The Black Swan and Your Portfolio
Earlier in the year, we talked about the backdrop being favorable as we entered 2020. However, we noted that 2020 would be like every other year in that it would include unpredictable or surprise events. It didn’t take long for that to materialize. The Coronavirus is the black swan event for 2020.
You hear the term “black swan” often on the news, or when the pundits talk about the financial markets, but what, exactly, do people mean when they talk about a black swan? A Black Swan Event is one that is completely unexpected and cannot be predicted. It also has significant consequences. A black swan event can have a tremendous effect, positive or negative, on societies, economies, financial markets and of course on investment portfolios.
The term Black Swan originates from the belief that all swans were white because these were the only ones ever seen or accounted for. However, around 1700, black swans were discovered in Australia. So, this unexpected, unpredictable event in (scientific) history profoundly changed zoology.
When it comes to stock markets, the main black swan effect is increased volatility. This is not just due to the actual effect, but the psychological effect of something completely unexpected happening on market sentiment.
With these events, often market dynamics can change substantially, and, as we saw this time, very quickly. In the week ending February 28th, the Coronavirus outbreak drove stocks to their worst weekly loss since the 2008 financial crisis. The Dow lost 12%, S&P 11.5% and the NASDAQ 10%. Since then, and on a variety of headlines, both the Dow and S & P have moved even lower, into bear market territory. A bear market is a term used to describe a market that has tumbled by 20% or more from its high.
So, while these things happen and are extremely difficult to predict, there are some things you can do to mitigate risk to your portfolio. Effective asset allocation may be the best way to ensure that a portfolio can endure over the long term as black swan type events inevitably occur. Chasing returns in the top-performing areas of the market may produce great returns in the short term, but it only takes one catastrophe to wipe out a portfolio that is not diversified. A portfolio can be diversified by asset class, region and investment or product style.
For example, we proactively rebalanced our portfolios in mid-January because of the great performance the markets saw in 2019. If people went from a 50/50 bond/equities mix to 60/40, we brought it back in line, which has helped mitigate some of the volatility we’re seeing now. Keep in mind that, in a look back over the past 20 years, (1998); every 5 day sell-off of over 10%, with the exception of the October 2008 plunge of 14.6%, led to positive returns just two weeks after the fall. And 6 months later the average gain was about 12%.
We consider a wide range of possible outcomes, both good and bad when helping an investor establish an asset allocation and plan. Those preparations include the possibility, even the inevitability, of a downturn. Amid the anxiety that accompanies developments surrounding the coronavirus, decades of financial science and long-term investing principles remain a strong guide.
If you have questions about your portfolio, we’re here to help. For clients, their advisor is always available to talk. For others, our advisors are also willing to discuss your portfolio, and how we may be able to help you.
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