Odds in Favor of 'Pink Swan' Events

The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

NEW YORK ( TheStreet) -- A "black swan" event -- a rare, unexpected event that has a major impact -- is most often referred to as something with negative consequences. The near-record low investor confidence readings and double-digit decline in the stock market during the third quarter reflect concern that the odds have sharply increased that a black swan event may take place.

It is easy to cite a few of them: a European financial crisis; a U.S. recession; a fiscal debacle in Washington. However, investors have just as sharply discounted the odds of a positive surprise, or "pink swan" event. Given the pessimistic tone of investors, the pink swan may have the bigger potential market impact.

Last week the U.S. economic data came in better than expected and progress was made on the European debt problem with Germany's ratification of the expansion of the European Financial Stability Facility. However, this provided little relief to investors as stocks were basically unchanged on the week and remained near the low end of the 1120 to 1220 range the S&P 500 Index has been stuck in for the past two months. While investors fret over black swans, there are a number of potential pink swan events that could take place and grab investors' attention in the weeks ahead:
  • The employment report is released this week and could surprise to the upside. Recent economic data has been better than expected, with the index of leading indicators rising for a fourth consecutive month and initial claims for unemployment benefits falling below 400,000 last week for the first time since April. These indicators may surprise investors braced for weak data.
  • Next week the third quarter earnings reporting season gets underway. Corporations were able to post double-digit earnings per share gains in the first and second quarters despite U.S. gross domestic product (GDP) growth that averaged less than 1%. Third-quarter GDP may have been more than twice the first half average, supporting continued solid earnings growth despite low expectations by investors priced into stock valuations.
  • Further signs may emerge in the coming weeks that Germany is supporting the euro zone as evidenced by the wide margin of passage on the German vote for the ratification to the expansion of the European Financial Stability Facility (EFSF). On the success in Germany of the EFSF vote, the European Commission may introduce a proposal for so-called eurobonds to the parliament. The potential for the adoption of a long-term solution to the European debt problems would be a confidence boost where it is needed most.
  • China may surprise by cutting rates. After hiking rates and restraining growth and inflation pressures over the past couple of years, China has recently declared victory over its inflation problem and could return to a more pro-growth policy after economic growth slowed from about 12% to 9% in the past year and a half. This would be a surprise positive for the markets -- particularly commodities.
  • The Federal Reserve's last effort to help the economy, the so-called Operation Twist, could spur home buying as it creates the lowest mortgage rates in history. Already low rates helped to lift existing home sales 18% over the past year and new home sales are up 6%. A rise in home prices, with median home prices basically unchanged since the free-fall ended in early 2009, would be a welcome surprise.
  • It is possible that the "super committee" tasked with finding the minimum of $1.5 trillion in deficit reduction by the end of this year as part of the debt ceiling legislation passed in August may succeed and recommend real fiscal reform. The bar is low. Many political pundits expect the group to fail by only finding a fraction of the intended deficit reduction, resulting in an automatic sequester to discretionary spending, the outcome largely reflected by markets.
  • Over the past 50 years, when stocks post a double-digit decline in a quarter they typically rebound 6% during the following quarter. Out of the 16 times the S&P 500 has registered a double-digit loss during a quarter, 13 of those times -- or over 80% of the time -- the following quarter posted a gain and those gains averaged 9%. It is worth noting that the month of October is historically the month that typically ends stock market slides as the market begins to reverse declines.

    Looking beyond the next several weeks or months, we continue to expect a below average growth environment in the years ahead. However, while they may be hard to see at the moment, there are potential "pink swans" that could result in stronger-than-expected growth:
  • A clear path to U.S. fiscal sustainability could emerge in the next few years. The current political gridlock may give way to action after the 2012 elections as rising interest costs force broad fiscal reforms.
  • China's consumers could begin to become a powerful force and drive global demand growth rather than just the growth in the global supply of goods. Employment and incomes are rising sharply in China. While domestic consumer spending currently only accounts for about one-third of China's GDP it is rising quickly. The United States is the world's largest manufacturer. U.S. companies would benefit from solid growth in Chinese consumer spending.
  • New technologies could greatly improve resource productivity. There is a correlation between patent grants and productivity a few years later. The United States is currently saddled with a backlog on new patent requests; however, this logjam is beginning to break. If recent efforts at patent reform are combined with an increased emphasis on providing protection to new ideas we could see an explosion of efforts driving innovation and creating new products.
  • With consumer, business, and investor confidence readings near historic lows it is hard for negative "black swan" events to surprise an unprepared marketplace. Alternatively, with so few expecting positive developments it is more likely that a "pink swan" event is the true outlier with the most potential market impact.

    This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.

    Jeffrey is Chief Market Strategist and Executive Vice President at LPL Financial.

    More from Opinion

    Elon Musk's Latest Twitter Tirade Is the Dumbest Thing on Wall Street

    Elon Musk's Latest Twitter Tirade Is the Dumbest Thing on Wall Street

    Elon Musk's Twitter Tirade Is the Dumbest Thing on Wall Street

    Elon Musk's Twitter Tirade Is the Dumbest Thing on Wall Street

    Why Google's Search Momentum Won't Be Badly Hurt by New EU Rules

    Why Google's Search Momentum Won't Be Badly Hurt by New EU Rules

    Flashback Friday: Amazon, Chip Stocks, Memorial Day

    Flashback Friday: Amazon, Chip Stocks, Memorial Day

    Time to Talk Tesla: What Happened This Week, Elon?

    Time to Talk Tesla: What Happened This Week, Elon?