Nassim Nicholas Taleb’s 2001 book ‘Fooled by Randomness’ used the term “Black Swan Event” to describe a low probability, high impact event, which caused serious fluctuations in the economic states quo Since then, the term has been rather more liberally applied to just about any large-scale event with an economically damaging aftermath that is deemed “unpredictable”.
The term ‘black swan’ stems from the fact, until its discovery in Australia in 1927, Westerners believed all swans were white simply because they had never seen a black one. One of the most commonly cited black swan events is the terrorist attacks on September 11th 2001, which caused a loss of a market cap of almost $1.4 trillion in less than a week.
In this article, we’ll be defining exactly what a black swan event is, giving examples of previous black swan events and discussing how certain investments, like fine wine and whisky, might represent a financial safe haven during black swan events
What is a black swan event?
The issue with labelling something as a black swan event is that it is subjective and any large-scale high-impact event is often mistakenly labelled as a black swan event.
In his book, Taleb laid out very specific criteria for what he considered a black swan event: “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.”
Taleb also points out that whether an event could be considered to be a black swan depends on your perspective. For instance, the turkey might consider Christmas to be a black swan event, but the chef does not.
Given these parameters, which are both very specific but also very subjective, events that are widely agreed to be black swan events are very rare.
If we go back to our example of the terrorist attacks on September 11th 2001, we can see that they fit into Taleb’s specific criteria:
- They were an outlier because a terrorist attack on that scale on U.S. soil was unprecedented
- They had an extreme social and economic impact
- In the wake of the attacks, people would describe them as being entirely explainable and predictable with the benefit of hindsight
What are other examples of black swan events?
Despite their comparative rarity, there are other events that are widely agreed to fit into Taleb’s specific criteria, including:
The 1997 Asian financial crisis
In the wake of significant economic growth in countries like South Korea, Thailand, Malaysia, Indonesia, Singapore and the Philippines, which were dubbed the “Asian Tigers”, large amounts of direct foreign investment started to flow into these countries.
In response, real estate prices soared, governments borrowed heavily to undertake ambitious infrastructure projects and corporations also borrowed to finance significant spending places.
This bubble popped when the property market in Thailand collapsed after the bankruptcy of Somprasong Land and Finance One. The Thai Baht was disconnected from the U.S. dollar and underwent significant devaluation. This pattern was quickly followed by the Malaysian Ringgit, Indonesian Rupiah, and Singapore Dollar. On average, these currencies lost 40% of their value, with the Indonesian Rupiah losing 83.20% of its value. In order to stave off a complete collapse, the International Monetary Fund (IMF) provided $110 billion in loans to Thailand, Indonesia, and South Korea on the condition that they impose higher taxes, reduce their infrastructure spending, and implement higher interest rates.
The 2000 Dot-Com Crash
The dot-com crash is an excellent example of how an unprecedented technology can result in valuations based on unrealistic metrics. In this case, the wider implementation of the internet and the tech revolution possibilities it brought, resulted in a massive overvaluation by excited pundits and huge injections of investment capital based solely on speculation. At one point the NASDAQ index rose from 1000 in 1995 to 5048 in 2000.
When larger companies like Dell and Cisco decided they’d had enough and placed huge sell orders, the market spiralled into a panicked sell-off, losing 10% of its value in just a week. The vast majority of the so-called dot-com companies saw their stock reduced to worthlessness over the coming months and it would take the NASDAQ around 15-years to recover.
2008 global financial crisis
In the wake of years of stable continuous growth and high employment rates, coupled with low inflation rates, U.S. financial institutions started providing sub-prime mortgages to basically anyone who applied.
This situation was exacerbated by the dropping of interest rates from 6.0% to 1.75% between 2000 and 2001. With more money available, more financial institutions began to distribute it to borrowers with questionable credit ratings.
In 2008, a tipping point was reached with a run on the stock of investment bank Bear Stearns. Bear Stearns, like many of its competitors, had accumulated a lot of mortgage-backed securities that investors were increasingly considering bad assets.
Bear Stearns represented the first domino, with global investment bank Lehman Brothers filing for bankruptcy soon after. The subprime mortgage collapse impacted the entirety of the closely linked global financial system, with corporations, banks, financial institutions, and pension and hedge funds rapidly going belly-up worldwide. Governments across the world were forced to step in with buyouts that added up to trillions of dollars, with the crisis denting the U.S. gross domestic product (GDP) by $7.6 trillion over the next ten years.
