The Black Swan

From Potomac Fund Management, this is the Conquer Risk Podcast. Join us as we discuss the business of running an RIA firm and the practice of investment management, and now our hosts. Welcome to the Conquer Risk Podcast. My name is Manish Kata.

I'm here with our Director of Advisor Education, Jeff Goodenau. How many times do you wash your hands today? Only a few. You know, I had empty tanks.

I definitely washed them. I had to put some bug stuff out, washed them. But I'm not having a connection fit over washing my hands. I stay pretty clean.

Alright, well the only reason I asked is we're recording this on Thursday, what's today's date? March 5th, so we're sort of in the midst of this whole outbreak. And that's something we're going to discuss here, the pandemic, coronavirus, all that stuff. So let's get into it.

I know you worked hard on this, get in the intro, and things framed out for what we want to talk about here. I know some of the pandemic news things, ruffle our feathers a little bit, but why don't you jump in? Yeah, sure enough. So ultimately you and I were talking the other day about, well, what is this black swan, right?

That's the word, the phrase, du jour. And so of course, we like being the column in the storm. But therefore we wanted to do a little bit of research. So there's a couple of things.

We really decided to talk about more specific than just black swan, but black swan as it relates to what the situation we're in right now, which is a virus or pandemic sort of circumstance. And so we did a little bit of research, put some stuff together. And that's really what we want to hit today, is talk about that subject. Yeah, so black swan in the, I guess, thought process of the market itself, not necessarily.

So, alright, let's start with this. What's the black swan? So for our context today, black swan, and this was popularized by Nicholas to lead back in his book. Excuse me.

I must be getting the flu. Anyway, the point is, if the black swan is it relates to investing, is something that cannot be predicted, right? You can model, you can do all these things, but if you can't predict something that happens, then it's considered a black swan by most. And that's kind of a scary proposition, if you think about it on the surface, because if you can't predict it, oh my goodness, what's it going to do?

And that's kind of our point today. And so I guess you posed the question to me, you know, when it comes to markets, do black swans even exist? And, you know, I'm a big proponent that there is no such thing as a black swan when it comes to stock markets. Reason being, you know, and Med Faber had this great article that will put in the show notes about risk and declines.

And one of the things he pointed out was 70 to 80% of 1% declines, this is going back to 1928, happened in a downtrending market. And he was, his definition of a downtrending market was a 200-day moving average, right? Below that would be a downtrending market. And the thought process is that humans, we are humans, and humans are still trading for the most part, react differently in markets that are declining.

And therefore, there really isn't a black swan. Most of the risk and volatility happen in declining markets. You can make the argument, people say, well, black swans happen in wars or, you know, attacks, but what's the context behind it? You know, that's the most important thing.

And that's where we can have these arguments back and forth. But in terms of the market and how it reacts, I just don't think black swans necessarily exist. Yeah. Now, that's not going to, not a lot of people going to agree with me there.

Well, that, no, you and I are on the same page. So what we're really looking at, the three things we're going to talk about this week, we've actually already kind of discussed what is a black swan, what's that look like. But we also want to look at what effects are correlated to these types of virus black swan events or pandemics, whatever you want to call them. And lastly, well, what does context matter, which you've just basically just touched on briefly, but also what about your style of investing?

Does that make a difference? So let's dig in a little bit and start looking at some of the effects. And I want to give a little disclaimer here first. We are going to focus, and I'm going to give you some stats on the issues surrounding the deaths that have occurred from these virus iterations over the last 20 years.

It is not intended to like make light of it. We're not trying to be humorous in that situation. It's just a matter of we want to get to the facts. How many people actually died?

And therefore, when we're in the middle of this one right now, how is it a black swan? Should we be super scared? What's going on from there? And listen, I know the point of this disclosure, we have to make sure.

But at the same time, whatever, man, people are going crazy. For what it's worth, when this airs, I'm going to be in Cancun. That tells you where I'm at. So maybe I can't come back.

