Black Swans

[IlliniDave]

When it comes to laymen in 2007-2009 the depth of the problem seemed to come out of the blue. The 2000-2002 event, that one a person could see coming but greed was rampant at the time. All though I rode the broad market down, I deliberately made sure I did not get overexposed to dot.coms on the way up. The financial crisis was different from my perspective, I don't doubt some people knew about the risks, but the underlying problems were pretty well obscured to outsiders. People knew dot.coms weren't making any money in 1999, and knew things were getting a little wonky in some of the real estate markets in the mid-2000s, but the toxic mess some of the institutional players cooked up for themselves was a surprise.A little air getting let out of real estate was expected, big Wall St players getting their legs get kicked out from under them because of it was not.

I guess to some extent black swans are relative since in a world of specialization information gets compartmentalized. And in the world of derivatives and hedge products people might get disincentivized from sharing what they know. A few people made a lot of money during the financial crisis.

As things stand today we know that asset prices are on the high side. That by itself is probably not enough to drive an big implosion (but a surge of another 30% without some pretty remarkable earnings growth might be too much). Enter the next black swan, perhaps, absent that. Clearly one should not get exposed to stocks beyond their ability to endure a loss. Easy to say, tough to do when markets keep moving upward.

[Riggerjack]

If it makes you feel any better, the Russians tested EMPs back in the 50's. No hawt Jessica Alba dark angel dystopian future from that, I'm afraid.

Telecom backbone is all fiber now, non conductive. Outside copper lines are fused for lightning, on both ends, with lots of spares. Central offices are hardened, with backup generators. I have no idea of what power companies do, but they will have their easily replaced fuse, too.

So I don't know how long such a solar storm could last, or if we could be hit by a series of them, but I doubt there would be much long term effects. Buy stock in Siemens and siecore, and alcatel/lucent/avaya, if it happens... Lots of profits in replacement parts there.

[ThisDinosaur]

In pre-2008 there were several people who figured out what was happening through deep analysis. They also made it known to others. That information diffused as far as retailers like me. I listened to them because I know enough about finance and quantitative modeling in 2008 to see who was "selling" analysis and who was just selling an investment ideology (the stopped clock).

Persuasive. I wasn't investing in 2008, so I wasn't paying attention then. But my point was that black swans are individual. Market bubbles happen when too many people are playing ostrich. Remember, in the original black swan story the Aboriginal Australians were very well aware that swans could be black.

So, you predicted 2008. What's the next one? Is it index funds? Its index funds isn't it.

[jacob]

@ThisDinosaur - There was also the shale collapse predicted due to low EREOIs and it being misfunded due to ZIRP. I remember arguing this with oil industry people who were adamant that everything was going great because these oil guys knew what they were doing---fancy calculations and knowing how to invest blablabla (except their assumptions were made in a vacuum that nobody else would be doing the exact same thing thus causing an oversupply that nobody would buy at the $100/bbl assumption --- and that just 5 years after $100 oil ignited the financial crisis. ARGH! But I think ... that maybe people don't connect the dots because they're only aware of them in the abstract.) There's a thread here somewhere too. That "debate" was remarkably similar to the one I had with an economist (on linkedin) back in 2008 when he suggested that I apply for a job with a certain mortgage company ("There's no problem with the models. These guys are experts. They've been doing it for a long time. They know what they're doing.") that was later acquired by BAC after it folded whereas I was a somewhat hesitant to apply because "isn't the entire industry in trouble because this, this, and that?" This seems to be a pattern---it can oftentimes feel very frustrating.

I don't know what the next thing will be yet. There's nothing obvious sticking out. However, since solutions over the past 8 years have been financial/systemic (not economic) in nature, I would expect the resulting problems to be similarly systemic. We've sort of misallocated the entire economy (insofar it's publicly traded) ... but all that means is that companies have LBOed themselves and made a bunch of dumb acquisitions. This is mostly a problem if interest rates are forced up sharply. Everybody has this problem though. There's no easily identifiable minority sector and asset class to take it out on though so we plod along. I do fear the lack of strategy diversification. Not just indexing but also the idea that everything can now be controlled by tuning a single financial knob. For example, attitudes like this:
https://www.reuters.com/article/us-usa- ... SKBN19I2I5 ... OMGWTFBBQ I-don't-even-know...

