Please do make any financial decisions based on the contents of this blog. My blogs are designed to be thought-provoking and introspective, not financial advice. Please do not act on any document unless it is titled “Statement of Advice.”
I recently finished reading The Black Swan by Nassim Nicholas Taleb (NNT) and it has rewired the way my brain deals with randomness, uncertainty and predictability.
The Black Swan is an epic confluence of philosophy, history, mathematics and science (both pure and of the dreaded “social” varietal). I encourage you to read this book and if you do, please take your time, and have an open mind.
The central theme behind the book is how the overwhelming majority of people (characterised by NNT as turkeys, suckers and fraudsters) are quite adept at predicting predictable events but are horrendously bad at predicting the rare and highly consequential events that change everything (Black Swans). Mainstream academics, senior economists, government policymakers, central bankers, financial advisers, journalists and so-called social “scientists” constantly get their predictions so spectacularly wrong, yet we continue to trust them.
We hear words like “unprecedented” and “this is a once in a million-year event” to justify the failures of policies which are based on defunct theories, such as Modern Monetary Theory, Climate Change Theory, Gaussian Distribution, and the social sciences (including economics). These theories periodically cause great harm to society (the bottom 99%), yet they are so ingrained into academia, law, government and popular discourse we can’t seem to abandon them. I suspect the real reason these failing theories survive and dominate and destroy our lives is not due to the intellectual cost of decommissioning them but how well they serve the elites (the top 1%). Indeed, the best time to be rich is during an economic or financial crisis as you get to be the first in line to borrow enormous amounts of cheap money hot off the printing press and use this money to buy assets that the bottom 99% are forced to sell at depressed prices to feed, clothe and house themselves.
The ”aha” moment for me was when NNT presented a chart showing the S&P500 returns over 50 years overlaid with the impact of being divested during the worst 10 days. As I was reading, I was expecting the difference to be substantial but not epic, perhaps 30% or 50%… The difference was a whopping 100%! In other words, if you can predict, or at least anticipate the reasonable probability of an upcoming Black Swan that will trigger a stock market crash, you could be 2x richer at retirement!
I was so amazed by this data that I wanted to test this model on more updated data and see if the same thing happened to other stock market indices. So I downloaded the daily pricing for the NASDAQ from 1 Jan 1973 to 1 Jan 2023 from FRED and what I discovered was shocking.
If you started with $100k and kept your money in the NASDAQ each day (no contributions or withdrawals) you would have $7.74m after the 50 years. Not bad, but if you divested on the 10 worst days, you would have a staggering $21.32m (yes, the 10 worst days can kill your retirement fund by 2.7x!)
Of course, it is ludicrous to expect that anyone could predict the worst 10 days, but what about the 5 worst calendar years?
If you sat in cash earning NIL during those 5 worst years (1974, 2000, 2001, 2008, 2022) how much do you reckon you’d have? The answer is a monumental $62.84m! (8.1x better off!).
Okay, picking the right year might be hard, but what if you were “super cautious” and sat on the sidelines for the 5 worst years AND their prior years? You’re not going to believe me but you would have an incredible $37.09m! That’s 4.8x better off!
This discovery is at odds with everything they teach you at university and what fiscal policies are based on. No academic models or economic policies consider Black Swans. Rather they are based on the theories that assume people, markets and economic systems behave perfectly and efficiently – newsflash, they don’t.
This discovery is also at odds with the rhetoric and sales pitches of fund managers, financial advisers and prominent investors who talk about “time in the market” and average rates of return and “Portfolio Theory.” When you hear someone crapping on about Standard Deviations, Sharpe Ratios and “R squared”… run away!
Even Warren Buffett, famous for having outperformed the major indices for the last 40 years, argues that passive index strategies (going with the flow of the index) outperform active dynamic strategies (trying to beat the index). Warren Buffett is correct on an “average” basis (that the average punter seldom outperforms the index), but he is spectacularly wrong in empirical reality. It is logically false to suggest an index (a collection of companies categorised by their size in “market capitalisation”) outperforms active funds (a collection of companies handpicked by a fund manager). Even if you assume the index and active fund were perfectly managed, the best outcome the index could hope for is a tie. Warren Buffett evidently doesn’t follow his own advice, having dumped $133 billion worth of stock in the first 9 months of 2024 alone. Perhaps what Buffett means to say is “active and dynamic strategies are superior if you know what you are doing!” Clearly, Warren Buffett does know what he is doing even if he can’t articulate it.
So, what should we do? (A lesson in humility)
What will happen in the future? I have no idea. The stock market may never crash again. A child genius from India might discover a way to make financial markets work perfectly and efficiently i.e. without human interference. Central bankers and policymakers may even abandon their fraudulent and flawed models and accept that Black Swans do occur (hard to write that bit without laughing out loud!)
The alternative theory (a Black Swan event will not happen) has no empirical basis and borders on insanity (yes… the current models are literally insane). Remind me to tell you about a conversation I had recently with a senior economist of a major fund manager (can’t say which one but I will say that they manage trillions of dollars globally) – he was telling me that he sees double digit growth in the NASDAQ for the next 10 years. I think he might be right, except he may have forgotten the minus sign. We shall see.
One thing is for certain. Black Swan events do happen, and when they do, they change everything forever. You don’t need to predict what will happen, but you can bet your reputation and your retirement savings that a Black Swan event will happen. The upside on such a bet is enormous and might make you 4-8 times richer in retirement (refer to NASDAQ scenarios). The downside is you might get a little market FOMO from time to time.
The key thing to remember is this: it is not the Black Swan that causes the crash. By the time The Black Swan strikes, the damage has already been done. Rather, the Black Swan shines a light on the mistakes that were made by those in power, and forces the markets to repay their dues* and revise their asset valuations back down to empirical reality.
*Or in some cases get bailed out by taxpayers.
Interesting facts:
Nasdaq’s Worst 10 days in 50 years:
Date Nasdaq Closing Performance 2020-03-16 6904.590 -12.32% 1987-10-19 360.210 -11.35% 2000-04-14 3321.290 -9.67% 2020-03-12 7201.800 -9.43% 2008-09-29 1983.730 -9.14% 1987-10-20 327.790 -9.00% 1987-10-26 298.900 -9.00% 2008-12-01 1398.070 -8.95% 1998-08-31 1499.250 -8.56% 2008-10-15 1628.330 -8.47%
Nasdaq’s Worst 5 Calendar Years in 50 years:
1974 -35.10% (Oil Crisis)
2000 -39.29% (Dotcom Bubble)
2001 -21.05% (Dotcom Bubble cont.)
2008 -40.54% (Global Financial Crisis)
2022 -33.10% (Government Lockdowns)
I genuinely feel for those who had their retirement savings invested in index funds and had the rotten luck of retiring during any of these years.
NASDAQ $100k over 50 years ended 1 Jan 2023
All days $7,774,260
Excluding worst 10 days $21,325,090 (2.7x better off)
Excluding worst 5 calendar years $62,841,540 (8.1x better off)
Excluding worst 5 calendar years and their prior 12 months $37,096,370 (4.8x better off)
Please do make any financial decisions based on the contents of this blog. My blogs are designed to be thought-provoking and introspective, not financial advice. Please do not act on any document unless it is titled “Statement of Advice.”