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What Exactly Is a Black Swan, Anyway?

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There is near universal agreement that the Brexit – and the walloping it gave the market – was a black swan event. But actually defining what a black swan is can be a challenge.

Most investors equate a black swan with a market crash. But that’s really putting the cart before the horse. A black swan is simply an event that no one saw coming… that also has a large, outsized impact. So a market crash is more the result of a black swan than a black swan itself.

And a black swan need not always be something bad. Sure, a meteor falling out of the sky and hitting your house would be a black swan event. But so would be an inheritance check for a million dollars from an aunt you never knew you had. Both would be completely unexpected… and both would have major impacts on your life.

Trader, professor and financial writer Nassim Nicholas Taleb made “black swan” a household word (at least in households that regularly debate financial topics… like mine) and gave it its current meaning, but the expression has been around a lot longer for something that was assumed to be impossible. The first recorded use of black swan as this kind of metaphor dates to the Roman Empire, and it was a common expression in 1500s London.

Until 1636 – when European exploration of Australia was underway – all swans were presumed to be white. No one had ever seen a black swan, so it was presumed that none existed.

If you want to get really wonky, the black swan is an example of the problem of induction, or trying to draw general conclusions from specific observations. In plain English, seeing a thousand white swans and not a single black swan doesn’t “prove” that no black swans exist. And just because something has never happened before doesn’t mean it can never happen. Up until March of 2000, it was popularly believed to be impossible for a tornado to hit a major, urban area. The thinking was that the skyscrapers affected the wind patterns in such as a way as to make a tornado touchdown impossible. Well, then on March 28, 2000, an F3 tornado touched down on downtown Fort Worth’s Main Street and proceeded to obliterate one of the largest skyscrapers in the city. (I was living in Fort Worth at the time, and distinctly remember cowering in the basement of the building I was in…)

Let’s get back to Nassim Taleb. In black swan of the financial variety, Taleb says you need to have three conditions in place:

  1. The event has to be a surprise, or a statistical outlier in finance-speak
  2. It has to have an extreme impact
  3. Despite it being unpredictable beforehand, we spin a narrative that makes it seem completely predictable in hindsight.

And this is where you get back to the fun parallels with finance. No country has ever left the European Union before… and no opinion poll or betting market suggested it was possible. So the financial markets assumed a UK vote to leave to be impossible.

Well… it turned out that it wasn’t impossible, and the impact was definitely outsized. No one knew at the time – or knows now – what the full impact of Brexit will be once all is said and done. And as for the narrative, after the fact it became “obvious” that Brexit would happen because of the dissatisfaction of older, blue-collar British voters, the rise of Donald Trump in America or any number of other reasons.

So, Brexit does indeed make the cut as a black swan.

All of this is fine and good, but if black swans are always unpredictable and obvious only after the fact… what’s the point of even talking about them?

Even if you can’t anticipate individual black swans, you can definitely take a few simple steps to “black swan proof” your portfolio… or at least come close.

First, don’t make the assumption that something can’t happen simply because it hasn’t happened yet. Don’t be overconfident based on your limited observations.

Second, always have a little portfolio insurance. That can mean different things to different investors, but as a general rule it means you should have a few assets in your portfolio that zig when the market zags. Taleb himself made enough money in a single day to walk away from Wall Street forever. He was “long volatility” on the day of the 1987 stock market crash, and walked with millions when the market cratered.

Finally, beware of debt. Excessive debt has been the death of many a good trader. The people who ran Long-Term Capital Management were geniuses. They were quite literally the men who wrote the books on quantitative finance, a who’s who list of brilliant academics. And in 1998, their hedge fund blew up in spectacular fashion when a black swan hit. Russia defaulted on its debts, which was something no one expected. It caused investors to dump everything related to emerging markets and run for the hills.

Long-Term Capital Management went out of business, not because it made bad trades, but because it borrowed far too much money to make them. Had the professors simply borrowed less, they would have been able to ride out the storm and live to trade another day.

Excessive leverage can turn a safe investment into a risky one and make you more susceptible to black swan risks. So simply avoiding debt will do wonders for making your portfolio black swan resistant.

Photo credit: Joe Shlabotnik

Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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Merry Christmas

I’m not writing much this week, and there is a good reason for that: I’m on a Christmas ski trip, trying my best not to make a fool of myself on skis. Assuming I don’t get myself killed, we’ll pick this up next week.

Merry Christmas!

Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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Thoughts on Yellen’s Rate Hike

I gave my thoughts on the Fed’s decision yesterday to CNBC:

“She is in no hurry to ‘normalize’ rates. She’s raising them today because she’s afraid that if she doesn’t, she might have to act more aggressively at some point in the future. But she also made it very clear that she’s going to remain very accommodative for quite a while to come. Bottom line, we might be sitting at 25 basis points for a while. What does this mean? It means the dollar might give back some of its recent gains. All else equal, it’s also good for the markets broadly. The Fed isn’t taking away the punch bowl. It’s just putting a little less booze in it. All in all, this is probably the best outcome we could have hoped for,” said Charles Sizemore, principal of Sizemore Capital.

