Broker Check

A New Black Swan Event?

February 28, 2020
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Nassim Taleb, in his 2001 book ‘Fooled by Randomness’, described ‘Black Swan Events’ as high-profile, hard-to-predict and rare events that are beyond the realm of normal expectations in history, science, finance, and technology.

Black Swan Events are named for real-life black swans, which at one time were widely believed to not even exist. Second Century Romans even had a phrase: ‘Rara avis in terris nigroque simillima cygno’, to describe someone or something as so rare or unlikely to exist that it would be like seeing a black swan. Centuries later, however, black swans were discovered to actually exist, in Australia!

This week, I think we can probably agree that a black swan has landed once more.

The sudden spread of the Covid-19 coronavirus, and the subsequent worldwide shock that it has produced, has now infected the stock market. Thursday, February 27th, was the largest point-drop ever for the Dow 30 (but given the lofty levels of the previous high, it’s nowhere among the historical largest percent-drops).

The S&P 500 and the Nasdaq both set new all-time highs just a week and a day ago (February 19th), and the Dow a week before that (February 12th); but since then, each has lost more than 12% in a cascade of multi-hundred-point down-days.

The S&P 500 is now back to where we were in mid-October of last year. In the big picture, being set back by four months in the market doesn’t typically raise an eyebrow, as that’s a pretty common occurrence; such corrections have happened dozens of times in history. What makes this time seem different, however, is the speed of the decline ... that’s the ‘black swan’ nature of it.

Thursday was the third day in the last week with a hugely-lopsided down-to-up volume ratio (almost 30:1 Down:Up among S&P 500 stocks on Thursday). Usually, such a tremendously-oversold condition leads to an imminent rally. The most memorable such episode in recent times would be December 24th, 2018 and December 26th, 2018, going from worst-in-a-decade (or even a bit beyond that) new Maximum Drawdowns for many investment portfolios, to a months-long steep and unabated run-up commencing the very next market day. That being said, we can’t say exactly how things may play out this time, of course.

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Our current market assumptions:

If prior infectious diseases (SARS, H1N1, Ebola, AIDS, avian flu, etc.) serves as an example of its impact on market performance, then the coronavirus (COVID-19) alone should give little fear to Wall Street investors that the pathogen will sicken the US stock market. Each prior disease began initially with an enormous amount of volatility as the news is spread to the public and the medical and health community determine how to deal with the contagion/pandemic. Fear exacerbated by the media and disruption to businesses and communities continue with increased volatility. However, as epidemic cases declined the markets began to regain its footing. Below is a table highlighting prior major epidemics and the change over a 6 month and 12 month time frame.

The severity of the virus, will ultimately dictate the market’s reaction. Should the pandemic cause longer term issues like supply chain disruption, layoffs, quarantines, etc. a larger issue like a global recession could be the result.

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In closing:

From here, as stated earlier, the markets could certainly be in for a parabolic rise as bargain hunters begin to appear for the timeliest re-entry after such a week. If things continue to deteriorate, we will take appropriate actions. Day to day, it’s certainly still the case that they’ve told the tale without ‘telling tales’, far more often than not.

Your Guidant Planning Team

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