Concerns over possible ‘Black Swan’ event loom
On this year’s first “Black Monday,” I happened to be busy all day and was oblivious to what was happening in the stock market. I had other reasons to bring up my accounts late in the day and was surprised to see that all the stocks or stock-oriented mutual funds had dropped about 5 percent. Whoa! Looking at the bright side, the uniform losses across the collection of my holdings confirmed the fact that any single stock’s performance is a function of what the entire market is doing — the latter being like a tide that raises and lowers all the ships.
Stanford professors proved this about 50 years ago by throwing darts at the Wall Street Journal. They illustrated that stock performance was largely (70 percent at least) controlled by market forces rather than by the fortunes of any individual company. So here was my online statement full of investments distinguished mostly by downward facing arrows all colored red and most showing 5 percent losses. The tide had gone out. All of my stock-oriented holdings had been caught in the rip.
So what does this mean to investors? In recent columns I had suggested that, to maintain composure when the inevitable happened, it would be wise to assume that the total account balance of an allstock portfolio should be reduced by about 15 percent
— at least in the mind’s eye. This acknowledges that a major portion of the recent gains were just a temporary gift — like the “Secret Santa” game where you wind up temporarily with the present you hope to take home until someone else gets to claim it.
Creating the demand that generated around half of the stock-market gain over the past two years was what Goldman Sachs identified as the largest buyer of stocks. No, it wasn’t retirement plans or individual investors, but corporations themselves buying and retiring their own company shares. It was done primarily to increase the price and deploy what they anticipate to be their upcoming tax savings.
Corporations buying and retiring their own stocks boost stock prices on two fronts. First, they create demand for shares in the open market, which pushes prices up. Second, they reduce the number of outstanding company shares overall so that each share now represents a slightly higher percentage of ownership — which, in turn, makes each share more valuable based on simple arithmetic, rather than just the market’s primitive animal spirits fueled by irrational exuberance.
At the moment, the reasons for last Monday’s downdraft are not specifically identifiable, but speculation is rife — as in the Yahoo Finance headline: “Wall Street to Washington — Stop Screwing Around.” The market hates uncertainty, and while the economy — both here and abroad — is performing well, the cloud on the horizon is one of “event risk” as much as any change in traditional market forces. As for “event risk” — a so-called “black swan” event with a low probability — there is a growing list of possibilities. War in Korea, a growing pile of Russian interference evidence, administration and congressional instability and other disconcerting issues all contribute to raising the volatility (or “worry”) index — for which there is an actual index, the VIX. Not surprisingly, after two years at historic low levels, the VIX doubled last Monday.
There’s never a clear answer as to why major moves occur when they do. But if
you’re thinking, “I’m getting too old for this,” there is always the safe harbor offered by some bonds or balanced funds that include a mix to create lower risk levels — a lower personal VIX. Beyond that, it’s then a matter of gripping the arms of the chair tighter than usual and holding the
thought that every past downdraft has been followed by an astounding “snap-back.”
Steve Butler is the CEO and founder of Pension Dynamics Company LLC. To read past columns and learn more about his book, visit www. pensiondynamics.com and click on resources. Steve can be reached at 925-956-0505 ext. 228 or sbutler@ pensiondynamics.com.