Black Swan Events in the Stock Market - How to Survive the Unpredictable

Hey there, fellow finance aficionados! Today, we’re going to talk about a topic that’s rarer than a Shiny Pokémon, offers more opportunity to get rich than just about anything, and you’ve probably seen it happen at least five times already in your life… What is it?

A Black Swan Event in the Stock Market

Now, I know what you’re thinking. “Black Swan? Is that some kind of goth bird that listens to My Chemical Romance on the daily?” Well, my friend, let me tell you, a black swan event is no laughing matter… except when we’re making jokes about it.

Alright, enough of the shenanigans. Let’s get into it:

What is a Black Swan Event?

A Black Swan Event is defined as “A rare, unpredictable event that has severe consequences.” Nassim Nicholas Taleb popularized the term in his popular book “The Black Swan: The Impact of the Highly Improbable.”

The Black Swan Theory in the Stock Market is based on three characteristics:

1. The event is mostly unpredictable.

2. The event has widespread impact.

3. Investors rationalize the event in hindsight bias, making it seem as if the event was predictable.

Well, we disagree with this whole ‘Black Swan Theory’ crap. We believe you CAN predict a Black Swan Event.

Why would we think something so crazy?

Because it’s been proved time and time again throughout history:

• Michael Burry successfully predicted the 2008 financial crisis. It’s estimated his fund, Scion Capital, made $700 million from the crash.

• Jeremy Grantham predicted the dot-com crash in 2000.

• Bill Ackman profited more than $2.6 Billion predicting the Covid Crash of 2020.

You tell me… are Black Swan Events really “unpredictable”

Not only do we believe Black Swan Events are predictable, but they’re one of the most straightforward ways to build wealth. No, I don’t mean it’s easy by any means. It’s actually incredibly tough. You have to be one of the select few who sees something coming that no one else sees. But the ones who have successfully predicted these events have all become filthy rich. And there are countless examples throughout history of individuals making a fortune from predicting Black Swan Events.

We want to help you be the next example of someone who successfully predicted a Black Swan Event. Just make sure you Venmo me my share for writing the article that helped you do it.

This Article is Broken into Four Sections:

• Examples of Black Swan Events and the Warning Signs

• Identifying the Different Types of Black Swan Events

• How to Prepare for a Black Swan Event

• How to Capitalize on a Black Swan Event

Black Swan Events and The Warnings Signs

As we just said, we believe Black Swan Events are predictable, and we will prove it in this section. We’re going to cover two different Black Swan Events and some of the associated warning signs that could’ve been used to predict these specific events.

The Dot-Com Bubble

The Dot-Com Bubble happened in the late 1990s and early 2000s and was a period of excessive speculation and investment into internet-based companies.

• Insane Valuations. Internet companies were starting to explode, and investors couldn’t control themselves. The valuations of these internet companies were excessive, to say the least. Some companies were trading at price-to-earnings ratios of 100 or more. That’s NOT Sustainable. Investors soon came to their senses and realized investing in companies with no real track record of profits can’t go on.

• Undeserving Rally. The NASDAQ Composite Index rose 582% from January 1995 to March 2000. That’s NOT Sustainable. As an investor and trader, you must be able to spot when something is too good to be true. And this was that. From March 2000 to October 2002, the NASDAQ fell by 75%, erasing most of the gains since the bubble started.

Look for circumstances within the market that are NOT Sustainable. Unsustainable moves in markets and asset classes create excellent opportunities. You may commonly know these as ‘bubbles,’ when asset prices greatly exceed their intrinsic value.

Financial Crisis of 2008

The Financial Crisis of 2008 was a direct result of the housing market beginning to crumble.

If you wanna really get into it, you can talk about the Michael Burry strategy of sifting through all the sub-prime mortgages that made up the CDOs and MBS, but that’s boring and you can just go watch The Big Short. Let’s get into other warning signs you could’ve seen:

• Excessive Leverage. Financial institutions before the crisis were so heavily leveraged that it’s wild to think about. Let’s use Bear Stearns as an example, as they were the first investment bank to fail. Bear Stearns had two hedge funds: The High-Grade Structured Credit Strategies Fund and the High-Grade Structured Credit Strategies Enhanced Leverage Fund. These funds had a 10:1 leverage ratio and 12:1 leverage ratio, respectively. To put this into context, The High-Grade Structured Credit Strategies Enhanced Leverage Fund, with the 12:1 leverage ratio, had $9.4 billion in assets at the end of the first year. $8.5 billion was in borrowed money. Very risky stuff. If something goes wrong, it's going to crumble fast. Which is exactly what happened as the funds got margin called.

I like this example because it highlights just how over-leveraged and risk-taking these investment banks were around the time period of the financial crisis. The investment banks were making incomprehensible amounts of money through originating and distributing loans, CDOs, MBS - blah blah blah. The main takeaway here is: When something is too good to be true, it usually is.

Later in the article, we discuss exactly how you could’ve capitalized on these Black Swan Events.

