A Black Swan Event?

What Is A Black Swan Event?

A black swan event is an unforeseen occurrence that lies beyond the realm of regular expectations and carries potentially severe consequences. These events are marked by their extreme rarity, significant impact, and the common retrospective assertion that they were predictable. The term gained prominence through Nassim Nicholas Taleb, a finance professor, writer, and former Wall Street trader, who discussed black swan events in his book published just before the 2007-2008 financial crisis. Taleb emphasized that, due to their unpredictability and profound effects, it's crucial to always consider the possibility of black swan events and plan accordingly. Some suggest that diversification may offer some protection when such events occur.​

Over the past several decades, U.S. non-financial businesses have experienced massive leveraging, a trend that starkly contrasts with the stock market capitalization rising from 62% to 204% of GDP. Currently, the U.S. business economy carries 13 times more leverage than it did 50 years ago.​

Evolution of Business Balance Sheets

• In 1972, total business debt stood at $634 billion, amounting to just 46% of the gross value of U.S. industrial production, which was $1.38 trillion.​

• By 2007, business debt had escalated to $10.1 trillion, representing 321% of the gross industrial production of $3.15 trillion.​

• By 2020, the debt figure had risen to $17.7 trillion, while the value of industrial production remained relatively flat. Consequently, the leverage ratio reached an unprecedented 592%.​

This high leverage suggests that growth and profit generation may weaken over time, implying that the stock market capitalization rate of national income should be decreasing, not increasing as observed.​

Role of Central Banks

Central banks have not only inflated asset prices but have also fundamentally altered financial markets, leading to the creation of numerous new products that primarily serve speculative purposes. The larger concern is that an external shock—a black swan event—could disrupt the continuous cycle of dip-buying and options-based speculation, potentially triggering a widespread sell-off. The 1987 crash serves as a pertinent example of the risks associated with uncontrolled positive feedback loops in the market.​

Given these dynamics, it's essential for investors to remain vigilant and consider strategies to safeguard their portfolios against potential black swan events.