now off about 6.5% from its recent high a month ago, and other, more volatile indexes are down more. Japan’s Nikkei-225 has lost nearly 20% of its value.
Once again, investors have been thrown for a loop by events that seemingly came out of nowhere. The black swan is back, and this time she’s radioactive.
A black swan, popularized by Nassim Nicholas Taleb in his 2007 book of the same name, is a rare, unexpected, disruptive event. It has three attributes.
“First, it is an outlier, as it lies outside the realm of regular expectations,” Taleb wrote. “Second, it carries an extreme impact. Third…human nature makes us concoct explanations for its occurrence after the fact, making it explainable and predictable.”
A Whole Herd of Dangerous Swans
By Taleb’s definition, I can think of four major black-swan events over the past 15 years:
- the 1997-98 Asian currency crisis
- the September 11, 2001 terrorist attacks
- the housing crash and financial crisis
- and this.
(I don’t include Hurricane Katrina and the Deepwater Horizon oil spill because they primarily affected the Gulf of Mexico, while the dot.com boom and bust was a bubble within the market itself, not a “real-world” event.)
Taleb despised the academic orthodoxy of contemporary economics and finance, which he said focus almost exclusively on the most likely outcomes of economic and investment decisions—the big round bell of the bell curve.
Turning probability theory on its head, Taleb argued that the unlikely events on the far end of the bell curve will hurt you most, precisely because they’re unexpected and because “cumulatively, their impact is so dramatic.”
It all adds up to more uncertainty, or risk—which in many investors’ minds has been growing exponentially in recent years.
But Was This Really Such a Surprise?
Any natural disaster is by definition unexpected—on the day it occurs. But Japan is in an active seismic zone, with a big earthquake as recently as 1995. The island nation sits near four major tectonic plates, which makes it more susceptible to tsunamis, too. After all, tsunami was originally a Japanese word.
At first blush, the nuclear accident also came out of nowhere. But it, too, should not have been a surprise.
Tokyo Electric Power had a long history of problems in its nuclear facilities—it had to shut down all its reactors in 2002 for emergency inspections after the company failed to report many cases of falsifying inspection records.
These particular reactors were nearly 40 years old, with an antiquated design.
Granted, there was no way to anticipate the confluence of all three events, whose impact was devastating—but each discreet element was predictable.
That’s why despite the awful human toll of the earthquake and tsunami, the destruction wasn’t even worse: Japan was generally very well-prepared to deal with the natural disaster of the earthquake and tsunami, and undoubtedly averted even bigger damage. The nuclear accident is another story.
But the bigger question is, has the world changed so much that black swans are likely to happen more often?
Next: Financial Crises and Nuclear Meltdowns