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5 WAYS TO PREPARE FOR THE NEXT STOCK MARKET BLACK SWAN

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The devastation in Houston and surrounding areas reminds us once again just how fragile our lives are. With a city so large I’m sure all of us have friends and family whose lives are being altered in ways no one imagined just a few weeks ago. Weathermen are now calling it a once in a 1,000 year event. We can only pray they are finally right on a forecast.

Hurricane Harvey Devastation

Events like Harvey have been given a name. Author Nassim Taleb developed the phrase “Black Swan” into a theory to describe seemingly impossible events that become possible, and the major effect it has on all of us.

The term was actually coined in the 16th century when it was believed that black swans didn’t exist and thus a black swan was impossible. Later when black swans were discovered by Dutch explorers in Western Australia the term metamorphosed.

We have lots of examples of Black Swan events just in the past hundred years or so. The Titanic, the Wall Street Crash of 1929, the rise of Hitler and the Nazi military, Roger Bannister and the Four Minute Mile, Chernobyl, the Munich Olympics, the Dot-com bubble, 9/11, the 9.1 Indian Ocean earthquake and tsunami, the collapse of Lehman Brothers, Hurricane Katrina, and most recently the rise of ISIS are just a few events that may be placed in the Black Swan category.

The Titanic - A Black Swan

And now the events of the past month in southeast Texas and Louisiana. It’s not the hurricane that is the Black Swan. Those occur from time to time, and the good folks along the Gulf Coast are used to them. As far as hurricanes go, the Galveston Hurricane of 1900 was also a Category 4 storm, but it killed over 6,000 people. No, it’s not Harvey that was the surprise. It was the 50 inches of rain in less than a week over a flat, swampy terrain that was the outlier.

Hurricane Harvey Devastation

To be termed a Black Swan event it must have a major impact on us. Don’t tell me you don’t think about Leonardo DiCaprio every time you go through the cruise ship safety drill. Roger Bannister made everyone begin to rethink our physical limitations. Remember when we could show up to the airport thirty minutes before takeoff, or could meet our party right at the gate? When’s the last time we built a nuclear power plant here in the U.S.? And after more than 70 years the word “Nazi” still makes our skin crawl, and we still view every dictator through the lens of 1937 Germany.

Not everyone agrees on whether certain events should be categorized as Black Swans. I would argue that categorizing the flooding of a city built six feet below sea level right on the coast as a surprise event is a bit of a stretch. But New Orleans is being rebuilt six feet below sea level like it will never flood again. On the other hand, I would add the 2016 Presidential election to the list of Black Swans. In my opinion, November 8, will go down as one of the biggest political surprises in our nation’s history- a complete outsider winning the White House- and ten months removed it’s still having a “yuge” effect on the political hierarchy, as both the Democrat and Republican establishment along with the main stream media and Hollywood elites still have their hair on fire.

Here in Okie land we have been surprised with something no one saw come sweeping down the plain, and it’s not tornadoes. It’s earthquakes. Large ones. California size. The size that made me do something I would have deemed as silly and worthless just a few years ago. I purchased earthquake insurance. I’ll still have to pay out the nose in case of a disaster, but it’s better than nothing. For around $500 a year it will keep me from experiencing the devastating loss that can change my life for good if the big one does hit.

Black Swan events occur in the stock market. We’ve experienced two in just the past seventeen years.

Black Swan events occur in the stock market. We’ve experienced two in just the past seventeen years. Of course, you have your Monday quarterbacks who claim they saw both the dot-com bubble and mortgage meltdown coming, but everyone sees real clear out of their rear view mirrors.

I think stock market prognosticators spend way too much time and energy attempting to predict the what and the how and the when of the next surprise event. Yet they really have no more of a clue than you and I. They will only know after it’s occurred. So, I don’t waste my time on what I don’t know. I spend my energy on what I do know, and what I do know is there will be another Black Swan event coming in the stock market. I don’t know the what, how, when or where, just know it will, and that’s good enough. Knowing an event will eventually come that will have a major impact on our markets gives me the opportunity to assess risk and take steps now to minimize damage as much as possible for myself and my clients.

One of the great things about being a market technician is that I’m provided with small clues when a surprise event is more likely to materialize. Without getting into the weeds, stock market Black Swans are precluded by a period of calm and euphoria when the great majority of investors, commonly called “the crowd”, goes all in the stock market. The trick of the trade is to recognize when euphoria is setting on the market, and to sell into it. Though we’re not there just yet, I’m pretty sure we’re driving to the scene.

So what can you do to prepare for the next stock market Black Swan? Here are at least five suggestions:

  1. Monitor your holdings more closely over the year. Review what you own, and ask if the reason you own it is still valid today. If not, consider taking profit.
  2. Think shorter term. Buy and hold is great when we are at the beginning of a bull market, but this one is getting pretty long in the tooth. Euphoric stages, also called blow off tops, are typically short and sweet, and can reverse as quickly as they rise. Trim your time horizon some, as any profits will probably be short lived. And if you miss the move, let it go.
  3. Set stops now. Determine a specific price that if your stock falls below, you promise no matter what, no questions asked, scouts honor, you will sell. Establish it now while you’re unemotional, write it down, and don’t talk yourself out of it when it’s time to press the sell button.
  4. Be slow and deliberate in making new purchases. When euphoria comes, your Uber driver and real estate agent will be providing stock tips. You will feel like you are missing on the opportunity of the century. You’re not, so chill.
  5. Turn off the noise. Rather than watching the so-called stock market gurus, just watch the price. It will tell you what you need to know.

Like you, I’m always surprised by the variety of Black Swan events that come our way. It’s interesting to speculate where the next one is coming from, and when it will take place. But no one knows or can offer any explanation until after the fact. There wasn’t a weatherman on earth who saw the rains coming this past month in southeast Texas and Louisiana. The seemingly impossible once more became possible, and we lift prayers for the victims, the responders and rescuers, the volunteers, the officials and everyone else directly affected as they work through this shocking event.


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