For all the fear of black swans, the stock market is acting roughly the same

By Steve Goldstein

Nassim Taleb published "The Black Swan: The Impact of the Highly Improbable" at arguably the perfect time - in April 2007, about six months before the worst financial crisis since the Great Depression.

The book argues that rare, high-impact events make it incredibly difficult to forecast the future. That the global economy crashed due to leveraged bets on a risky part of the U.S. housing market could be described as a classic black-swan event.

That said, Nicholas Colas, co-founder of DataTrek Research, crunched the numbers on the stock market's return since the publication of that book. The S&P 500 SPX has compounded at a 10.2% total return basis, which he says is pretty much the same as its historical average.

"If the modern world is growing ever more complex and more black swans are flying around as a result, it is not apparent in the historical return data," said Colas.

That's a period that includes what Colas calls a classic black-swan event, the 2020 pandemic.

Colas does note that black swans are not always negative. He cited data showing that only 1% to 2% of stocks created all the value in equity markets between 1990 and 2020.

He offers a few lessons for investors. One is that negative black-swan events happen often enough to make them a part of an investment process. This leads to fixed-income allocations to protect against drawdowns. "How much of a weighting is up to investor risk tolerance, but only risk-free paper tends to appreciate when the black swans start to growl," he says.

Another is that there's only two ways to capture positive black-swan events. The first is to identify them early and stick with them, but the other is to hold broadly diversified index funds, since these black-swan companies will grow into these portfolios.

He says positive black-swan stocks cluster in the technology sector. "This group, underpinned by innovation more than any other sector, has the best chance to create and sustain outsized winners. We've seen this many times over the years, with Internet 1.0, then global mobile computing, and now Generative Artificial Intelligence providing the impetus for the unexpected growth which drives stock prices higher," he said.

Nvidia shares (NVDA) have jumped 159% this year, and Super Micro Computer (SMCI) is up 198%.

That's not always the case however. Eli Lilly (LLY) and Novo Nordisk (NVO) have produced a class of weight-loss drugs that have potentially revolutionary impact on health and have seen their stock prices surge as a result. But Colas's index rule applies: Lilly is now the eighth-largest constituent in the S&P 500, and Novo Nordisk is the largest company in the MSCI World ex-USA index.

-Steve Goldstein

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07-04-24 0350ET

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