I'll take my laptop. I'll maybe quarantine from there. So let's hit a couple of these briefly, some stats. We're going to show, we'll have this image up here.

What got this started was an image from LPL put out of social media. And it referenced SARS and Ebola and Zika and the S&P index returns 90 days after the announcement of these. And when you'll be able to see this during the podcast, it's up 22, up six, up nine and a half basically. This is all this, no problem at all.

But again, that doesn't take into account what was really going on. So I'm going to give you. Do you have any comments about that before I give you the stats on how many deaths occurred from these different things? Yeah, I mean, this type of buying hold marketing is as disingenuous as it gets.

I hate it. It's usually broker dealer led where they just shoot it out to their monkey advisors who then forwarded on social media and everyone just gets in line. There's no context around it. Yes, three years later, after the bear market markets were up, whatever percent.

But no mention of the 56% data decline in the middle of that. That's okay. So again, let's get to the context of how many deaths occurred from these things. I think it's going to shock some folks.

So in SARS, and most of these were basically two years. So SARS was 2003 to 2004. Zero deaths. Ebola was 2014 to 2016.

Zero deaths in America. This is all for the United States. Oh, you're so America century. Look, there's a whole world outside of green.

I would agree. However, if we're going to get scared, freak out and have, you know, fall down in convulsions over our investing philosophy and process because of these things, well, then I wanted to know what deaths occurred in the United States. I agree. Most Americans only care about Americans.

SARS, zero. Ebola was 2014 to 2016, one in the United States, Zika, one in the United States. That was 2015 to 2016. So there's a little bit of overlap there.

H1N1 is the oddball, and that was very unfortunate. In the United States, there's an estimated almost 12,500 deaths. That was basically April, 2009 to April, 10. That's an estimate.

It's the only one that CDC gave an estimate on because they really were looking for not just, I have to give this caveat, not just immediate deaths because of that, but did that cause your system to be compromised? And six or eight months later? Well, hold on a second. Did you look up what the regular flu is?

Because isn't that something like 15,000 years ago? Last year was 16,000 people. Regular flu. Okay.

Fair enough. So H1N1 will go ahead. SARS is now considered just the flu. Did you know that?

CDC says so. All right. So COVID-19, that is our current situation, right? We are in the coronavirus, of which there are many coronaviruses.

There have been now as of this morning, it was updated to 11 deaths. Again, it's a sad circumstance for sure. But again, to your point, with regular flu, or I'm going to give you two other fun little stats, I think you keep it into perspective. From 19, let's see what we got here.

The American Federation of State County Municipal Employees, 1970 to 2005. Did you know we averaged over five deaths a year from Manhole Covers? That's like cutting your, like, being thrown at you or being... You can fall into one if you're, you know, walking and not paying attention.

I suppose maybe they're moving one, it could fall on you and kill you. They had a whole list. There were 185 people killed in that 35-year span from Manhole Covers. So something that, but that's a man-made thing.

So I wanted to take another step back, right? And I just get, again, not trying to be humorous about it. But what about something that none of us have any control over? Right?

That's the idea of a black swan. You can't predict it. Lightning strikes. On average, the National Weather Service has killed 49 people a year.

So we don't have conifption fits, sell all, jump out the building and say we can't save any money because of these things. So when we have a virus scare, yes, it is scary. Yes, you want to take your own self-assessment, but, you know, come on, take a breath, take a breather. I think it's important.

Again, we're not medical experts, but I think it's important to take a step back and just kind of let some of those things happen and keep to your process. So that... Well, I'm going to play, I'm going to play, I'm going to play Devil's Advocate here. I know we're the voice of calm and we're trying, we're on the same page.

But Devil's Advocate, you know, the Spanish flew, wiped out millions, right? A lightning strike will never wipe out millions. So, manhole cover will never wipe out millions. And I think that's the sort of, the missing point here is that these things were contained, but a pandemic can be a once in a lifetime bug that wipes out millions and millions of people.

