Clem Sunter

A lamentation of black swans

2011-03-18 09:49

What do you call a group of black swans? A lamentation. As the phrase black swan is now applied to low probability catastrophes, ever since Nassim Taleb’s book on the subject in 2007, the collective noun is appropriate.

We have had our fair share of catastrophes this year – the floods in Australia and the earthquakes in New Zealand and Japan, the latter one moving the main island 2.4 metres in its location. Chantell Ilbury and I foresaw more smacks from Mother Nature in our breaking futures for  2011, but nothing on the scale of what has happened.

Then, of course, there is the unrest in the Middle East which is unprecedented in terms of the number of countries involved at the same time. Moreover, lurking under the radar at the moment are the European debt crisis which has not gone away as well as the yawning US budget deficit. All in all, we have a lamentation of black swan events which could change the short-term course of the world considerably.

One must also add into the mix the terrible impact of the tsunami which followed the Japanese earthquake and the current possibility of radiation from the damaged nuclear reactors posing long-term health risks to the population in the vicinity. Remember Japan represents 10% of the global economy and plays an enormous role as a component supplier and end-product-producer in the world’s manufacturing industry.

At the beginning of this year, I wrote an article entitled The Global Tightrope which featured the following scenario diagram for the next five years:

The two mainstream scenarios were “Ultraviolet” depicting a two-speed world where emerging economies grew three times faster than advanced economies mired in debt; and “Hard Times” painting an ugly flat “stagflationary” world of low economic growth for everybody. The flag indicating which of the two scenarios was in play was China’s annual GDP growth. If it stayed in the 8-10% range, we were in “Ultraviolet”; and if it fell below 6% we were heading into “Hard Times”. At the time we gave China’s economic prospects the benefit of the doubt and accorded a 40% probability to “Ultraviolet” and a 30% probability to “Hard Times”.

Given the lamentation of black swans, we now reverse those two probability figures and make our favourite scenario “Hard Times” with “Ultraviolet” in second place. We think it is increasingly difficult for China to continue to grow at the pace it has done for three reasons: the likelihood of an economic slowdown in Japan which is one of its principal trading partners; a jump in oil prices above $150 a barrel in the event that unrest spreads to other authoritarian regimes involved in OPEC; and possible unrest in China itself as a result of food price inflation. It is already 15% per annum.

“New Balls Please” and “Forked Lightning” remain the outliers, the first scenario being a short-term utopian recovery for advanced and emerging economies alike; and the second being the dreaded double-dip scenario precipitated by another crash in financial markets and a loss of faith in the US.

The two flags for “New Balls Please” – a significant drop in US unemployment and a reduction in its national debt-to-GDP ratio – remain firmly down. So we still give it only a  20% probability. As for “Forked Lightning”, our sole flag was a sudden jump in the 10-year US Treasury bond interest rate to over 5%. In fact, with the flight from equities, the rate has recently declined to 3.3%. Thus, it remains a wild-card scenario with a 10% probability.

So much can happen over the next few months that you have to keep our scenario gameboard permanently in your head; and adapt your plan of action as the probabilities change. The curse of interesting times is upon us.

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