Posted by Don Martin on Wed, Mar 16, 2011 @ 03:38 PM
CNBC headline: Black Swans Now a Regular Part of Market Landscape
The article published today said “once-in-a-lifetime events are happening with such regularity that black swans may as well be white swans.”
Since 1994 Orange County, a very rich county, went bankrupt, 1998 we have the failure and bailout of LTCM, in 2000 the Nasdaq bubble, 2001 Enron, 2002 Worldcom, 2007 the real estate and mortgage backed bond bubble crash, 2008 bank crash, Bear Stearns and Lehman demise, and 2009 stocks crashed 56% from the top. Now there is the Japanese quake, the worst there in 300 years.
“A Black Swan” is a symbol based on a book by Nassim Taleb where he warned that traditional risk models don’t show that the true level of risk is much higher than it appears. He believes it is best to have mostly safe investments like government bonds, etc. issued by governments with low debt loads.
This is very similar to my philosophy. I have been advocating investing in investment grade bonds via mutual funds and avoid equities, junk bonds, Muni bonds, in order to avoid excessive, hidden, uncompensated risk.
Independent investment advice is what is needed to become aware of Black Swans.
Posted by Don Martin on Wed, Mar 16, 2011 @ 02:30 PM
The huge Japanese quake may have scared investors, but the real concern that investors should have (but don’t) is that U.S. equities are 70% overpriced according to various indicators such as the Shiller PE10 or Tobin’s Q.
My intuition regarding the quake and the nuclear plant is that eventually things will go back to normal and people will forget about the quake and the risk of nuclear power.
However, regarding buying Japanese equities on a dip, I’m not ready to recommend that because of macroeconomic and demographic fundamentals that existed in Japan before the quake. The Japanese equities have had low Return on Equity which is why Warren Buffett does not like investing in Japan. Japanese publicly traded companies appear to be focused on maintaining employment and sales volume rather than profits. Japan has a long term problem with declining birth rate, no immigration, less entrepreneurial behavior than in other countries and huge debts financed at artificially low rates. (Of course the U.S. also has a big problem with debt).
The problem with “Value” investing is that occasionally investors can get into a “Value trap” where they buy stocks with low PE’s only to find they were low because the company was moving into a worsening situation and thus the company’s share price continues to go down. So the risk of investing in Japan is not the quake but rather the macroeconomic fundamentals that existed before the quake.
Assuming the developed world is in a 17 year bear market then we have another five or so years to go until it ends. Also, after a bad financial crash where deleveraging is needed it takes seven years to return to normal growth rates, according to the book “This Time it’s Different” by Rogoff and Reinhart (This would apply to the U.S. and Europe, not Japan). So if most of the developed world will be weak for some time then this would affect Japan’s economy in addition to its own structural problems that existed before the quake. Specifically I’m thinking that if the bear market can only end by going through a “Capitulation phase” where the SP goes back to 666, then only after that time will the developed world be able to return to a bull market, which will also involve Japan.
So I prefer to sit tight with quality bonds rather than risk a value trap in Japanese stocks.
I have written about the these topics here. This is an example of independent investment advice.
Posted by Don Martin on Mon, Mar 14, 2011 @ 04:22 PM
The Japanese quake can inspire people to be aware of other risks. Are you prepared for:
* Cyber war: So many things would not work if the internet was sabotaged. Imagine if your ATM card, credit card, etc. did not work and your bank would not give you cash because their software was down. Imagine if the gas station would not dispense gasoline.
* A local earthquake. Perhaps the single most important risk to Californians is that there would be a severe shortage of drinking water after a quake. Do you have several weeks worth of drinking water, plus purification systems such as iodine or Steripen?
* Psychological survival after a quake. Have you tried backpacking and learning to survive with minimal resources, no showers, no utilities, etc.? Are you tough enough to go camping in your backyard or in the local park for a month and eat only dried food? Do you have backpacking supplies including food and fuel at home?
* Do you have first aid training in case there are no doctors available? Do you have a supply of prescription medicine and know how to use them? Are you able to walk home from work?
These ideas remind me of the concept of indepenent investment advice, where one must be self-reliant, and prepared for some unusual Black Swan event where no help is available from others.
Posted by Don Martin on Fri, Mar 11, 2011 @ 05:04 PM
The U.S. Geological Survey has published a guide for preparing for earthquakes, titled "Putting Down Roots in Earthquake Country". Please download and read it.
I have written about how the tragedy of earthquakes are a metaphor for economic shocks. By reading the earthquake pamphlet perhaps you will think of some analogies about protecting your investments in addition to protecting your home.
Posted by Don Martin on Fri, Mar 11, 2011 @ 01:38 PM
Last night’s 8.9 earthquake in Japan was the worst in 300 years in Japan, which gets a lot of quakes and it was one of the ten worst in the world in the past century. So it was a Black Swan (a statistical outlier) event. The lesson is that occasionally people can be damaged by statistical outlier events that were hard to plan for. So for investing that means each investment should be carefully evaluated with a stress test to see if the investment is high quality asset that can withstand shocks.
The lesson is that avoiding risk is more important than chasing after gains. For example when a stock purchased at $100 drops 50% and then rises by 50% it is now at $75, which is 75% of its previous price, so instead of breaking even, a person has lost money. The stock would have to rise 100% from the low of $50 to return to its original value. Thus it takes a higher proportion of gains to make up for losses.
The ways to reduce investment risk is to:
*Only invest in things that have a risk level that you feel comfortable with
*Invest in things that are high quality such as stocks with low debt loads, stable earnings, a corporate moat, etc.
*Diversify
*Maintain plenty of spare cash
The tragedy reminds one of the need to avoid risk by having homes and office stocked with earthqauke supplies, planning for quakes with safety drills, learning about how to cope with the afertermath of a quake, etc.
I have written about investment risk here. This is an example of independent investment advice.