@Riggerjack - This is no mere EMP or lightning strike. We're talking about stuff coming out of the sun and hitting Earth directly. A coronal mass ejection can take up space comparable to the distance between the Earth and the sun. The Earth is just a puny dot in comparison. CMEs are mostly ionized hydrogen. When it interacts with the Earth's magnetic field, the movement of the ions will set up huge electric fields. These fields with set up a voltage along any metal line. Powerlines. Railroad lines. The longer the line, the higher the voltage, the higher current. Fuses are void. These are strong enough to jump air gaps. Smaller ones happen every few decades and usually blow out a few transformers taking the grid down with them. A Carrington event would be much larger than those. Think sparks flying off of power lines and connected electrical equipment. I dunno how hardened ordinary cars are against even human induced EMPs, but I presume the electronics would fry? Knocking out satellites would knock out GPS and financial transactions (from paying with credit cards to trading stocks). Hence, the trillions of dollars price tag.

Here's a good video. https://www.youtube.com/watch?v=7ukQhycKOFw ...

Also, for analysis and cost of big risks Lloyd's put out good stuff (not just science but also actual economic impacts):
https://www.lloyds.com/news-and-insight ... olar-storm

They also have one for crop failure.

[7Wannabe5]

@jacob: Cool site. I added the report on stranded assets to my reading list and downloaded the Detroit Risk profile information.

[Campitor]

@Riggerjack - This is no mere EMP or lightning strike. We're talking about stuff coming out of the sun and hitting Earth directly. A coronal mass ejection can take up space comparable to the distance between the Earth and the sun. The Earth is just a puny dot in comparison. CMEs are mostly ionized hydrogen. When it interacts with the Earth's magnetic field, the movement of the ions will set up huge electric fields. These fields with set up a voltage along any metal line. Powerlines. Railroad lines. The longer the line, the higher the voltage, the higher current. Fuses are void. These are strong enough to jump air gaps. Smaller ones happen every few decades and usually blow out a few transformers taking the grid down with them. A Carrington event would be much larger than those. Think sparks flying off of power lines and connected electrical equipment. I dunno how hardened ordinary cars are against even human induced EMPs, but I presume the electronics would fry? Knocking out satellites would knock out GPS and financial transactions (from paying with credit cards to trading stocks). Hence, the trillions of dollars price tag.

Here's a good video. https://www.youtube.com/watch?v=7ukQhycKOFw ...

Also, for analysis and cost of big risks Lloyd's put out good stuff (not just science but also actual economic impacts):
https://www.lloyds.com/news-and-insight ... olar-storm

They also have one for crop failure.

Most homes, from what I've seen as I travel across the US, get their electricity and internet/cable from wires strung on poles. On these poles at intervals you will see those trash can shaped barrels that step down the voltage from power companies to a level acceptable for home use. It's these devices that are very vulnerable to EMP surges. A Carrington event would fry all these step-down transformers across the US and many parts of the electrical grid would be offline for a significant duration. Smart people have been working on mitigating these effects but I'm not confident that these protections have been implemented on any significant portion of our power grid - brown outs occur when too many people turn on the AC - imagine a Carrington Event.

https://www.ferc.gov/industries/electri ... ummary.pdf
http://www.eiscouncil.com/App_Data/Uplo ... d248bc.pdf

Before I made my switch to the tech industry, I spent years working in the hospital logistics industry. My job was to make the supply chain resilient to failure and ensuring there were sufficient supplies to keep the medical centers I serviced running. As transportation became cheaper, and manufacturing profit margins prioritized, I witnessed the increasing fragility of the USA's supply chains. I recall having to ship in medical supplies from Asia when a Central American medical hardware manufacturing site was destroyed by a 100 year flood. I also recall needing to fly in blood oxygenators (used in heart transplants to keep oxygen flowing to vital organs) on a privately chartered plane when the supplier had a catastrophic failure of their computer systems and couldn't track their inventory.

Our supplies chains (food, medical, industrial) would be pulverized if a Carrington Event prevented the transportation business and manufacturing facilities from doing their jobs. Since everyone wants to run "lean", most companies try to keep as few supplies onsite as possible; they depend on "just-in-time" deliveries to keep business flowing. I've been worried about Carrington Events even more now that I work in the tech field. Everyone has their data centers protected by faraday cages but desktops are still vulnerable and the backup generators may or may not be protected from EMPs. If your lucky enough to have a data center that is 100% EMP resilient, you still depend on the logistics industry to keep your data center running. No food, no internet, no fuel, no electricity. Hmm...