See “Fed’s done, now traders look for Santa rally” for the full article.

 

Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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Rise of the Robots

Rodney Johnson has some interesting comments on the rise of robots as a labor replacement.  Robots have been replacing assembly line workers for decades.  But now, they’re starting to replace retail clerks too…sort of:

Just as desktop computing, voicemail, and email erased much of the need for secretaries, robots are quickly gaining ground in areas such as machine operation in manufacturing… but they might not be ready to replace retail clerks just yet…

The cost of the collaborative robots has fallen to as low as $20,000 making them affordable for even the smallest of operations. Compare that with the wage of a machine shop operator of $22.42 per hour as reported by the Bureau of Labor Statistics.

This operator, who gets sick days, holidays, time off every day after work and benefits will cost a company roughly $44,000 per year. The robot, which can operate 24 hours per day and never calls in sick, would save the company money over hiring the operator in just under six months. And that’s if they simply worked the same hours.

Of course, not every new use of a robot turns out to be a great idea.

Lowe’s Home Improvement (LOW) is rolling out two retail robots in a subsidiary store, Orchard Supply Hardware, in San Jose, CA. The units will greet customers at the door and ask if they need assistance.

Customers can ask where products are located, place a bolt, nut or nail on a 3D scanner that will determine the exact size and where replacement pieces are located in the store. It’ll even provide video conferencing with personnel who can assist clients with their needs for projects.

The robots then travel with the customers to the appropriate location in the store to locate the exact product in question…

There is a big problem here. As Rodney pointed out later in the article, most people going to a hardware store don’t know how to articulate what they want, and they don’t have a replacement part to scan. And waiting for the robot to call a customer service rep via teleconference would probably cause me to smash in the robot’s iPad face with the first heavy-duty tool I could get my hands on.  At the very least, I would leave the store and head to the Home Depot (HD) next door.

As Rodney continues,

Both of these developments — collaborative and guide robots — increase the speed at which people are being replaced in the workplace. Such displacements have happened throughout history, constantly killing different types of employment, driving would-be weavers, carriage makers, secretaries and now machine operators into other jobs.

While there’s no doubt that society as a whole is better off with greater productivity, the picture isn’t so bright for the would-be machine operator. With median income falling as the middle class loses ground, we need a faster method for retraining displaced workers and training those new to the workforce in jobs that are unlikely to be automated in the near future.

Otherwise, we’ll end up with many potential workers who can’t even get a job at McDonald’s… because that company is also automating the ordering process.

You can view the full article here.

We’re still a long way off from having guides replace customer service personnel.  But self-checkout lines have already reduced the number of cashiers at Home Depot, Lowes, and even Walmart.  Again, all of this is great for productivity…and keeping labor costs in check.  But it does raise the uncomfortable question of where low-skilled workers will find jobs a decade from now.

Related: Labor replacement is not only making low-skilled labor redundant.  It’s also weeding out stockbrokers and financial advisors: Running a financial advisory practice in the age of the robo-advisor.

 

Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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Zombies Outselling Vampires This Halloween

I liked World War Z.  As far as zombie apocalypse movies go, it was well done, and the scenes set in Jerusalem gave it a different twist.   But as a horror genre, I’ve always preferred vampire stories (I was probably the only person in America disappointed that NBC’s Dracula was cancelled earlier this year).  You can develop a more complex storyline with a conniving vampire as your villain, but you’re really pretty limited with zombies.  They’re brain-dead corpses.

At any rate, I appear to be in the minority.  Zombie merchandise is massively outselling vampire merchandise this year and has done so since 2012:


Zombies

From Panjiva:

In pop culture, the undead world has had many leading creatures that have captured audiences’ attention, from vampire heartthrob Edward Cullen to horror classic like Frankenstein and Dracula. However, according to shipment data from the authoritative information source on global trade, Panjiva, a different undead creature has separated from the pack this Halloween season to capture audiences across the countries: Zombies.

With the Season 5 premiere of the most popular zombie television show, The Walking Dead, returning to screens this Sunday, zombies are giving vampires the boot this Halloween, with shipments of zombie merchandise up 125 percent according to analysis of shipments from June-September.

Apparently, the popularity of undead creatures is a cyclical phenomenon.  Vampires were wildly popular in the late 1980s and early 1990s (remember The Lost Boys and Interview with the Vampire) and more recently with HBO’s True Blood and the Twilight books and movies.  But zombies started the modern horror genre with 1968’s Night of the Living Dead and zombies are killin’ it today in merchandising.  Yes, pun intended.

Charles Lewis Sizemore, CFA, is the chief investment officer of the investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays. 

Disclaimer: This material is provided for informational purposes only, as of the date hereof, and is subject to change without notice. This material may not be suitable for all investors and is not intended to be an offer, or the solicitation of any offer, to buy or sell any securities nor is it intended to be investment advice. You should speak to a financial advisor before attempting to implement any of the strategies discussed in this material. There is risk in any investment in traded securities, and all investment strategies discussed in this material have the possibility of loss. Past performance is no guarantee of future results. The author of the material or a related party will often have an interest in the securities discussed. Please see Full Disclaimer for a full disclaimer.

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