Market Analysis

Black Swans or Gray Pigeons?

As the media bemoans an increasing prevalence of “Black Swans,” it’s worthwhile to consider the definition and whether it’s truly applicable to recent events.

Story Highlights:

  • Recent events in the Middle East and Japan have many decrying an increase in the number of Black Swans.
  • But such events—while shocking and tragic—are hardly rare or unexpected.
  • And in the long run, they’re also not sources of larger economic disruption.

There are many ways to describe the recent earthquake and tsunami in Japan—among them, a tragedy and a disaster with staggering human and economic costs. But one description’s entirely inappropriate: a Black Swan.

First, a definition: A Black Swanis an outlier—a highly improbable event exhibiting “rarity, extreme impact, and retrospective (though not prospective) predictability.”* Based on this definition, many unexpected events don’t qualify as Black Swans: natural disasters; weather-related challenges such as food shortages, droughts, floods, etc.; Mideast unrest; financial markets upheaval caused by misguided government regulation; and so on. While their precise timing is unpredictable, these events are neither unprecedented, highly improbable, nor extraordinarily rare.

Japan, sitting on the Pacific Ring of Fireand one of the world’s most active subduction zones, has earthquakes frequently—not rarely. As such, Japan has highly advanced earthquake warning technology. And it’s why their building codes are stricterthan most—even those in similarly earthquake-prone California. While this preparation doesn’t eliminate all potential damage from large events, that preparations were made and currently exist eliminates the use of the term “Black Swan.”

And here’s another non-Black Swan: Trouble at Japanese nuclear power plants. Why not? Again, technologies developed in response to the Three Mile Island and Chernobyl incidents are helping to mitigate a repeat of those issues in Japan. Though serious accidents are exceedingly rare, nuclear power plants just aren’t widely viewed as risk-free—that’s exactly why containment structures exist.

Adding to the confusion, all recently discussed Black Swanshave been negative—but the original definition carried no such implication. Seen in this light, any positive development unexpected by global markets would also be a Black Swan—the invention of the Internet, the worldwide technology boom, medical breakthroughs, etc. But their positive impacts aren’t nearly as widely discussed as the deleterious effects of disastrous “Black Swans.” In fact, one increasingly gets the sense these are all really just points along a rather normal trajectory of human development.

So how best to respond to such events? Well, consider: We can’t think of a single instance of a natural disaster leading to a global recession in modern times. Does that mean recession triggered by natural disaster is impossible? No, but virtually nothing is impossible. However, it does allude to probability being strongly against a longer-term global economic disruption from a natural disaster. And if one still believes such events are worthy of reaction in the investment realm, this presents myriad difficulties: How do you know when to get back in? What’s the green light following something like an earthquake? A non-earthquake? How much time has to pass without one before jumping back into markets? And when you get back in, how do you protect yourself against future so-called Black Swans? Finally, what if the Black Swan you’re protecting against doesn’t happen, but some other one, positive or negative, does?

Yes, unpredictable events can roil markets, and their human toll can be catastrophic. But they’re hardly unprecedented, and there’s no evidence their frequency is increasing. (It’s a common cognitive error—hindsight bias—that leads investors to believe they weren’t rattled by unpredictable events in the pastand to say, “It’s different now. Now is a more [insert adjective of your choice: volatile, dangerous, uncertain, etc.] time than ever.”)

Rather than Black Swans, such events seem much more like gray pigeons—pesky, disease-ridden animals prevalent in every major city in the world. A reality not worth building a protective bubble around yourself for.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.