Identifying the Different Types of Black Swan Events

Black Swan Events can take many forms. The examples in the graphic above and the ones we cover below are just a few of the many Black Swan Events that can occur. Let’s cover what these mean exactly:

• Natural Disasters: Major Floods, hurricanes, earthquakes, and other natural disasters can have a significant impact on the economy. These events are so important as they can disrupt supply chains, damage infrastructures, and lead to an overall sharp decline in economic activity.

• Political Crisis: Sudden changes in governmental policies or political instability can significantly impact the overall economy and the financial markets. An example was the 2016 Brexit referendum, which resulted in the UK’s decision to leave the European Union. This had a significant impact on the British pound and the financial markets.

• Financial Crisis: Financial crises, such as the 2008 financial crisis, typically have the most significant impact on the stock market and the global economy. These events can arise from a variety of factors such as unsustainable debt levels, asset bubbles, and systematic failure.

• Pandemics: Widespread outbreaks of infectious diseases. The first one that comes to everyone's mind: The Covid-19 Pandemic. We all know how the Covid-19 Pandemic affected the stock market, so let's take a look at some other examples:

As you see a Black Swan Event can fall under a number of different categories. These are just some of the categories in which a Black Swan Event can fall under, and there are also plenty more. History always repeats itself. These events are certain to continue happening, so the best thing you can do is prepare for the next Black Swan Event.

How to Prepare for Black Swan Events

This section will mostly take a risk-management approach to prepare for a Black Swan Event. We will discuss more defensive strategies to ensure you are properly prepared to navigate these dangerous events.

Let’s cover two ways you can prepare for a Black Swan Event:

1. As the saying goes: don’t put all your eggs in one basket. Instead, invest in various assets and securities, such as stocks, bonds, cash, target-date funds, and commodities. This helps reduce overall risk and protect you from the impact of a single event. Lehman Brothers, before their bankruptcy, was the fourth-largest investment bank in the United States. If you had gone all in on Lehman Brothers before 2008, you would have lost your entire fortune. I know. I know. It’s boring. But please, for us, diversify your investments. Different industries, different asset classes, and always remember: Cash is a position. One of the smartest things you can do is to wait on the sidelines with cash until an opportunity presents itself.

2. You can’t predict a Black Swan Event if you don’t know what’s happening in the global economy and financial markets. Staying up-to-date on the news is CRUCIAL. There are always warning signs of these catastrophic events. It doesn’t just happen out of nowhere. Some warning signs include identifying an asset bubble, economic indicators, and intuition. Intuition comes through years of experience.

We help you with just that. Every Week, on Friday after the market close, our team of analysts here at Black Swan Street send an in-depth rundown of everything that’s happening.

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How to Capitalize on a Black Swan Event

Most people view Black Swan Events as nightmares and the truth is, they are. Black Swan Events destroy households. They wipe out retirement income, years of savings, and cause much more pain. But on the other side of this, few individuals make fortunes from these rare events. As we discussed earlier, Michael Burry made his fund $700 million from the financial crisis in 2008, and Bill Ackman made more than $2.6 Billion from the Covid-19 Crash.

During Black Swan Events: The rich get richer and the poor get poorer.

Black Swan Events present the greatest opportunities—one example: Zoom stock during the Covid-19 Pandemic. Zoom is a video communications company whose shares were trading around $70 at the start of 2020. By the end of the year, in October, the stock had hit $588 per share. That's a 740% return in less than a year. Pretty freakin good opportunity if you ask me.

This brings me to my first point:

1. Be Prepared. We just covered two ways to be prepared for a Black Swan Event, but that was in a more defensive manner, to manage risk. Now, let’s talk about being prepared for any opportunities that present themself. Every Black Swan Event opens up opportunities. You have to be able to spot them. Let’s stick to the Zoom example:

The Covid-19 Pandemic has come, and no one can leave their houses. What stocks will this affect? Video communication companies. People are stuck at home and the demand for these video communication companies rockets. Therefore, the stock price rockets. Duh. In my opinion, this doesn’t take a genius to realize. All it takes is someone who can be forward-looking, patient, and react fast when the opportunity presents itself.

2. Be Strategic. Don’t just go YOLOing into every investment you see because an asset class has slightly sold off, and you think you’re gonna get rich. Know your conviction behind the decision, remain patient, know the price you feel comfortable paying, and most importantly, know your risk tolerance. Have a plan.  

We’ve used the 2008 financial crisis as an example frequently throughout this article, so let’s use it again. The 2007-2008 financial crisis was the most-severe financial crisis since the Great Depression. This crisis gave way to 8.8 million jobs lost, $19.2 trillion in household wealth lost, and $7.4 trillion in stock wealth lost from 2008-2009.

But when there’s tragedy, there’s also opportunity.

During the financial crisis of 2008, long-term U.S Treasury Bonds rose 20%.

In some Asset Class, in some Investment Vehicle, there will ALWAYS be an opportunity that presents itself. You just need to know where to look. Knowing where to look involves being prepared, strategic, and patient.

Main Takeaways

Black Swan Events are rare and very difficult to predict. You have to be able to dig deeper to see one of these events coming. But if you are prepared and strategic when they arise, they open the possibility for limitless financial returns.

We’ll leave you in the only way we find fitting- a Warren Buffett quote:

“Be fearful when others are greedy and be greedy when others are fearful.”

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