Stability and calm is an illusion. In truth, the world is constantly in flux and macro crises is the norm, not the exception. Just from the last decade, there was the Greek debt crisis, Brexit, the Taper Tantrum, the US debt ceiling and the Arab Spring (as a reminder, the oil price spiked to $128 during the latter and stayed elevated above $110 for more than three years).
As investors, how much attention should we pay to global macro events? If you look at history, the answer is surprisingly little (when Greece was struggling with its debt, Money TV became obsessed with the drama but, in hindsight, it hardly mattered).
Having said all that, there’s one major exception.
Originally, Black Swan was a metaphor for an event that seemed impossible (for centuries, based on historical records, Europeans had assumed such a bird didn’t exist). Then, in 1697, much to their surprise, Dutch explorers witnessed them first-hand in Western Australia. Consequently, Black Swan became a completely different metaphor – the idea that a perceived impossibility might later be disproven.
In his 2001 book, Fooled by Randomness, Nassim Nicholas Taleb defined Black Swan events as follows:
“First, it is an outlier, as it lies outside the realm of regular expectations, because nothing in the past can convincingly point to its possibility. Second, it carries an extreme ‘impact’. Third, in spite of its outlier status, human nature makes us concoct explanations for its occurrence after the fact, making it explainable and predictable.”
According to the strict technical definition, the Great Financial Crisis of 2008 wasn’t a Black Swan event (if you’ve seen the movie The Big Short, you know many people saw it coming and indeed profited from it). However, events can also be Black Swans events depending on the observer. As Taleb explains:
“Consider a turkey that is fed every day. Every single feeding will firm up the bird’s belief that it is the general rule of life to be fed every day by friendly members of the human race ‘looking out for its best interests.’ On the afternoon before Thanksgiving, though, something unexpected will happen to the turkey. It will incur a revision of belief. Let’s not be turkeys.”
The above can be compared to the statement of Fed chairperson Ben Bernanke who famously declared before the financial meltdown of 2008 – “We’ve never had a decline in house prices on a nationwide basis before. So, what I think what is more likely is that house prices will slow, maybe stabilize, might slow consumption spending a bit. I don’t think it’s going to drive the economy too far from its full employment path, though.”
Of course, financial markets were elevated in 2008. The combination of expensive stock markets, high leverage and risks underestimated by many (most economists never saw it coming), lead to a meltdown in equities that saw the S&P 500 crash more than 50%. In that case, paying attention to the macro issues would’ve been essential.
The world is experiencing a lot of turmoil at the moment. There’s been a covid pandemic, Russia invaded Ukraine, and inflation in the developed world is reaching levels not seen in decades.
Are any of these events Black Swans? Personally, I believe covid comes close (in the sense that many didn’t appreciate the risks), although people like Taleb disagrees (since people should have expected a global pandemic eventually taking place, he considers it a White Swan; an event that has a major effect, but is compatible with statistical properties). However, covid is unlikely to have a lasting economic impact (it’s not very lethal to the economically active population and vaccinations are readily available).
What about the rest? Well, unless NATO gets involved, the Ukraine conflict should have limited impact on the rest of the world. Russia is less than 2% of world GDP and, although it plays an outsized role in commodity markets, the economic impact is manageable on a global scale (although individual countries, sectors or companies might suffer severely).
Inflation is a worry, but some of it should reverse due to base effects and an unwind of covid-induced supply chain issues. The Fed is also determined to dampen inflation expectations by hiking interest rates aggressively (which poses macro headwinds of its own).
There’s also a major slowdown in Chinese real estate, although this is a deliberate attempt (controlled) by the Chinese government to prick an unhealthy bubble. As a result, the government will try and minimise the economic fallout with all kinds of measures.
The only potential true Black Swan event is probably a nuclear apocalypse, given recent Russian threats. However, this isn’t something investors need to concern themselves with. If it comes to pass, you’ll be too busy scavenging for food or fighting off zombie hordes (if you weren’t killed by the initial shock wave or radiation), to worry about the value of your investment portfolio. Hence it’s a complete waste of time to try and predict its probability.
In summary, there’s currently no macro headwind that poses extreme risks comparable to the 2008 GFC, but there certainly are a lot of them around.
So, while no 2008-style financial market meltdown seems imminent, the world is facing more macro headwinds than it has in the recent past. In isolation, this wouldn’t be cause for concern (markets often climb a wall of worry). Combined with elevated equity markets, though, (especially the US), there are outsized risks for investors. So I believe it’s time to be selective.
As a rule of thumb, big companies are more exposed to big macro trends than smaller companies (although many caveats apply). For example, in Meta’s (Facebook) recent results, it was evident how the Ukraine situation and general economic conditions in Europe had impacted their performance (when you’re that big, there’s no place to hide).
That’s why I believe smaller companies, especially 1) cheap and under-the-radar types, or 2) ones still growing market share or 3) special situations, offer the best potential rewards in the current environment.
Hosken Consolidated Investments (HCI) is a company that fits the above bill. Its hospitality assets are still in recovery mode while one of its investments (an oil exploration company) recently made a major find off the Namibian coast. I’ll be doing a detailed analysis in Sunday’s INSIGHTS newsletter, along with all the regular features.
Disclaimer: This newsletter should not be construed as formal investment advice for a specific individual or entity, but is for informational purposes only. Investors must always consider their own individual circumstances and risk appetite. Even with income instruments, there’s a risk of capital loss. Whilst every care is taken, I accept no responsibility or liability for any errors or omissions in any of the content.