Saving the world from itself is not a story.
I can forgive a general for being defeated. I cannot forgive him being surprised.-Napoleon
Low Probability, High Consequence
On 26th December 2004 an earthquake off Sumatra caused a tsunami that sped across the Indian Ocean and led to the death of nearly 230,000 people.
It was one of the deadliest natural disasters in recorded history.
Despite the possibility of such an event being long acknowledged and the relatively low cost of putting early warning systems in place no such protection was available.
In the jargon it was a low probability, high consequence event and the failure to plan for it is a consequence of the human psychological focus on the predictable and short term to the exclusion of the unpredictable and long term.
More colloquially the world had witnessed a Black Swan.
Taleb's Black Swans
The “Black Swan” is Nassim Nicolas Taleb’s metaphor for such events as the tsunami.
Taleb’s contention is that massive and devastating events happen far more often than you’d expect and that when they do we are almost always unprepared for them.
A further consequence of such events, combined with modern media, is that we then overestimate the likelihood of a further similar event and modify our behaviour accordingly.
A grim example of this is the behaviour of Americans in the wake of the 9/11 Twin Towers terrorist attack.
Even though the actual risk of a reoccurrence was very small and even though if terrorists had started to hijack and crash a plan a week flying would still have been the safest mode of travel – by a huge magnitude, people stopped flying.
I don’t blame them, it scared the living daylights out of me.
Instead they started driving, which is statistically much more dangerous than flying.
Predictably the result was that far more people started dying on the roads, as much victims of the events of September 11th 2001 as those who died on the day.
The psychological triggers that cause us to overrate the stuff we can see and ignore the stuff we can’t are hardwired into our neural systems and can only be overcome with huge efforts of will.
Surprising Stock markets, Unsurprising Commentators
Stock markets are classical territory for Black Swans and are where Taleb’s ideas originated.
Although returns oscillate about a stable midpoint over many years out at the extremes we see many more surprises than you’d predict.
Yet despite the relative regularity of these Black Swan events – think 1907, 1929, 1931, 1936, 1973, 1987, 1989, 1997, 2000, 2008 – most commentators and fund managers simply ignore them in any analysis of stockmarket returns. (2020? Anyone? -ed.)
There’s a good reason for this – anyone sticking their neck out is more than likely to be wrong, since although Black Swans are more common than we might expect they’re still much rarer than normal market behaviour.
So any commentator predicting a market crash is very likely to end up looking very silly indeed.
As are fund managers.
The classic example of this was the late Tony Dye of the British fund manager Phillips & Drew who remained bearish all the way through the dotcom boom at the end of the 1990’s, remaining invested in value stocks throughout.
Stuck to the bottom of the performance charts his management finally lost patience just as the UK stockmarket peaked.
With a certain natural irony markets then crashed before his replacements could modify his selections and Phillips & Drew soared to the top of the performance charts.
For fund managers and expert commentators is usually better to run with the herd.
If everyone’s wrong there’s safety in numbers, but if you’re on your own you’d better be right.
Real World Black Swans
Black Swans, Tsunamis and Cardiac Arrests
Back in 2003 Dorothy Fletcher suffered a massive and life-threatening cardiac arrest, during which her heart stopped, on a transatlantic flight from Manchester to Florida.
Only the prompt and immediate intervention of a cardiologist could have saved her.
So it was her good fortune was that when a stewardess made an appeal for help no less than fifteen of the world’s leading heart experts, on their way to a conference in Orlando, came rushing to her rescue.
Black Swans are not always bad.
Just don’t expect the financial wizards of the world to tell you when the next one will arrive.
They have no incentive to predict one and no ability to do so.
Random stuff is simply random, I’m afraid.