Wednesday, December 22, 2010

Black Swan

I've been trading stocks, a lot of options, for years. I learned everything the hard way. College classes, economics, business. I read every book in the library. Chart theory, random walk theory. I've done some exotic option buying, I've used options as insurance. And I am certainly not going to say I was victorious all of the time. I've made a lot of trading mistakes. Some were brutal. One Chinese shell corporation I bought was a horrible trade. Three years ago, I packed it in after I had my very own black swan event. Parked my dough in treasuries. I did ok in 2008, while the equity universe got a haircut. I cashed out in 2009.

I am getting ready to get back in. The reason is simple. I think that we are on the verge of a major black swan event. I think the odds are better than 60-40. As a gambler and an odds maker, I make a personal line for everything. And trust me, I am not going long.

The Black Swan Theory or "Theory of Black Swan Events" was developed by Nassim Nicholas Taleb to explain:
  1. The disproportionate role of high-impact, hard to predict, and rare events that are beyond the realm of normal expectations in history, science, finance and technology
  2. The non-computability of the probability of the consequential rare events using scientific methods (owing to their very nature of small probabilities)
  3. The psychological biases that make people individually and collectively blind to uncertainty and unaware of the massive role of the rare event in historical affairs.
Now as I use the term black swan, I do not count war in Korea. I am not looking for a single gunman. That would have limited impact initially and at this point, war there is hardly a qualifying black swan event. It is fully possible that war could break out but I put that possibility at 10%. But war in Korea could in fact- be part of my much larger black swan event. Particularly from a financial point of view.

Europe is completely bankrupt. Forget the PIIGS. Take a look at Germany, France, and the UK's debt levels on US Debt clock. These are the guys bailing out the PIIGS? You'll note they are not much better off than Ireland. Check out Canada's debt levels. Interesting.

The Eurozone is in deep, deep, trouble. The euro will collapse before the U.S. dollar does. But I think that might have a triggering effect. As fools rush out, this will cause the value of a worthless dollar to go absolutely supernova. I can see it happening in 2011. An excellent read on the euro circling the drain...

China despite it's inflation woes, is going to be sitting "chilly" ready to pick up the pieces.

Stateside, I see no end to quantitative easing. I see no jobs, I have yet to see the 7 million pending foreclosures in the housing market get placed on the market. That supply, while hidden, continues to build. It is killing the housing market, it is killing lending,  and it is killing the construction segment. Who is paying the taxes on that vacant real estate? Municipal debt is exploding, states at least five of them- Illinois, California, New York, New Jersey, Michigan, and perhaps Florida are in horrific shape. States are raising real estate tax levels and gouging the middle class even more. The dollar is also deteriorating. Oil is priced in dollars. That price is going up and will continue to go up, demand or not, as the dollar weakens. But it may plunge if the euro implodes. 

When you enter the stock market, they tell you to do so based on fundamentals. That's bullshit when they have rigged the "fundamentals." What you are really trying to do, is to predict human behavior at this point. There are so many triggering events building worldwide, that I think the odds for a black swan event are very good.

I want to finish with a balls to the wall story. In early 2007, I had shorted a little company in Colorado called Fuel Tech Inc. Their products cleaned up coal fired emissions. They were a feel good stock. Their earnings were barely existent, future earnings and I am talking years in the future, were simply not visible. The CEO was gifted at spin. This stock was trading in the mid twenties and was approaching the first quarter earnings report. I had loaded up, short side, expecting a significant miss. Then the miss. It was a significant miss. The stock immediately ramped UP nearly 35%. Shit, there went my new Cadillac up in smoke. I nearly needed heart bypass surgery. In utter shock, I could not fully explain what had happened. But I refused to cover my position which was way too large- almost 40% at that point. I was caught in a monstrous short squeeze. I went home that night and thought it through. I did the unthinkable. I began shorting FTEK even more. At the most significant point, I was nearly 80% invested in that POS company. Had I told my wife, I would not have survived. When it finally cratered to 20, I unloaded my positions. I made money on the trade but not enough to account for all of those sleepless nights I had. In fact, it was FTEK that caused me to exit the most ridiculous, inflated, and irrational market I had ever seen. FTEK trades now for something like 8 bucks and I had it fairly priced at 5 bucks in '07. FTEK rising 35% on missed earnings was a black swan. I never saw it coming. I examined that trade a year later and saw what had happened.

Where there is ruin, there is opportunity. So I try not to base my decisions on emotions or somebody else's opinion of what is good or bad. I look at what's going on, I evaluate it, and I try to decide as unemotionally as possible if this is something I want to get involved in. Sometimes it takes great courage. I really think 2011 is going to be an interesting year, not interesting in the way that many people had hoped. Just interesting.

1 comment:

Anonymous said...

While I agree that 2011 will be interesting, I would caution you on equities. Just my opinion though. I'm sure you're on top of things. Played right, 2011 could be good. Played wrong? Very, very bad.

And the fact that you are expecting a Black Swan makes it, well, not a Black Swan. At least not for you. It makes it an opportunity!


Good Luck!