Four Black Swans and 1 Grey Swan for 2022 December 21, 2021

Four Black Swans and 1 Grey Swan for 2022

Summary

A black swan is an extremely rare event with severe consequences. It cannot be predicted, though after the fact, many claim it should have been predictable1.

Grey swan is a term used to describe a potentially very significant event whose possible occurrence may be predicted beforehand, but the probability of it occurring is considered small2.

Here, we explore four potential black swan events and a positive grey swan event:

1. The retake of Afghanistan prompts fears of the emergence of a safe haven for terrorists.
2. Mother lode of cyberterrorism
3. The reality of a $200 barrel of crude oil
4. A deer caught in the headlights of runaway all-time-high inflation
5. Grey Swan sighted! Possible all-time high for Chinese technology stocks

The declaration by the World Health Organisation (WHO) of the latest COVID-19 “variant of concern” Omicron3 on the day after the US Thanksgiving holiday caused the Dow Jones Index to plunge 905 points4, or 2.5%. The S&P index fell 106.84 points, or 2.27%, while the Nasdaq Composite Index lost 353.57 points, or 2.2%.

The decline of the three major indices effectively marked their worst Black Friday performance since 19505.

Prior to this, governments worldwide had conducted extensive vaccination programs to safeguard their people. And countries were looking forward to opening their borders and economies with the resumption of travel between nations.

Families that had been separated for months were looking forward to reunite with loved ones. Everywhere there was a sense of “all might just be finally behind us”.

That was until COVID-19 gave us another jolt.

This episode underlines why it’s so important to prepare for so-called black swan events that cause market crashes because they are sudden, overwhelming and unpredictable.


1. The fall of Afghanistan, the rise of Osama Bin Laden 2.0

In August 2021, only days after the US military withdrew from Afghanistan, the Taliban took control of the country and installed themselves in Kabul6.

Since regaining control, the Taliban have taken actions reminiscent of their brutal rule in the late 1990s. They have cracked down on protestors, reportedly detained and beaten journalists and generally threatened to set back Afghanistan, which had made progress after the US invasion.

International observers remain concerned that they support terrorist organizations, posing a threat to regional and international security.

Afghanistan could again become a safe haven for terrorists capable of launching attacks against the US and its allies.

As reported by the Financial Times7, China and Russia – two of the US’ staunchest rivals — are both poised to move in to fill the void left behind by Washington in the region.

With the withdrawal of the US military presence from Afghanistan, we have entered a new era of geopolitical uncertainty.

Also, as the world focuses on combating the COVID-19 virus and its variants, terrorism may get less attention and resources.

In short, the environment for terrorism to breed could not be more ideal. And Afghanistan could become the prefect breeding ground for a more radical, determined, better supported and funded terrorist leader to emerge.

Unlike the 2001 attacks which were conducted relatively in-silo by the al-Qaeda terrorists, the next terrorist attack could be a well-coordinated multipronged attack on the US by its rivals coming together.

Which brings us to the next possible black swan event.


2. Mother lode of cyberterrorism

One of the latest examples of a cyberattack saw disruptions to gasoline stations across Iran, which led to long lines outside gas stations8. And in Tel Aviv, a well-known broadcaster was shocked to find intimate details of his sex life, and those of thousands stolen from an L.G.B.T.Q dating site and uploaded on social media9.

We may chuckle while reading about these incidents, which stem from a longstanding covert cyberwar between Israel and Iran, but they do present very real dangers to all.

Unlike the 9/11 attacks on the US World Trade Center, cyberterrorism, or cyberattacks, are not limited by geography. And nobody is truly safe from them.

In Congressional testimony from the FBI in 2014, the FBI stated that virtually every national security threat and crime problem the agency has faced in recent times is either cyber-based or -facilitated.

Its testimony titled “Worldwide Threats to the Homeland,” stated:

We face cyber threats from state-sponsored hackers, hackers for hire, global cyber syndicates, and terrorists. They seek our state secrets, our trade secrets, our technology, and our ideas – things of incredible value to all of us. They seek to strike our critical infrastructure and to harm our economy.

