Well, I didn’t expect that…

Events, by their very nature, are unpredictable. It, therefore, follows that the really market-moving ones are those that few saw coming.

| 4 min read

When things happen, it doesn’t necessarily move financial markets as people expect. We have had a taste of this recently with some poor economic growth figures from the US. The market reaction has been muted, even though economic contraction and the threat of recession are seen as very bad news.

Perhaps then, markets had already anticipated this ‘very bad news', digested it, and priced assets accordingly. This is what makes them so difficult to predict. You never really quite know what’s already baked into prices.

This happens a lot. In 2015, many investors worried about the election of Donald Trump as American President. Markets sold off when he took The White House but, in the end, performed very well under his tenure. Various worries such as erratic foreign policy seemed well-founded but ultimately didn’t have a significant impact.

Individual shares have this trait too. A company can announce strong earnings but see its share price tumble.

What gives? Well, investors had probably expected even more. The same is true for bad company news. If it’s not as bad as feared, then shares can rise. We have seen this recently in differing results from Alphabet (good, but not good enough) and Meta (pretty bad, but better than they might have been).

A bolt from the blue

Instead, what tends to move markets often comes largely out of the blue. Economist Nassim Taleb defined these shocks as ‘black swan’ events, so-called due to the animal’s presumed rarity. Taleb’s theory describes that the really impactful, market-moving events are those that few saw coming, but are often rationalised as being more obvious afterwards. For instance, the Covid pandemic was not widely highlighted as a risk in 2019, and few gave much thought to a Russian invasion of Ukraine in 2021. Yet these were both seismic events, for humanity as well as markets.

Market black swans are then, rather like their avian variety, not that rare. In fact, it seems like they come along quite often. Stability never lasts long before something, inevitably something that is not on many people’s radar occurs.

A cloudy crystal ball

Does this undermine our ability to look into the future and make predictions? It does, to an extent.

Renowned fund manager Peter Lynch once said, “If you spend 13 minutes a year on economics, you have wasted 10 minutes”. We wouldn’t go that far. Analysing macroeconomics can be useful in terms of deciding upon asset allocation and avoiding big areas of risk.

For instance, avoiding China on the grounds of geopolitical risk, as we largely have in our managed portfolios over the past few years, has been a wise move. However, Lynch’s view was valid in that what matters more in the context of picking shares over the long run is not economics, but the earnings of the underlying business and the price you pay for the asset.

He also has a point in the sense that the biggest risks, the most momentous events, are often unseen, somewhat random and largely unpredictable. Why waste your time trying to predict them? You can’t map the world for every single possible scenario.

As former US Defence Secretary, Donald Rumsfeld, once noted (about Iraq’s alleged supply of weapons to terrorists), “There are known knowns”, “known unknowns” and “unknown unknowns”. In the context of investing, we can comfortably tackle the first. We can create scenario analysis and ascribe likelihoods to the outcomes of the second. But for the third, the unknown unknowns, we have to shrug our shoulders and admit the finite boundaries of our knowledge.

We all have to live with this, accept it is the way of the world and invest with it in mind. That doesn’t mean being overcautious. Constantly living in fear that the sky is about to fall on our heads isn’t healthy or useful. Instead, it’s best to be humble and accept we don’t know what we don’t know. We have to be prepared to be surprised by building resilient financial circumstances and plans, as well as owning a diversified portfolio of investments that is less susceptible to being struck by misfortune. Finally, we should also be optimistic. Surprises aren’t always negative. Human ingenuity usually overcomes the biggest obstacles and progress usually prevails.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

Well, I didn’t expect that…

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