What Could Go Wrong? Some Black Swans.

Well we're cruising towards the end of summer now. As I mentioned last week most of the investment class is more worried about their tans than their stocks while the markets have mostly traded with a positive bias.  So what could go wrong?  I mean if we sometimes focus on the positives shouldn't we also look at what could wash over the transom that would lead to a more negative bias by investors?   Today I'm not going to focus on economic numbers or issues such as market valuation.  Instead, I'm going to throw out a five scenarios that are mostly overlooked by investors.  These for the most part are what we refer to in the business as "Black Swans".  You can read more about the theory and history of "Black Swans" here.  For my definition I'll go with something simpler and say a black swan is a low probability and unlooked for event that usually catches investors offsides in the risk profiles of their portfolios.  Examples of "Black Swans are 09.11.2001 and the Japanese earthquakes that led to the Fukushima nuclear disaster in 2011.  So here are my five most likely "Black Swan" candidates in no particular order and my amateurish estimated assessment of the probability of each occurring:

Mr. Trump either wins or closes in on Mrs. Clinton in the polls as we get closer to the elections. Now before the hate mail or phone calls start let me say that I'm not making any political judgement here. What I'm saying and what I've been saying for the past few months is that the market's expectation is that Mrs. Clinton will be the next President.  Since her views on many issues are relatively well-known, the markets are already discounting her likely economic policies.  Should this consensus change then it is possible investors would get more nervous and potentially lower their risk levels until events become more certain. At this point, given some of Mr. Trump's more recent statements and actions this outcome seems less likely.  Also the electoral map does not seem to be in Mr. Trump's favor. However a major gaffe by the  Clinton campaign, a health issue for Mrs. Clinton or a poor performance by her in the debates could change this assessment.  Estimated probability of this outcome less than 30%.

A major weather event affecting the United States or another major economic center around the globe.  Earthquakes and hurricanes are events that cannot be gamed.  The can happen tomorrow or a year from now or maybe never.  Still these have happened in the past and will occur again.  Investors usually focus  on the possibility of a hurricane hitting in the southern US or earthquakes in California but tend to forget that some of the more powerful hurricanes have visited New England and one of the strongest earthquakes occurred along the New Madrid fault in 1811-12.  Overseas what would be the impact of a major eruption of Mount Vesuvius?  Estimated probability of occurrence: Less than 15%.

A major terrorist attack that causes a massive economic US or global  disruption.  Think something like a dirty nuclear device unleashed in the middle of London or New York City. Estimated probability of occurrence:  Unknowable.

A world-wide medical emergency.  A medical event that  rapidly spins out of control and forces countries to either close their borders or significantly limit exposure to the outside world. Such an event would not only be psychologically devastating but would also cause a massive disruption in global trade and economic activity.  Think here of Ebola gone bad. Estimated probability of occurrence:  Less than 15%.

A major international crisis.  Here are a few candidates:  Immigration crisis in Europe inflames tensions in the Middle-East.  The Syrian war becomes a more broad-based conflict.  Conflict between Iran and Saudi Arabia.  A Russian military move against the Baltic members of NATO. A North Korean attack on South Korea.  Finally the scenario I think is the most likely, a sudden sharp military engagement between China and a potential host of regional neighbors over issues stemming in the South China Sea.  Estimated probability of occurrence:  Less than 25%.

Of course since these Black Swans can be identified, none of these will probably occurr.  Instead maybe it will be something like this:  The Cubs win the World Series!  OK this last one is for fun but for all of us long suffering fans it would be an earth shattering event, although most likely not something that would impact markets. Then again maybe it would depress the spirits of the folks in Boston and New York to the point we'd have a bear market!  A Cubby bear market.  Probability of occurrence:  Not even going to go there!

Back Thursday.