4/3/2020
The vast majority of Americans have probably never heard of the term “Black Swan” especially when used in the context of an economic event. So why are we writing an article about this thing called a Black Swan? It’s because Black Swans create an unpredictable, negative and many times catastrophic event that reaches beyond what is normally expected of a situation. Sound familiar? Black Swans potentially almost always create severe consequences even though they are characterized as an extreme rarity. After the event is over and the severity of its impact is understood, there is generally a widespread insistence that the event was obvious when viewed in hindsight! In 2007 Nassim Nicholas Taleb wrote a New York Times best-selling book on the subject titled “The Black Swan: The Impact Of The Highly Improbable”. So what was the origin of the name “Black Swan”? In his book Taleb explains that before the discovery of Australia, people in the “Old World” (Europe) were convinced that all swans are always white. No one had ever seen a black one, never! This unassailable belief was confirmed by empirical evidence which was that no one had ever seen a black swan before. So when a black swan actually appeared it challenged what this meant from a statistical perspective.
Black Swan events have three characteristics: First, they are outliers because it lives outside the realm of regular expectations because nothing in the past can convincingly point to its possibility. Second, it carries an extreme impact. Third, in spite of its outlier status human nature makes us concoct explanations for its occurrence after the fact, making us believe that the event was explainable or predictable. Let’s think in terms of historical events that lacked predictability. Taleb’s example focused on the September 11, 2001 terrorist attacks in the United States. If the risks had been conceivable the day before on September 10th, the Twin Towers would be standing today and the disaster would have been averted as if it never happened. If the disaster had been predictable and understood there would have been fighter planes encircling the sky above the Twin Towers. Airplane cockpit doors would have been built so they locked and were bulletproof (which of course they weren’t at the time of the downing of the towers) and of course New Yorkers would have stayed home from work. This is simply an example of a Black Swan event. There are many others including the 1997 Asian Financial Crisis, the Dot-Com Bubble 2001 and the 2008-2009 “Global Financial Meltdown” which includes the “Great Recession” in the USA. Let’s elaborate for a moment on America’s “Great Recession”. In the USA the Great Recession needs to be combined with a second Black Swan event known as the Subprime Crisis. This is the time from November 9th of 2007 to March 9th of 2009 when the S&P 500 lost 56% of its value in 16 months. The sub-prime crisis led to a devastating increase in thousands of foreclosures and bankruptcies of mortgages that caused millions of people to lose their homes as well their life’s savings. It is generally considered to be the strongest economic decline since the Great Depression of the 1930s. Although its affects were definitely global in nature, especially in Europe, it was most pronounced in the United States where it originated.
A recession is defined as a macro-economic event that refers to a significant decline in general economic activity. Based on this definition one may ask is a recession a Black Swan event? The answer is “No”, but that doesn’t mean that there can’t be overlapping events and characteristics similar to that of a Black Swan. Remember Black Swans are not predictable and are always devastatingly catastrophic. Recessions are defined as two consecutive quarters of economic decline as scored by GDP (Gross Domestic Product). Recessions can however, like Black Swans, range from mild to catastrophic. In an examination of the Great Recession of 2008 we saw the Federal Reserve step in and attempt to curtail negative economic activity. In February of 2008 President George W Bush signed into law the “Economic Stimulus Act”. This legislation provided taxpayers with rebates from $600 to $1,200, which they were encouraged to spend back into the economy. The plan also reduced taxes and increased the loan limits through the Federal Home Loan Program like those offered through Fannie Mae and Freddie Mac. This last element was designed to hopefully generate new home sales and provide a boost to the economy. The so called stimulus package also provided businesses with financial incentives for capital investment. However, even with these interventions the country’s economic troubles were far from over. In March of 2008, investment banking giant Bear Stearns collapsed after attributing its financial troubles to investments in subprime mortgages and its assets were acquired by JP Morgan Chase at a discounted rate. A few months later financial behemoth Lehman Brothers declared bankruptcy for similar reasons creating the largest bankruptcy filing in U.S. history. Within days of the Lehman Brothers announcement the Fed Reserve agreed to lend insurance and insurance giant AIG $85 billion dollars so that it could remain afloat. Political leaders justified their decision by saying AIG was “Too Big To Fail”! The government believed a collapse of AIG would further destabilize the U.S. economy and possibly accelerate fears that similar collapses could be sustained by other major financial companies and banks. In the early fall of 2008 President Bush approved the Troubled Asset Relief Program better known as “TARP”. TARP was essentially to provide loans (with interest paid back to taxpayers) to troubled US banks. A massive $700 billion dollar war chest was created to lend to mostly struggling financial institutions in order to keep them in business. The program would also enable the government to buy assets which they in turn could later sell, hopefully at a profit. Within a few weeks of the initiation of TARP the government had spent $125 billion acquiring assets from nine US banks in early 2009. TARP funds were also used to bail out automakers General Motors and Chrysler for a combined $80 billion, and aided banking giant Bank of America for $125 billion.
