Confronting the Black Swan
Over the past weekend, I was re-reading one of my favorite novels, Ernest Hemingway’s The Sun Also Rises (1926), when I came across this verbal exchange:
“How did you go bankrupt?” Bill asked. “Two ways,” Mike said. “Gradually and then suddenly.”
Great topic for Monday’s column, I thought.
“Gradually and then suddenly” is an apt description of how disruption often plays out in life. Whether it’s the market collapse of February-March 2020, or the condo collapse last month in Florida, people often don’t see a calamity that’s long in the making, until the sky suddenly falls in.
My outlook for the rest of this year is generally bullish, but you should nonetheless take precautions. There are mounting perils over which Wall Street and Washington have no control.
The coronavirus pandemic is the perfect example of a sudden event, a “black swan,” that was gestating over a prolonged period but eluded all forecasting models. By definition, a black swan event is a total shock that no one expected.
Strictly speaking, the COVID outbreak could have been predicted. However, you could make the same assertion about, say, the crash of 1929. Or the deadly Surfside condo fiasco. The warnings were there, but they’re only apparent in retrospect. A combination of procrastination, denial, and willful ignorance precluded preventive action.
Financial busts, no matter how painful, are as inevitable as the booms that follow. What matters is that you prepare for the next crisis. Below, I’ll show you how to confront the possibility of another black swan.
Stocks retreated last week, amid widespread fear about two villains: inflation and the COVID Delta variant. However, the year-to-date ascendancy of the major U.S. and international equity indices continues, as the following table shows:
Surprisingly, large-cap technology stocks have regained their momentum. Analysts predict strong quarterly operating results in the coming days from Silicon Valley’s stalwarts. The big banks already have beaten second-quarter earnings expectations.
In addition to strong corporate earnings growth, monetary and fiscal stimulus policies are major factors behind the market’s upward trajectory. The Federal Reserve is pumping trillions of dollars into the financial markets, with a pledge to do what it takes to keep the economy (and by extension equities) afloat.
In his semiannual testimony to Congress last week, Fed Chair Jerome Powell stood his ground, reiterating his argument (to a skeptical audience) that inflation still hasn’t accelerated enough to warrant Fed tapering. The Fed’s sustained dovish stance should pave the way for further stock market gains for the rest of the year.
If you’re worried that inflation will prompt the Fed to tighten, which would in turn tank the stock market, consider these two facts:
- The Fed’s latest strategy is to hike rates no sooner than 2023, and
- Over the past 35 years, bull markets continued for about three years after the first interest rate hike.
Yes, it’s inevitable that rates will rise, but that’s way down the road. In the current context, investors should enjoy the bull market while they can. Interest rates are historically low and the financial markets are awash in liquidity. What’s more, negotiations now underway in Washington suggest that additional fiscal stimulus is coming soon.
That said, take precautions and buckle up for greater volatility ahead. Last Friday’s stock market swoon suggests that we’re in for a bout of choppy trading. About 15% of your portfolio should be devoted to investment hedges.
As evidenced by the emergence of the Delta variant, COVID isn’t finished giving us nasty surprises. For a while it seemed as if the pandemic was behind us, but COVID cases are rising again around the world. Uneven vaccination rates are creating an economic divide, among countries and U.S. states.
Scott Gottlieb, the former commissioner of the U.S. Food and Drug Administration, predicted Sunday that “most” unvaccinated Americans will get the Delta variant. (Yikes.)
As you fortify your portfolio against future shocks, avoid investment fads that are getting a lot of hype in the financial press. Meme stocks? Crypto? Non-fungible tokens? They’re disasters waiting to happen.
Instead, increase your exposure to high-yield dividend stocks, which provide the trifecta of safety, income and growth.
In fact, our investment team has pinpointed five safe, high-yielding stocks that you need to buy now. These stocks have withstood every dip and crash over the last 20 years. To learn more, click here.