[UK-with-kids]

A black swan is a large effect where the ostrich-effect dominates when looking ahead to be replaced with idiosyncratic "single cause" explanations in retrospect. One also needs to distinguish between issues that are personal (where nobody cares to or are able to help), regional (which can receive outside support, think Hurricane Katrina, or which happens elsewhere), and global (which happens everywhere and where the support areas have their own problems to deal with => no outside support).

Denial doesn't work for me, so I [try to] worry about "all of them", mostly at an intellectual level, not an emotional one, because I think we're prone to mainly concern ourselves with the one's we have a personal interest in while ignoring the one's that fall outside our sphere of interest. So I try to figure out what my unknown-knowns are and distribute my focus. Also, I don't think that I can "mitigate on the fly". Insofar people have democratically agreed not to worry about fire safety in the proverbial theater, I figure it's better to sit close to the exit in the theater in case someone yells "FIRE" rather than presuming that I can "adapt" to the fire or "mitigate my way through the exit along with everybody else" in case the theater is actually on fire.

My #1 concern is a continued rise in tribalism and the resulting identification of an "Other" as a minority scapegoat coupled with a callous disregard for any rights of that Other ... and in particular in being identified as belonging to that Other. The form of identification could be anything: religion, race, nationality, wealth, class, affiliation,... ideology, or even lack of ideology, etc. There is no way to pick a set that guarantees a lack of persecution other than society avoiding the potential for persecution in the first place (fat chance, because humans). This becomes particularly dangerous when coupled with authoritarianism, militarization, surveillance, or all of the above. In that case, laws (an oxymoron at such a point) could and would be made up but since it only affects individuals that the majority already disregards, sanctions could be anything: Wealth confiscation, capital controls, detention, camps, etc. "First they came for .. and I didn't care..."

My worry here is personal (becoming one of the Other) and global (that this happens everywhere). The strategy (regional out) is to identify this pattern early on and escape because there's no way to fight it and win. Strategies to avoid becoming a refugee or stuck involves establishing financial accounts in another country, having already done the research on which other countries/areas it is possible to go to, and not being glued into a location.

My #2 concern is a repeat of the Spanish Flu (H1N1 (standard flu) mutation or similar like H5N1 (bird flu)) that causes a cytokine storm or something equally deadly. Normally the flu kills 1 in 1000 and that mostly babies and the very old, whereas the Spanish flu killed the healthiest part of the position at a 1 in 5 to 1 in 10 ratio. With today's air transport, such an outbreak would quickly "touch" most people in recurring waves over a period of several months to a year or so. If 1/3 gets infected and death rate is 20%, we're talking 500 million dead on a world basis (20M in the US) and there would be nowhere to hide unless you're willing and capable of staying out of human contact for 12-24 months! There would be lots of secondary effects. First, people would argue that it's not happening. Most would keep going out to work and to shop because they need to. After it's officially a thing (expect governments to hide the fact for a while to prevent panic), people will stay home. This affects the operation of power plants, water treatment plants, etc. Certainly some people will be ordered into their possible deaths. It will also be hard to bury people at that rate of bodycount .. and again, it will be hard to find people willing to do that. After it all blows over, world population will be down by 5% or so of the healthiest people (15-45 year olds). This means less consumers, less need for offices, factories, and capital assets; higher demand for workers. Wages will rise and the stock market will utterly tank; prices on cyclicals will rise high ... non-cyclicals will go down. There will be nowhere to hide. Solution ... N95 or better masks. Lots of handwashing. Avoid people as much as possible. Work from home.

My #2.5 concern is a global crop failure. However ... I think impacts will be regional. There's also plenty of animal stock which could be sacrificed to "liberate" the calories for human consumption. It does mean that we will be eating soy beans for the better part of a year .. and paying a lot for the privilege. I would worry about this a lot more if I didn't live in a rich country. Humanity as such is not subject to "demand hardening" yet, but as we keep adding more people while reducing topsoil, etc. We're going in that direction. Solution ... store a few months of food to supplement what you can buy. Store increasingly more a few decades from now.