While anti-European Union (EU) feelings in the UK are hardly a novel idea, the way in which Brexit was implemented qualified it as a black swan event. Making a policy decision, on the magnitude of leaving the EU, on the basis of a simple majority advisory referendum was utterly unprecedented and the outcome of the vote led to significant devaluations of the Pound and the Euro.
The cost of leaving the EU has been estimated at around 2.25% of the UK’s GDP, or around £40bn in lost economic output, by 2022. The EU is also expected to lose around 0.5% of its GDP.
Was the COVID-19 pandemic a black swan event?
According to Taleb himself, no, the COVID-19 pandemic was not a black swan event. In fact, he, along with other economists Joseph Norman and Yaneer Bar-Yam, authored a paper in January 2020 warning governments about the non-linear spread of COVID-19 and its potential global impact.
While the COVID-19 pandemic has undoubtedly had a huge impact on the global economy, the idea of a catastrophic global pandemic is hardly new or unpredictable. In fact, there have been many comparisons between the COVID-19 pandemic and the 1918 influenza pandemic, as well as the related SARS and MERS outbreaks in recent years.
In effect, the COVID-19 pandemic doesn’t qualify as a black swan event because it is not an outlier and is, at its most basic level, comparable to other major global disease outbreaks going back to the Black Death.
Are we on the cusp of another black swan event?
One of the main provisions of a black swan event is that it is an unpredictable outlier and therefore not able to be predicted. One of the things that make black swan events so impactful is that we can never tell if one is about to happen.
Are we on the cusp of another market crash?
Most market crashes don’t really qualify as black swan events, they are neither unprecedented nor unpredictable at this point, it is far easier to point to current events and use them to predict potential market destabilisation.
For instance, economist and strategist David Rosenberg recently pointed to the fact that the “high-yield market was extremely overvalued even if we adjusted for the huge share of BB-rated bonds, which are the highest tranche in the junk bond market (in terms of rating quality).”
In essence, Rosenberg’s concern is that the investment-grade market is currently populated by companies that are highly susceptible to being downgraded to junk stock were the economy to take a hit. If this did happen, it would result in around US$3.1 trillion in stocks being reduced to junk status, or so-called fallen angels. Should this happen, it could increase the debt cost of capital and make any economic downturn that much worse. Rosenberg’s theory is just one doom-laden prediction for the current economy and all of these predictions lie alongside the ever-present danger of another inherently unpredictable black swan event.
Are there investment options that can mitigate a black swan event?
Despite the inherent unpredictability, there are some investment opportunities that have traditionally weathered the economic collapses caused by black swan events better than others.
Whisky is almost always held up as an example of one such investment. One of the benefits of investing in whisky is that the market is disconnected from other investment markets. Whisky has traditionally proved resistant to economic declines and has been considered a safe investment dating back to the Great Depression.
In fact, whisky investment has risen in popularity massively over the last decade, with The Knight Frank 2020 Wealth Report showing a market growth of 582%. The desire for high-quality whisky in the Asian markets has had a significant impact on this growth, with sales of scotch to India, China and Singapore rising by nearly 50%.
One of the unique benefits of investing in whisky is the fact that the investment can be made before the product is bottled. Unlike a bottle of whisky, cask whisky continues to develop in flavour and character. This continued ageing process adds to the value of the product. Likewise, as whisky is a consumable, reductions in the number of remaining products automatically inflates their value.
Added to this is the fact that, in the case of scotch whisky, the casks are held in a secure HM Revenue and Customs (HMRC) warehouse, overseen by the Scottish government. This makes establishing the provenance of a whisky cask remarkably easy compared to other similar commodity investments such as fine wine or art. Even with the current pandemic ongoing, fine and rare whisky auctions are continuing to set world records.
This year, Bonhams set a world record for their sale of a 30-year whisky sherry hogshead cask from the Macallan Distillery. This cask is also expected to yield a world record per-bottle price of around $2035 (US$2800). In 2019, Bonhams set a world record for the sale of Japanese whisky, with a Hanyu Ichiro’s Full Card Series selling for £665,865 (US$917,000).
Also in 2019, a world record was set for a single bottle auction, with a bottle of The Macallan Fine and Rare 60-Year-Old selling for $14 million (US1.9 million). These huge sales demonstrate the continued global desire for fine whisky, even during the most turbulent of economic conditions.
If investors take a holistic approach to safe investment, whisky represents a stable and growing market, with a global reach and a huge desire among buyers for examples of rare and aged whisky. With cask whisky offering a unique opportunity to invest in a commodity that gets more valuable as it ages without any input from the investor, whisky investment represents an excellent hedge against challenging economic conditions and even the threat of a black swan event.