Black swans, white swans and very boring swans

Just about every day, someone, somewhere, makes a prediction of economic disaster with perfect logical arguments for its imminence. It's a fact that economic disasters do happen, so it is also a fact that as they do, someone will have been correct in predicting them. When that happens the media jumps on this oracle to soak up their wisdom. Such was the great fortune of Nassim Taleb, whose book The Black Swan (referring to sudden unexpected market collapses), was fortuitously released the year before the great financial crisis.

The truth is there are black swans, white swans and very boring swans. Markets unexpectedly zoom higher, plateau for excruciatingly long times, and occasionally collapse without warning. The complexities of macro-economics can make predictions almost impossible. Just ask Ray Dalio. No one does macro-economics better but even he gets it wrong. In February 2018, Ray, one of the best hedge fund managers ever, went out to the market stating that economic downturn was 70% likely before 2020 (Pendzich, 2018; Herbst-Bayliss, 2018). If you had taken Ray’s warning on board and sat on the sidelines since, you would have missed out on a terrific market rally.

But he certainly wasn't alone. At the same time, David Stockman, former investment banker and Reagan White House director, stated “There is surely a doozy just around the bend.” Scott Minerd, chairman of Guggenheim Partners stated that “markets are potentially on a collision course for disaster” in 2019. Paul Tudor Jones, the famous hedge fund manager who predicted the 1987 crash believed that a recession was coming in 2019, as did John Hussman who expected a market crash “in the order of 60%” (Derousseau, 2018).

Implications

As investors we must suffer. We must be ready to watch the value of our holdings plummet and hold fast without selling. When markets crash, lean on your analysis. Go back over the drivers of price and volume for the companies you hold and look again at the prospects. The reasons given for the market collapse likely have nothing to do with revenue streams in your businesses. Do people check the stock price of McDonalds before buying a burger? “Oh, McDonalds stock is down 5% today - that means I can't order an Angus meal until it starts going back up.” Are people going to stop buying homes on realestate.com because its stock price is down in a market crash? Hold your stocks, wait it out; if you have any cash, this is the time to buy quality businesses at terrific prices.

At Blue Oceans Capital, we don't pay attention to macro-economics. We don’t believe we have any capability in predicting macro-economic events. We stay completely focused on the individual performance of companies in our portfolio. When looking for new investments, if we find a business model with compelling financials and a fair or discounted valuation, we buy it, no matter what macro-economic issues present at the time. Stock markets do serve up plenty of surprises, up, down and sideways. Stay focused on the fundamentals.

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References

Derousseau, R., May 2018. “5 successful investors predict when the stock market will crash.” Business Insider. Retrieved from: https://www.businessinsider.com/5-successful-investors-predict-when-the-stock-market-will-crash-2018-5?r=AU&IR=T

Herb-Bayliss, S., February, 2018. “Bridgewater’s Dalio see 70 percent chance of recession before 2020.” Reuters. Retrieved from: https://www.reuters.com/article/us-hedgefunds-dalio/bridgewaters-dalio-sees-70-percent-chance-of-recession-before-2020-idUSKCN1G604T

Pendzich, K., & Schatzker, E., September, 2018. “Hedge Fund Manager Who Predicted Financial Crisis Says U.S is 2 Years From Economic Downturn.” Time. Retrieved from: https://time.com/5394187/hedge-fund-manager-financial-crisis/