Is A Black Swan In The Way Of The 14,000 Dow? Robert Lenzner 07.20.07, 6:00 AM ET
Robert Lenzner
The stock market hits new peaks while the Black Swan: The Impact of the Highly Improbable stays on the best seller list. There is meaning to this dichotomy.
Traders and investors wonder what event or series of happenings could stop the music. So, the traders sit by their country club pools and look for clues in Nassim Nicholas Taleb's hard-to-digest work.
Why the absorption in the Black Swan? In financial terms we're talking about unexpected developments that trigger shocking volatility that crushes fortunes overnight. The book is providing sufficient food for thought among enough money men to put it on the best seller list.
And Taleb is not even a billionaire investor himself with a record like Warren Buffett's. On the contrary. He's a philosopher, a muser on the mediocrity of conventional thinking. He unmercifully puts down the teachings of Robert Merton and Myron Scholes, two Nobel prize-winning econmists with a huge Wall Street following.
October 19,1987, was a Black Swan when the market fell 23%. So was the denouement of Long Term Capital in 1998, which coincided with the Russian devaluation and financial crises in several Asian nations. So was Sept. 11, 2001, when terrorists struck the World Trade Center and paralyzed (at least for a nanosecond) the U.S. economy.
Taleb calls a Black Swan Extremistan, "the province where the total can be conceivably impacted by a single observation." It's a concept for the Age of Terrorism. For the financial terrorism of the subprime mortgage fallout or the overdone leverage from the private equity binge or the rising price of oil are unlikely to be Black Swans.
The proof of financial Black Swans? Taleb asserts that in the last 50 years, "the 10 most extreme days in the financial markets represent half the returns. Ten days in 50 years. Meanwhile, we are mired in chit chat." The chit chat he cites is the constant daily explanation of market movements, earnings projections of investment analysts and, even more significantly, the need to project the future from the past. After all, a century ago, nobody predicted the computer or the Internet or Sept. 11, 2001.
What's going to get us is the unexpected. Maybe it's globalization, he suggests, which creates "interlocking fragility, while reducing volatility and giving the appearance of stability." Listen up folks. Taleb thinks we may be living under the threat of a global collapse. And where will it come from? From the consolidation of global banks into "gigantic, incestuous bureaucratic banks."
I think Taleb is wrong. The increased concentration in banks all obsessed with risk control will not be the cause of a massive financial crisis. But Taleb thinks this could be the "improbable" event that drives the Dow into a panic of selling.
Taleb claims he was a "barbell" investor--putting up to 90% of his money in Treasury bills and only risking 10% on speculative, highly leveraged bets. Trouble is that in a global climate of low inflation and minimal volatility, the strategy was a big flop.
So, why should we bloody well read Taleb, except to confirm that we all have to be long-term investors or miss the 10 big days in half a century when 50% of the action--hopefully upside--takes place. And as for the unexpected event, the Black Swan, we'll just have to live through that too.
Trees don't grow to the skies as the late great investment banker and down-to-earth thinker John Weinberg, once chairman of Goldman Sachs (nyse: GS - news - people ), used to say. And that's the lesson in investment wisdom today.
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