Given the scope of the cyber threat, agencies across the Federal government are making cybersecurity a top priority. The Department of Justice, including the FBI; the Department of Homeland Security; the National Security Agency; and other US Intelligence Community and law enforcement agencies have truly undertaken a whole-of-government effort to combat the cyber threat10.

One year after these remarks from the FBI, at a 2015 technology conference, Admiral Michael Rogers, at the time director of the National Security Agency and the US Cyber Command, cited some of the cyber threats that concerned him the most from a national security perspective:

  • Cyberattacks that do infrastructure damage – “It is only a matter of ‘when’ that someone uses cyber as a tool to do damage to the critical infrastructure of our nation,” Rogers said. By that, the admiral meant the electric grid, railroad switches, traffic control systems, nuclear power plants, and more.
  • Data manipulation – “Historically, we’ve largely been focused on stopping the extraction of data and insights, whether for intellectual property for commercial or criminal advantage, but what happens when suddenly our data is manipulated and you no longer can believe what you’re physically seeing?” he said11

The recent cyberattacks on the Colonial pipeline12 and the software contractor SolarWinds Corp13 prompted US President Joe Biden to host a cybersecurity meeting with the heads of some of the biggest technology, energy, and finance companies.

While there were commitments from some of the companies after the meeting, it must be noted that cybersecurity needs to be a collective effort by all involved.

The COVID-19 pandemic has fast-forwarded digital adoption that would otherwise have taken a longer time in normal circumstances14. The mandatary lockdowns and stay home requirements implemented by governments worldwide has meant that our reliance on technology to continue daily living and performance has never been higher.

This translates directly to a high opportunity for cyberterrorism or cyberattacks.

While we cannot be sure of when, what and how the next attack will be, it pays to remind ourselves that the mother lode of all cyberattacks may just be around the corner.


3. $200 oil per barrel

While Electric vehicles (EV), clean energy and their adoption are all the rage (which are essentially oil-killers), they will not come about unless countries and companies have the necessary infrastructure in place.

For example, charging stations will need to be widely available for EV use, solar panels need to be priced at a substantially lower cost for families to install them etc.

While in the long term, EV use, battery technology and clean energy will hurt the oil industry, these are next-decade trends. They are not next-year trends.

Around 295,700 battery vehicles were sold in the US in 2020 according to statista15, and represent only around 2% of total US vehicles sales16.

Simply put, EV sales will need to grow 500% to 1,000% next year alone to cause any problems to oil demand. EV sales will grow eventually no doubt, but it will not happen anytime soon.

In the meantime, as travel grows with the world eventually opening up in the near future, oil demand may see a drastic uptake and with that a spike in oil prices as well.

This will lead to the next black swan event.


4. Runaway all-time-high Inflation

According to Investopedia17, the highest year-over-year inflation rate was 29.78% in 1778. In the period of time since the introduction of the CPI, the highest inflation rate observed was 19.66% in 1917. A black swan event will see the inflation rate surpass previous highs.

The Federal Reserve seeks to control inflation by influencing interest rates. And when inflation is too high, the Federal Reserve typically raises interest rates to slow the economy and bring inflation down18.

However, the US government exploded in response to the major global shock of 2020 with unprecedented stimulus. The mismatch between government revenue and spending has now gone to a potentially reckless situation as the national debt; now approaching US$30 trillion, spirals out of control19.

The reality is, it is unlikely that the US will pay down its debt in a meaningful way. As interest rates rise, interest payments to service this debt will likely be unmanageable. National debt servicing was a record $585 billion in 2019.

This record was when their debt was under $24 trillion and interest rates averaged about 2%. Today, the US debt is about 25% higher, but with interest rates being lower, this mitigates the debt cost for now20.

But if the Fed is forced to raise interest rates substantially to combat inflation, it risks raising the cost of the enormous debt burden, creating a debt trap. Rate hikes due to the financial crisis had dramatically negative consequences, hammering equities markets and inhibiting growth.

So the last thing the Fed could wish for today is repeating that mistake and having to court recession.

The key takeaway is, yes there will be interest rate increases in the future. But the question will be; will the rate increases be sufficient to combat inflation?

