Is Your Portfolio Ready For A Black Swan Event?

TruePoint Capital

What is a black swan?

​​In the world of finance, a black swan is an unpredictable event that is beyond what is normally expected of a situation and has potentially severe consequences. The 2008 Financial Crisis is the most recent black swan event.

Black swans wreak the most havoc and devastation when people least expect it. If 2008 is any indication, the current economic environment might be the perfect breeding ground for a black swan where investors stand to lose trillions.

The current economic environment reminds me of 2008 because the investing public is asleep at the wheel, lulled into thinking all is well with the financial markets when in fact, they are not. All the usual suspects enable the investors. The latter creates this environment of false security – from the financial media to social media, policymakers, and financial institutions like the central banks.

Similar to the current investor sentiment to 2008, there is one big difference that could prove the next black swan to be even more devastating. The difference between now and 2008 is the current low-interest rates.

​​With interest rates at already all-time lows and the market already flooded with trillions of free money, the central banks will be powerless to affect any economic stimulus when the next black swan appears.

How did we get here?

Investors are currently steeped in false security partly because of stock market performance and false trust and overconfidence in policymakers, financial institutions, and central banks, and their ability to avert or correct potential disasters.

2008 taught us that stock market performance should never be used to gauge the health of the underlying economy.

​​Before the Financial Crisis, the stock market was soaring just as it is now. Still, suppose the PE (price to earnings) ratio is an indication of stock market overvaluation. In that case, the current stock market is more overvalued than the peaks of 2008 and even the dot-com bubble.

The problem with gauging the economy’s health by the stock market is that the stock market isn’t as it appears. That’s because everyone is fooled by randomness.

​​How does randomness fool investors? The investing public looks at the rare random investor that occasionally hits it big and thinks that’s the way the market is all the time and that anyone can be successful. Investors don’t realize that the success stories are the rare exception and not the rule and are usually the result of unsustainable luck.

So, as Wall Street and the media focus on success stories, the reality is lost on the public, and the reality is, very few investors beat the market consistently. Everyone thinks they can do it when investors hear about super investors like Bill Hwang, who amassed a 20 billion dollar empire from humble beginnings. What gets less coverage is when Hwang loses that $20 billion empire in two days. Why do you hear less about the crash than the success story? Because Wall Street doesn’t want you to stop trading. They want to perpetuate the illusion because it keeps them in business.

Investors need to realize that the random investor who makes it big is exactly that – random – and as in Bill Hwang’s case, the lucky streak doesn’t last.

Wall Street’s randomness doesn’t fool smart investors. They know it’s a rare feat to beat the market. They’re not particularly impressed by an overvalued stock market fueled by free money in today’s environment. They’re already preparing for a black swan that they’re expecting to see sooner rather than later.

What do savvy, ultra-wealthy investors do to protect themselves from black swans? ​​They allocate away from the assets most vulnerable to disaster. Those assets are stocks and crypto.

​​But can’t the central banks swoop in and boost the markets through stimulus like in 2008? Not if interest rates can’t go any lower. The cost of borrowing is already low. Without anywhere to go, lowering interest rates to stimulate business borrowing and consumer spending to avert economic disaster is no longer an option.

So what do the ultra-wealthy gravitate to if they’re avoiding stocks and crypto?

​​Recession-resistant and inflation-insulated tangible assets like real estate and private businesses.  

Recession-resistant real estate and private business (i.e., private equity) investments – insulated from the diminishing effects of inflation on buying power – are ideal for combating the destructive effects of black swan events. Uncorrelated to the broader markets and mob rule, private real estate and private equity offer a calm in the storm by providing steady income and growth through an uncertain landscape.

As another black swan prepares to rear its ugly head, protect yourself by allocating your portfolio away from the assets most susceptible to black swans towards assets insulated from them.

Public equities and cryptocurrency are currently two of the most vulnerable segments and are the assets investors need to shed to avert disaster. That’s because there is no floor on how much you can lose with these intangible assets.

​​Real assets and income-producing businesses, on the other hand, can never go to zero, and that’s why the wealthy favor them in the face of impending financial doom and why you should be allocating more to these types of assets to avert disaster.