And I think that's the fear where these other stats that we pull out, you know, like I pulled out one because you asked me to, last year, 6,200 pedestrians died, right? But you're never going to have a year where 10 million pedestrians died. Maybe after Telsa does the autopilot some more then, but not now. So that's, before you move on, I think that's the caveat we should make sure people understand.

Yeah, well, and so that's where we're going to, no, I agree with you. I mean, again, we're going to take the next step, though, and we're going to go into the context of both what was going on in the market environment when these things happen, and therefore some of those effects and where they directly correlated. And that's your bailiwick, as well as what, does it matter what your philosophy is or your style or what, should it matter, right? So you can fire away on context.

With everything in life, context matters. You know, you cannot make statements, and this is what bugs me about the media and also the buying whole crowd now. You cannot just make these statements without context, because in most cases, they're false, right? So when I hear things like, hey, don't worry, after H1N1, the market rallied 35%.

Well, no shit, Sherlock. That was from April 2009 to what? Sorry, April 2009 to April 2010, coming off one of the greatest bear markets ever. So March 10th, the bottom of the great recession.

Correct. So did the market rally, you know, because they didn't care about H1N1 or because we just had a bear market? So I want to go through these cars, for example, February 2003 to February 2004. The S&P rallied 35% during that period, right?

Also coming off a bear market, context matters. So in that case, it didn't have an effect because of where we were in the market cycle. H1N1, the market rallied 48% coming off one of the worst bear markets ever. Ebola, once again, rallied 8.5%.

We were in the middle of a bull market. It didn't matter. Context matters. In this case, we are way deep.

Extremely, extremely overbought on the end of a really long bull market. So if the market starts declining from here, was it because of this or was it because of the fact that we were already in such an overbought condition that the market was waiting to sell off no matter what it was? I don't know, but this is my point about black swans not necessarily mattering without context. Everything has to be given with context.

And in these past examples, you can't say that, hey, look, you know, don't worry, the market was up this much after this pandemic without telling people what exactly was happening during that period. And, you know, so you've given some detail around the context, and I want to take a step back, and this really goes back to a podcast that I thought was one of our first ones, and I referenced this kind of circumstance. I wanted to look at or talk about, well, what about the style of investing, the philosophy that you have? Should that make a difference?

And I'm going to make this very simple statement. Since the world seems to do nothing but talk about strategic investing. If you're a strategic investor, kudos to you, no problem there, right, no judgment, but none of these things should matter. Black swans should not be in your vocabulary because if you're a strategic investor, by definition, you're investing for this long-term trajectory and not going to change anything, based on what happens in the markets.

So what difference does it make if there's a virus or there's a whatever, right? It shouldn't. You just dial across the average into it, and, you know, this shouldn't let it fall. But, unfortunately, it does.

Because people are human, their emotions get ahold of them, then they want to make a change. You know, oh, I want to get out now. I don't want to get out. Hold on.

I want to get the last week, right? It's this nasty, ugly, back and forth. But, again, it's, you know, it's all about your style and your philosophy because if you're trying to be the opposite would be true. If you're trying to be active or tactical in some format, then it's not necessarily the headline itself, and that's what I wanted to distinguish.

It's not necessarily the headline. It's that context that you spoke of from the standpoint of, okay, well, what is our process and are we following it? And I'm not just saying that for us as a manager, but every advisor that's listening to this call, if you're trying to be active in some form or fashion, follow your process and headlines be damned. Because if you try and chase headlines, I don't know if anybody that's ever tried to, excuse me, have been successful.

Investing positive or negative on headlines. You just can't. I think that's a fool's errand. Listen, I brought this story in the commentary.

I had my parents out here last week, and my dad was sort of, you know, flicking his phone left and right, trying to figure out what's going on. I got through about Wednesday afternoon without even looking at CNBC, you know, because a lot of times we're not trading intraday. And so I just, I see the emotional side of it all over. Just people talk it to me.

