How Does a Black Swan Event Affect the Stock Market?

October 25, 20226 min read
How Does a Black Swan Event Affect the Stock Market?
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Key Takeaways

• A black swan is a rare and unexpected event that has potentially severe consequences for the stock market.

• Black swan events tend to rewrite the philosophies underpinning the aspects of the market they impact.

• The most recent occurrence of a black swan event was the emergence of the COVID-19 pandemic and the global quarantines that were imposed in response to it. 

Swans native to the Northern Hemisphere have white plumage. Because of this fact, the birth of a black swan north of the Equator is looked upon as a rare and unexpected event. Similarly, the financial markets consider a previously inconceivable occurrence to be a “black swan” phenomenon.

Such events tend to shift paradigms, disrupt the markets, and recalibrate expectations on Wall Street. Within that, however, the ultimate effect of a black swan event on an individual investor can be either positive or negative. The result is largely dependent upon the asset classes dominating an investor’s portfolio, the positions they hold in those investments — and just plain luck.  

The Term’s Origins

Initially coined by finance professor, writer, and former Wall Street trader Nassim Nicholas Taleb, the concept was put forth in his 2001 book, Fooled by Randomness. In it, Taleb discusses the hidden role chance plays in life in general and the markets in particular. 

His follow-up volume, The Black Swan, was written in 2007 and published just prior to the financial crisis of 2008.  In that book, Taleb posited the idea that randomness and uncertainty can present significant challenges to investors. 

According to Taleb, the defining elements of a black swan event are:

• Unpredictability

• Severe, widespread consequences

• Post-event predictability claims (hindsight bias)

In recognition of the unpredictable nature of the market, Taleb suggested that a focus on portfolio robustness and resilience could have a mitigating effect on the consequences of a black swan event. 

The seemingly prescient timing of The Black Swan reinforced the validity of the theorem, which, in fairness, had been put forth by financial experts before the book was written. The overriding idea is that rather than trying to predict the unpredictable, a smart approach is to expect the unexpected. 

In other words, the best approach to the potential occurrences of black swan events is to embrace investing strategies that are not dependent on a continuously favorable market to deliver desirable outcomes.

Black Swans and the Stock Market

Black swan events tend to rewrite the philosophies underpinning the aspects of the market they impact.  A good example of this was the aftermath of the emergence of eCommerce. 

Long standing retail behemoths such as J.C. Penney (NYSE:JCP) and Sears (OTCMKTS: SHLDQ) found the ground beneath their feet crumbling as the paradigm upon which their business models depended was disrupted. However, what was bad for those companies was great for new Internet-based sellers such as eBay (NASDAQ: EBAY) and Amazon (NASDAQ: AMZN). The shift also worked out for brick and mortar retailers such as Best Buy (NYSE:BBY), which successfully incorporated the new paradigm into the way they do business. 

In other words, black swan events aren’t bad for everyone. 

Similarly, an investor holding a long position in a stock negatively affected by a black swan event will likely suffer. Meanwhile, an investor holding a short position in that same stock will profit.

Private Market Investing 101, with Kal Penn

Black Swan Examples

The most recent occurrence of a black swan event was the emergence of the COVID-19 pandemic and the global quarantines that were imposed in response to it. 

Markets and economies around the world were disrupted. 

However, within all of that disruption, companies like Zoom (NASDAQ:ZM) found new traction. Shares in the company were trading at $66.08 on October 18, 2019. The price peaked at $559 on October 16, 2020. Share prices then retreated once quarantines were lifted. As of this writing (October 24, 2022), Zoom shares are trading for $79.78. 

Black swans can give and they can take away. The key is to be positioned to benefit from the unpredictable. Other historical black swan events include the Dot.com crash of 2000, the 9/11 attacks in 2001, the global financial crisis of 2008 and Brexit in 2020. In each instance, well-positioned investors realized gains despite the market’s setbacks. 

Predicting the Unpredictable

Seasoned investors know adverse occurrences can emerge without notice. They also know keeping an eye on current events can provide clues. The buildup to the Russian invasion of Ukraine for example, forewarned disruptions in the supplies of oil and natural gas, as sanctions against Russia — a major producer of those commodities — were implemented. 

Political issues such as the Russian invasion, worldwide health concerns such as the Coronavirus pandemic, and cyber attacks against major cloud services providers all hold the potential to trigger black swan events. Scanning the news for developments such as those give investors time to reorient their holdings to avoid the downsides of such instances—and potentially benefit from them.

Investors with long time horizons would do well to consider resilience as well as profit potential when populating their portfolios. Companies that tend to suffer the most during black swan events are well-established blue-chip firms that lack agility. Meanwhile, startups can often maneuver around black swans more effectively.

Varying the mix of asset classes held within a portfolio (diversification) can potentially offer a degree protection as well. Fixed-price assets such as bonds, certificates of deposit and treasury notes tend to respond to market volatility more favorably than publicly traded equities. 

Black Swans and Alternative Investments

Alternative investments can also be useful tools for portfolio diversification. Traditional portfolio asset allocation envisages a 60% public stock and 40% fixed income allocation. However, a more balanced 60/20/20 or 50/30/20 split, incorporating alternative assets, may make a portfolio less sensitive to public market short-term swings. 

Real estate, private equity, venture capital, digital assets, and collectibles are among asset classes deemed “alternative investments.” Broadly speaking, such investments tend to be less connected to public equity, and thus offer good potential for diversification. 

These asset classes were traditionally accessible only to an exclusive base of wealthy individuals and institutional investors buying in at very high minimums — often between $500,000 and $1 million.  Yieldstreet opens a number of investment strategies that were formerly available only to institutional investors and the top one percent of earners to all investors. 

The company offers help in capitalizing on areas such as real estate, legal finance, art finance and structured notes — as well as a wide range of other unique alternative investments. Moreover, investors can get started with a relatively small amount of capital. Yieldstreet has opportunities across a broad range of asset classes, offering a variety of yields and durations, with minimum investments as low as $500.

Learn more about the ways Yieldstreet can help diversify and grow portfolios.

In Summary

Black swans happen. They can emerge suddenly and their consequences can be devastating. However, as we have illustrated, black swan events can be beneficial as well. As unpredictable as they can be, there are instances in which careful observation of current events can provide clues. There really is no such thing as plug, play and walk away when it comes to investing. Vigilance can return dividends.