My #3 concern is a Carrington event. IIRC odds are about 10% per century. So may or may not happen ... but can't be entirely ignored either. While odds are low, impact is very high. Pretty much everything finance, technology, and commercial delivery (just in time) is based around electricity. Estimated time to replace this stuff if it gets overloaded enough to burn out would be 5-10 years. It would end technological civilization as we know it. We're talking trillions of dollars worth of damage (a mid-fraction of GDP... compare to how people freak out just when the economy is "only" growing by 1%) and not just in the year it happens, but cascading down the following years. In terms of financial sector impact, expect the opposite of #2. This time capital gets destroyed. There are now very many humans around with no useful skills (how many skills do you bring to the table and how much money can YOU make without access to electricity). Solution ... Ha!

I do not worry about things like climate change and oil depletion because the increasing "suck" is predictable and inevitable (humanity is pretty much committed at this point) making it possible to [adapt and mitigate] over time. The effects here won't be "shocking" on a year to year or month to month basis whereas all the above would be. These issues will make the fall out from the others worse and/or more likely though.

So a version of Jacob's #2 concern happened this year. I wonder if the consequences were as anticipated, and how the rest of the story will turn out.

(And is calling it the Chinese Flu a version of Jacob's #1 concern?)

[Jean]

I don't think it's really #2 as the number are much Closer to normal flu than to spanish flu, even on a log scale. It is more a potential of #2.

In France, questioning this potential already could earn you a beat up and a fine, so it's kind of a #1. I don't see how calling it Chinese is more a #1 than calling it spanish.

[ertyu]

We're heading for #2.5. Food prices have risen appreciably here in spite of headline inflation being quoted at negligible levels. Rumblings of food scarcity are being heard from various places all over the world. Industrial commodities (excluding PMs) have been falling, but grains have been on the rise. So. Not crisis levels yet, but enough to make me start thinking of buying a village house with a garden. Dry beans were 3 euro per kg at the open air market yesterday. Might be that just like sorting out one's transportation was the chief way to reduce non-housing related expenses in the past couple of decades, the ability to supplement one's food might be the one for the couple of decades to come. The city-bred couch potato in me dislikes this and would prefer to stay ignorant of it, but. But.

[Alphaville]

My #2 concern is a repeat of the Spanish Flu (H1N1 (standard flu) mutation or similar like H5N1 (bird flu)) that causes a cytokine storm or something equally deadly.

wow! jacob wins the office pool. took less than 3 years?

#1 also a concern for me though i’ve seen it coming so not unpredictable. still huge risk.

#3 i used to live without electricity so no terminal fear for me in that area (but it would be a massive social shock)

[Alphaville]

Dry beans were 3 euro per kg at the open air market yesterday.

that’s similar to US prices for retail beans, $1+/lb.

here, open air market (“farmer’s market”) costs more, they’re like a boutique really, $3/lb for local pinto beans WAT. sorry, pass. mechanized agribusiness for all it evils delivers low cost.

[7Wannabe5]

Mechanized agri-business in the U.S. does not result in anything resembling pure market pricing/availability. For instance, where could you as a consumer go to buy Canner grade beef, if you so desired? I mean, you might have to cook it for a whole day and it still might not be chewable, but if you could get it for $.20/lb, you just might make the attempt.

[Alphaville]

idk. walmart sells 10lb tubes of polycountry ground beef for fairly cheap, but i never touch the stuff.

this is $2.88/lb but goes down for bigger sizes

https://www.walmart.com/ip/73-Lean-27-F ... b/46180257

eta oh here you go:

https://www.walmart.com/ip/73-Lean-27-F ... b/44001602

10lb for $24 (might vary in your location)

but i still avoid perhaps due to prejudice

(i do buy their black beans though. they seem “safer”.)


==

oh 20cents not 2.20!! i misread. yeah.

that’s a fantastical figure you couldnt pay for standing cattle at auction i believe

[7Wannabe5]

Right, but even Walmart doesn't sell below Grade Select, so the cattle at auction would mostly be raised to those specifications. Just like how you can't build your own house out of empty cans in 2020 U.S., but you could in 1970s Tehran. My only point being that, as has been made obvious during Covid crisis, markets can quickly adapt to accept inferior goods. In fact, Walmart did reduce its lowest standard offering from Choice to Select during the crisis. Market gardeners and small farmers generally only bring superior produce to sell to upscale clientele at Farmer's Market, but this could also change fairly quickly under pressure.