I rarely tell people what I do, but the people that know, it's like, oh, what's going on with this market? What should I do? And it's just like a conversation that ends to me, right? And it's just like, it's emotions, it's emotions.

And if your process is to trade, get involved, start doing what you have to do, reduce risk, you know, buy on certain triggers. But if it's not, then just go do something else. No, I absolutely agree. And I think, I mean, unless you've got other input there, I think we need to sum up this concept of what's your summation?

If you will, your short answer. I just, I don't think, I mean, to us, we follow the data, right? So as the market declines or increases and the underlying data changes, whether that's the price of indices or market breadth, it affects our systems. It doesn't matter what actually happened to make the data change.

It just comes down to the data changing. And I always tell people that where, you know, a lot of times like 2011 with 9-11, you know, the market sort of declined after, but it was already weakening going into it. It had nothing to do with necessarily that attack. Maybe it could, you can make the argument that that flipped it off the edge, but for the most part, you know, markets react on data and not on news, at least in the mid to long term.

Maybe a couple days here and there, you get some overreaction, but it's usually warranted. Right. Yeah. And so, you know, and I go back to my statement, right?

The context of what your philosophy is and what your trading style is, or lack thereof, matters as much as anything. Because depending on what it is, these black swans, they don't exist. If you're strategic, if you're tactical, then it's not the black swan itself. It's about what effect it has on the data, and therefore you're making your decisions accordingly, hopefully not with a psychological emotional tilt to it.

Because that's, again, that's, I've seen horror stories just don't go there. Have a philosophy and stick to it. That's our summation. So on that note, how about recommendations?

So I, you know, we use a planning software, not financial planning, but we were using Microsoft Planner and as a team trying to figure out how to assign tasks and all these different things. And Christopher, our director of marketing, love these teamwork software. And so we went out there, looked at different pieces of software, and my first impression is I love it. I mean, the fact that we can set up a list of tasks and have them be in order where when you finish one thing, it automatically kicks off to me.

Maybe some companies and advisors already have this in place. This is our first crack at a teamwork software that actually works. And I don't know about you, what are your two thoughts on that? I think it's phenomenal.

Yeah, definitely. I like the organization. I like setting up my favorites with dependencies. So you wrote a blog, you've marked it, you've finished it, it shot me a notification.

Hey, Manisha's just finished this and now you're up, basically. And so when I finish it and it goes to Jen, right? And I don't have to, none of us are passing links back and forth. None of us are doing anything.

It's just check the box. I'm done with my task and it moved the date up. So her date was now two days away instead of three because I finished mine early. I mean, that's pretty slick.

I'm hesitant to give Mr. Norton any credit on this technology thing since he's such an Apple fanboy, but I have to give him a shout out. It works really well and it's teamwork has definitely helped us get organized. Alright, let me keep mine short and sweet, especially after this, a little bit on a sort of podcast with some of the data.

If you're ready to be offended and you're ready to have a good laugh, hopefully those two work together, you need to watch. I think it was 2012. Ron White did a special. He's a comedian, a comedian called A Little Unprofessional.

And that is probably the biggest understatement I've heard in six months. I mean, we have fun on our podcast, but glory be. Yeah, definitely watch it. But just don't do it.

If you're going to get where it's on. It's actually a number of places you can catch it streaming. But it's definitely worth a lot. My wife got mad at me.

She told me to be quiet. I'll just put it like that. Think about what I was going to say because it's not exactly what she said. Anyway, your wife told you to shut up.

I haven't heard that. Oh, she told me much more distinctly than that. Alright, have fun again. Peace out.

Thanks. All opinions expressed by podcast guests are solely their own and do not reflect the opinions of Potomac Fund Management. This podcast is for informational purposes only and should not be relied upon for investment decisions. Clients of Potomac Fund Management may maintain positions and securities discussed in this podcast.