Watch for inflation to potentially spiral out of control as the Fed’s hands are tied as to how much interest rates can be raised to fight inflation.

Do check out our past articles on inflation: 3 ways to invest during inflation, Is inflation good or bad for stocks?, FOMC Meeting: What happens when interest rates rise?


5. A grey swan: Chinese technology stocks make all-time high?

Let’s end with a positive grey swan event.

It’s easy to find parts of the market that investors love today. Cryptocurrencies and US stocks come to mind. These assets have soared in value since the pandemic bottom and investors have made money investing in them in 2021.

One emerging market has seen a complete bloodbath though.

Chinese technology stocks in particular have crashed this year.

We can see this by looking at the KraneShares CSI China Internet Fund (NYSE: KWEB). This fund holds a basket of Chinese technology stocks and the sector is down more than 50% since peaking in February this year.

Four Black Swans and 1 Grey Swan for 2022Source: Bloomberg 26 Nov 21

That decline happened due to a new wave of regulations from the Chinese government21.

It started in November 2020 when Chinese regulators shut down Ant Group’s initial public offering at the eleventh hour.

The regulators next investigated Alibaba (BABA) for monopoly-like behaviour and proceeded to slap the company with a $2.8 billion fine – the country’s largest antitrust fine on record22.

In June 2021 a few days after DiDi (DIDI) went public on the New York Stock Exchange, China’s cybersecurity arm banned new downloads of DiDi’s app in the country, accusing DiDi of improperly collecting and using data23.

That was, however, not the end, as Chinese regulators next took a hammer to the $100 billion for-profit education-tech sector. They banned these companies from making profits, raising capital, and going public.

The two largest companies in the space, New Oriental Education & Technology (EDU) and TAL Education (TAL), fell 54% and 71% respectively on the news. Today, both stocks are down roughly 90% from their February highs24.

When a foreign government exercises that kind of power over a group of major stocks, it frightens investors and has led many to stay away. The Chinese technology sector is one of the most, if not, the most hated sector ever since.

There are, however, some subtle signs that this might be reversing:

  • DiDi is planning to relaunch its apps by the end of the year after nearly six months of being banned by Beijing’s regulatory bodies25. The getting back on the app store is a sign that the worst of the sector’s regulatory problems are likely behind us. This would also not be possible without the blessing of the authorities.
  • The recent move by DIDI to delist from the US bourses and to relist on the Hong Kong Stock Exchange26 shows its desire to get back to the good side of the government which will ease further pressure by the authorities to clamp down.
  • As shown in the chart below, shares outstanding for the KWEB ETF has increased significantly. The share outstanding count for an ETF is a good indicator of investor interest. When investors are excited about an ETF, they will buy into it which causes the share outstanding count to increase.

In the chart below, we see that the shares outstanding for KWEB have increased by leaps and bounds, indicating that investors are pouring money into the fund at a record pace27.

Four Black Swans and 1 Grey Swan for 2022Source: Bloomberg 26 Nov 21

If the Chinese government does indeed reverse course on its regulation of its technology companies, investor interest will return and prices will likely rise in a hurry.


What can you do to protect yourself from a black swan event?

Consider protection against black swan events like buying a fire insurance on a property. You don’t know when you will need it, but when you do, you will be glad you have it. You may practise regular investing by using the POEMS Share Builder Plan or Recurring Plan.

In addition, whenever there were black swan events such as a war or financial crisis in the past, gold and precious metals came to the rescue as defensive assets. Not forgetting the traditional defensive sectors, which may also help you hedge your portfolios!

Please do also look at our popular top 10 traded US stocks on POEMS.


Reference:

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About the author

Roger Chan

Phillip Securities Pte Ltd

Roger holds a Business Degree in Electronic Commerce from the Monash University and is also the recipient of the Golden Key Scholarship Award for outstanding academic performance. He currently heads the Global Markets Night Trading team assisting clients with the US and European markets.

Prior to the night desk, he was a bond trader at the Debt Capital Markets desk and brings with him a wealth of equity and debt market knowledge.