January of 2009 also brought a new administration into the White House as Barack Obama was inaugurated as President of the United States. However many of the old financial problems remained on the new President’s desk. In his first few weeks in office President Obama signed a second stimulus package into law. This time earmarking $787 billion in tax cuts as well as additional spending on infrastructure for schools, health-care and green energy. Whether or not these initiatives brought about the end of the “Great Recession” is a matter of debate. However, at least officially, the National Bureau of Economic Research (NBER) determined that based on key economic indicators including unemployment rates and improvement in the stock market the recession in the United States officially ended in June of 2009.
Although the great recession was now “officially” over in the United States many people in America and for that matter in other countries around the world were still feeling the negative effects of the downturn and did so for many more years. In fact from 2010 through 2014 multiple European countries including Ireland, Greece, Portugal and Cyprus defaulted on their national debts forcing the European Union to provide them with bailout loans and other cash investments. These countries were also compelled to implement greater austerity measures such as tax increases and cuts to social benefit programs including health care and retirement programs to repay their debts associated with the Great Recession. The recession also ushered in a new period of financial regulation in the United States as well as other countries around the world. Economists have argued for years, and still do, that it was President Bill Clinton’s repeal in 1990 of the Glass Steagall Act that contributed to America’s banking problems that led to the Great Recession. While the truth is probably more complicated than that the Glass Steagall Act that was originally enacted in1933, right at the end Great Depression, was passed in order to place strict regulations on banks in order to stabilize our financial system. With Glass Steagall banking regulations now dismissed through its repeal or minimally watered down many of the country’s larger financial institutions morphed to become significantly larger which created the term “too big to fail!” In an attempt to reestablish the benefits lost by the repeal of Glass Steagall the government responded in 2010 with the passage of the Dodd Frank Act which was signed into law by President Obama. Dodd Frank reestablished and restored many of the U.S. government’s regulatory power over the entire financial industry and enabled the federal government to assume control of banks deemed to be on the brink of financial collapse Dodd-Frank also established and implemented various other consumer protections designed to safeguard investments and prevent predatory lending banks who provided high interest loans to borrowers who likely could have difficulty paying off their loans.
So what’s the multi-million dollar question we are addressing today? Is Coronavirus COVID-19 a Black Swan event?” The answer is, YES! It most certainly has met the requirement of being “unpredictable”. The results have obviously been massively negative and it most certainly has been in our opinion catastrophic! As well, the facts as they relate to the stock market’s decline has been historical! The S&P 500’s bull market in stocks officially ended on February 19,2020. The bull market for the Dow Jones and the Nasdaq Composite actually ended on February 12, 2020. If the bull for the S&P had lasted just a couple of weeks longer to March 9, 2020 it would have recorded it’s 11th consecutive year of the bull market run. Our recent stock market crash of 2020 fell on the new “Black Monday” March 9th 2020. On that day the Dow Jones Industrial Average recorded the its largest point drop ever of -2013.76. The previous record setting drop occurred on Black Monday October 19,1987 when the Dow fell 508 points (-22.61%) closing the day at 1738.74. Meanwhile, on that same day, the Nasdaq Composite and the broader-based S&P 500 shed -625 points and -226 respectively. This blew to smithereens their previous largest single-day point decline. On a percentage basis the NASDAQ gave up 7.29% and the S&P 500 lost 7.6% for its 17th largest percentage loss of all time. Before the current correction there have been 37 declines of at 10% in the S&P 500 since 1950. The good news is that everyone of these drops were completely erased by a bull market rally that many times started back up again around three months after the drop.
Black Swan, recession or correction historically it never really mattered whether you had just stayed the course or were lucky and had cash on hand to buy stocks as they declined, as a way of building and perpetuating wealth stocks have provided returns rarely seen from any other asset.