Investor Apathy Is a Black Swan Event That Could Spark a Market Crash
Despite a surge in earnings, stocks continue to suffer. The Dow Jones has not found its stride since the February flash crash and investors seem unimpressed or indifferent.
The pattern has been rather similar beyond the markets. Bitcoin and other cryptocurrencies are also lagging. That’s where the “black swan” event, or tail risk event, resides.
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Unfortunately, the markets have gone as high as they can go. Stock volatility is low, but global volatility and the potential for unforeseen factors that could sink the markets are aplenty.
The problem with black swans is that they can’t be identified as such until after their effects unfold. The very term “black swan” refers to the fact that, for years, Europeans believed that all swans were white. Until, that is, they traveled to Australia, where they were surprised to see a black swan (Latin Cygnus atratus), also known as the “impossible bird.”
Extreme Consequences
Although many have used the metaphor since long ago, it was in the context of stock markets—specifically stock market crashes—that the term “black swan” has found a renaissance.
Nicholas Nassim Taleb, an options trader and a practitioner of risk, studied the black swan phenomenon in a series of books he calls the “Incerto Project.” His definition (highly paraphrased here) is that a black swan is a highly improbable event that everyone ignores.
Yet, should such an event occur, it would produce extreme consequences.
We are all vulnerable to black swans. The capital markets are highly vulnerable to black swans, while gold tends to thrive from them. Now, global events and macroeconomic conditions are ripe for the kind of black swan event that smashes stocks.
Moreover, the most vulnerable sectors of the market have also exposed their weaknesses. Therefore, we have sufficient elements to identify where a stock market crash could begin and which stocks to watch closely.
FANG Stocks Are Most Vulnerable to Black Swan Events
The so-called FANG stocks have come under pressure. They’ve gained the most value (other than the defense sector, which benefits from an entirely different set of factors) from the market rally that technically began in 2009. The next black swan could hit tech stocks first.
“FANG” refers to the technology companies. It’s an acronym derived from Facebook Inc (NASDAQ:FB), Amazon.com, Inc. (NASDAQ:AMZN), Netflix, Inc. (NASDAQ:NFLX), and Google, which is now called Alphabet Inc (NASDAQ:GOOG).
It would not be wrong to consider FANG the new moniker for the tech stocks of the 1990s and early 2000s. And like those stocks, the FANG stocks are going to decay.
The media and Wall Street have been rather hushed about the possibility that the FANG rally has become rather bubbly in the past few months, even if these technology stocks are largely based in Silicon Valley. That’s where you are not “middle class” unless you make $400,000 a year, according to studies. (Source: “Silicon Valley is so expensive, people who make $400,000 think they’re middle class – here’s what middle class actually is in the 25 largest US cities,” Business Insider, February 24, 2018.)
Facebook stock may have already attracted a black swan flyby. Since it was found to have sold data to a third-party user, Cambridge Analytica, Facebook has struggled to resume its previous highs.
The social media giant lost over 20% from its all-time high when the data breach was revealed at the end of March.
There are big question marks as to whether Facebook will resume trading at the loftier plateaus on its stock chart. And Facebook has the power to burst the entire FANG bubble. Facebook’s reputation has suffered a loss that will take months to recover, if not years.
In that period, a multitude of other social media companies, especially those based outside California, could take advantage of the situation to win over users.
No Stock Is Infallible
Regardless of size and scope, corporations come and go. They experience glory but often cannot survive unforeseen risks and new competition.
Pan American World Airways, for example, one of the oldest and largest airlines in the world, collapsed under the pressure of airline deregulation, which bloomed in the 1980s and 1990s. Its former rival, Trans World Airlines, Inc, also collapsed, while Southwest Airlines Co (NYSE:LUV) thrived.
Therefore, there’s no reason to suggest, much less believe, that Facebook has developed infallibility. Facebook stock has become a barometer of the FANG stocks’ health.
The company has attracted political eyes, which could introduce regulations or force it to work with government agencies in such a way as to turn off several users. The company has been absorbing major risks with users’ privacy. And it could backfire.
Then there’s the issue of taxation. The European Union (EU) has long wanted to target Silicon Valley tech firms, which operate on the Internet.
In a sense, the companies earn significant revenues from operating beyond state borders. Thus, they pay very few taxes compared to companies with equivalent profits. This has helped explain their miraculous earnings.
The FANG stocks, like the tech companies before them, use their multinational status and incentives to shift tax burdens away from where they do their business. They channel profits through fiscal havens like Luxembourg and amass huge piles of cash. That’s what makes them so appealing to shareholders.
Consider that Apple Inc. (NASDAQ:AAPL) has managed to stash away some $250.0 billion from the IRS (legally), which solely benefits shareholders. (Source: “The tech giants will never pay their fair share of taxes – unless we make them,” The Guardian, December 11, 2017.)
Given that most of these corporations are run from the United States, Europeans and others—Australia in particular—have grown rather restless about reining in the tech giants.
At a recent G20 summit, held in March, attending ministers proposed a tax on tech companies’ gross revenues.
The Organisation for Economic Co-operation and Development (OECD) has proposed normalizing a new fiscal system aimed at introducing more intrusive fiscal measures against the companies so admired by the media and progressive political parties.
If the subject has dropped from the radar, it may be because, in an effort to quell President Donald Trump’s proposed trade tariffs against the EU, authorities in Brussels have brushed the topic aside for now. But it won’t go away.
Should the topic come up again and prevail, it will become one of those rare black swan events that could be predicted from miles away.
The current controversy over so-called “fake news,” which is as difficult to monitor as it is to identify, could lead to the application of much more concrete measures against the FANG stocks: higher taxes.
A FANG Crash Would Bring Down the House
Demanding that tech and FANG companies pay their fair share of taxes could kill their stocks. A FANG crash would drag down Wall Street with it.
If you think that international regulators won’t be able to touch the United States, think again.
It’s not so much the EU or Australia that Americans need to worry about. It’s their own government, especially as the Trump tax cuts have fueled the risk of losing all control over the national debt.
As for macroeconomic problems, U.S. debt certainly constitutes the potential source of a black swan. But there’s an even more likely black swan generator in the form of inflation. It’s rising for all the wrong reasons.
Oil prices are moving higher. And the Saudis seem to have forgotten their previously brilliant analysis vis-à-vis the risk of allowing oil prices to move too high.
Simply put, if the Organization of the Petroleum Exporting Countries (OPEC) oil prices rise beyond a threshold of about $60.00 per barrel, it makes shale oil development and extraction in Texas and elsewhere in the U.S. more attractive. The higher the price of oil, the more competitive non-OPEC sources become.
The Saudis cannot afford for this to happen for political reasons, even more than for economic ones. Without oil, despite its massive chemical sector, the Saudis cannot survive for long.
And they will lose the ability to subsidize their power base, causing a further imbalance to the Middle East.
The risk of the current Middle East conflict centered in Syria going out of control and turning into World War III is already too high. The world’s leading nuclear powers occupy opposing positions.
The introduction of an additional element of risk could be the black swan event that not only drags down markets, but drags down the world.
More locally, if interest rates have had little effect in 2018, the risk to markets in 2019–2020 will be far higher. Borrowing for homes and big-ticket items will be harder, impacting auto sales. And the global economy could be far slower because of the higher oil prices.
There will be demand for higher taxes to pay for unemployment benefits and other social welfare needs in the likelihood of another recession. And at that point, even the December 2017 tax cuts won’t work.