[Alphaville]

oh, i get your point, but i mean realistic prices, i’ve sold cattle straight from the range, not “raised” for anything, before feedlot etc., and i don’t recall it ever being less than 45c/lb during the recession (but i don’t know current prices, sold by the hundredweight). that’s at the bottom of the food chain, so prices can only go up from there as the product changes hands.

the one sold at walmart is global pink sludge, not sure which grade is like, i think “ungraded” is right.

for real cheapness there’s chicken gizzards, and i’ll cook them with rice

[Lucky C]

So I ask you all: what national or global event do you fear most financially, and what steps have you taken to prepare for said event, if any?

As others mentioned, if we can define the type of event that we fear, then it is not a "black swan" because we would not see it as a possibility beforehand, though we may see it as obvious in hindsight. Of course there always seem to be some people who saw the possibility of a certain shock beforehand, but there was no way they would have known when/how it would exactly play out, and it's unrealistic to expect someone could correctly predict several of these events throughout their lifetime even if they got lucky or had the rare expertise to be able to predict one of them.

The existence of Black Swans implies that financial markets, global events, etc., do not follow a normal probability distribution with symmetric probabilities of positive and negative events. The negative left tail is fatter than the positive right tail of the probability distribution. For example, if looking at S&P500 6-month price changes vs. their long term median 6-month price change, there has been a greater occurrence of prices falling short of their average by 30% or greater vs. exceeding their average by 30% or more (data going back to 1928). Even worse, a 30% shortfall requires a 43% recovery to get even whereas an unexpected 30% windfall would only take a drop of 23% to wipe out.

For a passive buy & hold investor, the solution is psychological. Don't worry about such risks and know that this negative tail risk dissipates over longer periods of time - invest for decades and don't worry about a bad 6 month run that couldn't have been predicted. For a non buy & hold investor or trader, either invest/trade in such a way that negative tail risk doesn't matter to your income flows, or find a way to insure against it, or find a way to alter the expected distribution of your returns such that they don't have the negative tail skew that buy & hold investors face.

[Quadalupe]

As others mentioned, if we can define the type of event that we fear, then it is not a "black swan" because we would not see it as a possibility beforehand, though we may see it as obvious in hindsight. Of course there always seem to be some people who saw the possibility of a certain shock beforehand, but there was no way they would have known when/how it would exactly play out, and it's unrealistic to expect someone could correctly predict several of these events throughout their lifetime even if they got lucky or had the rare expertise to be able to predict one of them.

What I took away from Taleb's writings is that we cannot predict events/causes. However, you can reason about what effects/situations would be detrimental for you. E.g. we cannot predict a war or earthquake, but we can predict that not having food/empty supermarket shelves are bad, no matter how that came to be. So maybe look at Maslow's pyramid and see what steps you can take to ensure access to each layer of the pyramid.

Or, phrased differently: risk is often defined as probability times impact. Taleb argues that we should mostly ignore the probability part and focus on mitigating the events with the highest impact.

[Aspirant]

My #2 concern is a repeat of the Spanish Flu (H1N1 (standard flu) mutation or similar like H5N1 (bird flu)) that causes a cytokine storm or something equally deadly. Normally the flu kills 1 in 1000 and that mostly babies and the very old, whereas the Spanish flu killed the healthiest part of the position at a 1 in 5 to 1 in 10 ratio. With today's air transport, such an outbreak would quickly "touch" most people in recurring waves over a period of several months to a year or so. If 1/3 gets infected and death rate is 20%, we're talking 500 million dead on a world basis (20M in the US) and there would be nowhere to hide unless you're willing and capable of staying out of human contact for 12-24 months! There would be lots of secondary effects. First, people would argue that it's not happening. Most would keep going out to work and to shop because they need to. After it's officially a thing (expect governments to hide the fact for a while to prevent panic), people will stay home. This affects the operation of power plants, water treatment plants, etc. Certainly some people will be ordered into their possible deaths. It will also be hard to bury people at that rate of bodycount .. and again, it will be hard to find people willing to do that. After it all blows over, world population will be down by 5% or so of the healthiest people (15-45 year olds). This means less consumers, less need for offices, factories, and capital assets; higher demand for workers. Wages will rise and the stock market will utterly tank; prices on cyclicals will rise high ... non-cyclicals will go down. There will be nowhere to hide. Solution ... N95 or better masks. Lots of handwashing. Avoid people as much as possible. Work from home.

Sorry about the wall of text, but that's Jacob in 2017. @Jacob How do you feel about that now?

[Seppia]

Proof number 2728382993 that Jacob is, like, very very smart

[Alphaville]

he keeps winning the office pool for sure

if anything we’ve dodged some bullets (so far) vs. his worst-case scenario