Six Potential Black Swans You Need to Be Aware Of

Includes: AGG, DIA, QQQ, SPY
by: John Henderson
By Tom Henderson, Strategist JBH Capital
With the Dow up about 4,600 points from its winter 2009 low of around 6,400, traders need to always be on the lookout for events that may stir volatility and decrease the calm waters that the markets seem to be sailing through currently.
One note about these potential black swan events – they often occur when people are not on the lookout for them. And since many remain vigilant to things that can go wrong (as can be seen by low equity exposure by John and Jane Q Public to the equity markets), perhaps the market will ignore these potential black swans even if they were to occur.
One other note, some of these potential black swans may be more potent than others, especially ones which nobody sees beforehand. (Think Asian crisis and Monica Lewinsky). There are times though when many predict a black swan event (like a national price decline in housing) and still the bubble continues to inflate.
In no particular order, here are six events which could act as Black Swans and throw the market off its kilter:
  1. Geopolitical blowup: An event in one country spreads around the world and leads to chaos. It could be Iran or North Korea testing nukes, or an opposition group in Kyrgyzstan seizing political power. These events can peter out and end quietly, stay in the headlines for a time and then fade, but they also can create havoc politically and in the financial markets. Under this category I will also include a sovereign bond default. In the late 1990s the Russian default led to market chaos.
  2. A surprise Fed Funds increase by the Fed: Bernanke has been a practitioner of telegraphing every move. But perhaps there will come a time when the Fed will need to act between meetings. Perhaps the inflation rate unexpectedly spikes or the US dollar suffers a severe setback. A between meeting tightening could roil the markets.
  3. A sizable bank failure: It could be in the US or in Europe or elsewhere. Except for some small banks that have closed in the US, this has mostly been contained. If a large bank somewhere in the world were to fail, there could be recurring questions about the interconnectedness of world banks. One of the things that tipped me off to the severity of the financial crisis was back in the summer of 2007. There was a photo of a bank line outside a Northern Rock bank branch. The electronic equivalent of this occurred following the collapse of Lehman when banks would not lend or trade with each other. The Ted Spread blew out to levels not seen before to between 400 and 500. Right now it is at a very low (and healthy) 20 or so. Watch the Ted for hints to lending problems.
  4. US consumer spending collapse: The US consumer makes up about 70% of the US GDP. With unemployment still hovering around 10% and other under employment rates up to around 17%. In 2010, the US consumer has shown more willingness to spend. However, spending is still often highly incentivized (think housing and autos and the subsidized rates provided by Federal Reserve QE). If the US consumer for whatever reason cut back sharply on spending again, there could be another leg down for the economy.
  5. A trade war: This can be looked at as a geopolitical risk as well but since there has recently been some talk in the US of slapping tariffs on Chinese goods if the Chinese currency policy is not changed this is worth putting on the black swan radar. The Great Depression in the 1930s was exacerbated by a world trade war. Tariffs were hiked and instead of acting to protect economies it led to a collapse in world trade. Although unlikely to occur in 2010 as lessons from the Great Depression have been learned, it should still be watched.
  6. A problem that causes commodities to soar or collapse in price: The Great Depression coincided with a collapse in food prices which then led to a collapse in land prices. In the US we take for granted the food that comes on the table as prices remain relatively steady and farmers have become more and more productive. However, if for whatever reason prices for agricultural products soared or collapsed the repercussions could spread to the financial markets.

These are some black swan like events that market participants could look out for. There are plenty of others that could ripple into and through the financial markets as well. Market participants can and should be on the lookout for odd seemingly small events that could spiral quickly and be prepared to act when they occur.

Disclosure: No positions