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Kass: A Contagion of Black Swans

But we must be mindful!

Throughout history, there have been times when it has even been more profitable for investors "to bind together in the wrong direction than to be alone in the right one." The long-term direction of equities will likely always be "higher," and the crowd of optimists will invariably outperform the remnants of pessimists.

Nevertheless, for years, investors seem to have been blinded to the uncertainty of the "rare" Black Swan event. We now know that these Black Swans are occurring with greater regularity and with greater overall impact -- and, as such, we must recognize that the occurrences may not only hold the potential for reducing aggregate growth but that the uncertainty of these outlier events could conceivably cast a pall over stock valuations.

After all, the inability to predict Black Swan events implies a greater inability to predict the course of economic and market history -- whether it is a natural disaster, a surprising geopolitical event or an unexpected economic or credit outcome.

It is only obvious after the fact, as investors, in particular, seem to harbor a crippling dislike for the abstract (like Black Swans). Perhaps the problem with experts is that they do not know what they do not know.

For some time, investors have been, as Taleb writes "picking up pennies in front of a steamroller," exposing themselves to the high impact, rare event yet sleeping like babies, unaware of it.

But recent events might bring on some nightmares.

Of a more immediate practical consequence to this writer is that our domestic economy faces numerous structural issues (the most important of which are the extreme fiscal imbalances at the federal, state and local levels), with governments (here and abroad) not necessarily up to the task of dealing with the complexities.

Given the "newness" of these and other nontraditional and secular challenges as well as the greater frequency of Black Swan events, P/E multiples might be pressured and could even contract as a comparison between today's valuations to those of history can be expected to lose some of its significance and relevance.
"If you hear a 'prominent' economist using the word 'equilibrium' or 'normal distribution,' do not argue with him; just ignore him, or try to put a rat down his shirt."

-- Nassim Taleb
In summary, I marvel at the confidence of strategists in a smooth and self-sustaining economic recovery in such an uncertain world.
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