Black Swan

Nassim Nicolas Taleb writes about 'Black Swans' in his book "The Black Swan".

For most of humanity people thought all swans were white in colour...till a black coloured swan was discovered in Australia.

Black swans, Taleb says, are low-probability high-impact events that are very consequential.

They are high impact events that cause a major shock, either positive or negative.

Black swans are inherently unpredictable. Our limited understanding on the world means we cannot predict when or where such events would take place. Of course, when they occur, in hindsight, they look so obvious that we wonder why no one thought them earlier.

For most days, the sacrificial lamb is well fed and looked after. The lamb continues to expect the future to be like the past. For most days this is true...until till the day the lamb is sacrificed. Most investors and experts alike expect the future to be more or less like the past. Till one day there is a black swan event that changes the course of the future.

Black Swan events can be positive as well as negative. A positive black swan is the internet. No body planned for the internet, we did not know what internet was before it came up, we did not know where or when the internet would develop and did not know how it would transform the world. A negative black swan was the world war 1 or the Great Depression in the 1930s.

What we are witnessing in the financial markets today in the USA is a black swan event. A huge negative black swan event that is changing the investment landscape, perhaps permanently, with huge implications for all world markets. Icons on Wall Street are going bust virtually every week. Stock markets are tumbling like nine pins and there is blood on the streets.

What does it mean for the Indian stock market?

1.) Generally, the current turmoil would mean a lot less money coming into countries like India. Maybe money would keep going out. Every rise might be sold into. Valuations for stocks are likely to to go down and stocks might get lower PE ratios in general.
2.) Investors should be prepared towards the possibility of black swans (both positive and negative). In terms of downsides, invest with protection. We have our cars insured, we buy life insurance, but most retail investors dont think about investment insurance or how to protect capital from major declines.
3.) Do not fall into the 'value' trap. The market is the final arbiter of value and in such an environment, there is no hurry to get in. Remember the time period from 2000-2002/3. The markets really tested the patience of investors while giving no returns.
4.) Return expectations from stocks will need to be reduced significantly. The fancy returns from stocks that we saw over the last 5 years are a thing of the past. There is still a lot of 'buy-on-dips' optimism out there.
5.) Do not think that India's great fundamentals will automatically mean good stock market performance in the longer run. Most analysts opine that fundamentals are great. This might be the case, or fundamentals might detoriate. In any event, the economy needs liquidity to grow, stocks need liquidity to perform. Foreign capital is in doubt. No athlete, however capable, can perform in an oxygen deficient environment.

Here is wishing you wise investing!