Black Swans Everywhere

05/20/2010 12:00 pm EST

Focus: MARKETS

Karen Gibbs

Video Network Hostess, MoneyShow.com

Karen Gibbs, editor of the Gibbs Perspective, recently told attendees of The MoneyShow Las Vegas that Black Swan events aren’t as rare as they once were.

In 2007, Nassim Nicholas Taleb wrote The Black Swan: The Impact of the Highly Improbable.  In it, he argues that most of the really big events in our world are rare and unpredictable.

Taleb lists three criteria for such an event:  It must be a surprise to the observer; it must have a major impact, and [will be] eventually rationalized by hindsight as predictable.

To most investors, the housing market implosion that led to the Great Recession was a black swan event.

BP (NYSE: BP) has its black swan event in the Gulf of Mexico. BP’s 2009 exploration plan and environmental impact analysis for the Deepwater Horizon well suggested it was unlikely, or virtually impossible, for an accident to occur that would lead to a giant crude oil spill and serious environmental and economic damage.

The Greek economic crisis is yet another Black Swan event, although those studying the situation saw legal accounting sleight of hand mask the country’s profligate spending, cheap money and few, if any, financial controls. 

The crisis in Greece threatens to spread to the other PIIGS (Portugal, Italy, Ireland, and Spain), quite possibly imploding the European Monetary Union just as the 16-member euro zone countries try to reach some solution that will save the single European currency.

If that wasn’t enough uncertainty to roil investors, the 1000-point drop [in the Dow Jones Industrial Average]—and partial recovery in a span of about 20 minutes—on heavy volume during the first week in May is being investigated.  No one really knows what caused the market to drop, although the usual suspects (computerized program trading and electronic networks) are getting the lion’s share of the blame. 

These events are obscuring positive economic news, [but] these back-to-back black swan events are conspiring to derail the fragile global economy and sparking a flight to quality into US Treasury securities and the US dollar. 

What will be the impact on investors?  The strength in the dollar may translate into lower prices for dollar-denominated assets, such as commodities.  (The exception seems to be gold, trading above $1,200 an ounce on safe-haven buying.)  A global economic slowdown will also dampen demand for crude, keeping prices in check as the US approaches the summer driving season.

Yes, computer program trading and electronic networks have been blamed before for wild fluctuations in the market.

Yes, we’ve weathered cataclysmic oil spills.

And yes, countries have defaulted on their debts, seen governments collapse, and spread contagion throughout global financial markets (remember Argentina, Mexico, and Thailand?).

But with uncertainty sapping confidence in the market, all eyes will remain on volatility and global markets.

The trading gyrations of early May will trigger more investigations and put more emphasis on financial reform and regulation currently being debated in Congress.  Until confidence is restored in the system, expect more volatility.

As long as governments engage in fiscal irresponsibility, [however,] the global economy will be buffeted by fear.  To paraphrase Mr. Taleb, until governments can refute rumors, expect more black swans.

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