Predicting the Black Swan
Regular readers will note that over the years, I have written extensively about the impact of human behavior on investment returns.
As a real world example, I used the U.S. Financial Crisis/Crash of 2008 and the subsequent recovery to illustrate three potentially different investor returns.
One was a minus 50% return, one was a 0% return and the other was a 100% return. Same investment - three different behaviors - three different returns! [Editor's note: click on this link to read the original article.]
The stock market can at times, be extremely overpriced and at other times be severely underpriced as predictibly irrational investors either buy too high or sell too low.
As Europe's debt problems reaches a crescendo in the headlines, are markets pricing in an event that will likely not occur? Certainly many of the world stock and bond markets have already priced in a financial disaster as if it had already happened.
I do not believe that Europe will be a black swan event. If Europe proves to be a disaster it will likely prove to be the most widely predicted disaster so far this century.
[Editor's note: The black swan event refers to the concept where an event is a surprise (to the observer) and has a major impact. After the fact, the event is rationalized by hindsight]. 9/11 is often used as an example of a black swan event and so too was the sudden collapse of the sub-prime mortgage market in 2008 caused by declining house prices in the U.S.
The rate of return for a 10 year U.S. government bond is about 1.50% and the 10 year Canadian government bond is only about 1/8 percent higher indicating the massive flow of money out of stock markets into the perceived safety of bonds. In some cases, returns on a government bond are negative as investors frenzied buying have driven up the bond prices to extremes. [Editor's note: the higher the bond’s price the lower the yield on the bond.]
Are panicking bond buyers setting themselves up for a fall by driving up bond prices too high?
Perhaps. Or are rates slated to stay permanently low like Japan? Or go lower still?
As outbidding wars for condos and houses might invariably lead to real estate prices crashing in the future - just like in the U.S., the same sort of risks might apply to bonds.
Often, the best advice is to do the opposite of what the majority of investors are doing. The majority appears to be buying bonds at any price and buying indiscriminately is often as sign of a frothy top forming. The same majority are avoiding stocks and stock market investments like the plague. Based on these investor attitudes, this is a great example of fear and greed in action. Everyone wants bonds[greed] - no one wants stocks[fear].
Did I say that investor behavior was important?
