Introducing the Gray Swan

As of May 8, 2020

Brian Collins, CIO, Harbor Capital Advisors

Not the Black Swan… or the White Swan… the Gray Swan

In 2010, Nassim Nicholas Taleb published a book titled, “The Black Swan” in which Taleb went into great detail about the challenges of accepting something that up until that point in time had been unimaginable and, equally important, considered unpredictable. He defined a Black Swan event as one that:

  • is an outlier, meaning it was outside the realm of expectations since to date nothing had provided any indication of such an event occurring,
  • the event carries great impact, and
  • after the fact explanations and justifications as to why the event did happen and could have been predicted are developed.

The Great Financial Crisis of 2008-2009 was deemed by many as a Black Swan event as it fit Taleb’s definitional criteria. Other Black Swan events include the terrorist attacks of September 2001 and the tsunami tragedy in 2004. While there had been terror attacks in the past and tsunamis are known to occur following undersea earthquakes, the type and magnitude of these events, and their unpredictability and lasting impact were so much greater than had been contemplated that many deemed them as Black Swans.

A true Gray Swan event

Is the Global Pandemic, an epidemic occurring on a scale that crosses international boundaries typically affecting people on a worldwide scale, and its impact on global economies and markets a Black Swan event? To some it would fit Taleb’s criteria. However, if one examines the breadth of the pandemic and subsequent economic collapses around the world, it may fail to meet all criteria.

Surely the impact is significant, and we are now working through explanations and justifications to describe the how and why of what happened. But was the Global Pandemic so far out of the realm of expectations that it could not be considered or even predicted? The evidence would point to the contrary. History reveals multiple instances of plagues and global pandemics occurring for centuries. In fact, most people now know more than they care to about the Spanish Flu of 1918. So how surprising is it -in this era of globalization and interconnected economies - that what started as a small regional health issue has spread to every corner of the globe and has so severely impacted the daily lives of billions of people that we are questioning fundamental human activities and common societal structures? Is this a Black Swan event or something similar yet different? I contend the Global Pandemic is a Gray Swan event.

A Gray Swan event is similar to a Black Swan event, but the Gray Swan event is not entirely outside the realm of possibility. Gray Swan events occur so infrequently that they are considered remote possibilities, and therefore are not part of most risk models. Economists and others do contemplate Gray Swan events, as there is often general acknowledgement of the possibility, albeit remote, of the event occurring. But it remains difficult to predict and accurately quantify a Gray Swan event’s path and outcome. The Global Pandemic would appear to fit Gray Swan event criteria:

  • Pandemics have occurred before
  • They are difficult to predict, and
  • Scale of their impact is unknown

I believe this is the situation at this point. While global pandemics had been predicted, there was so much uncertainty that many struggled to model with any degree of accuracy their likelihood or importantly their impacts.

The numbers and the recovery

Over the last ten weeks as the Global Pandemic spread across the globe, its path of economic destruction has been massive – on a scale that even the most pessimistic predictive models may have underestimated. In the U.S. alone, unemployment numbers, GDP decline, and stock market losses reached levels not seen in decades1. These changes have occurred more rapidly than ever anticipated. They’ve also been so dramatic that it is difficult to contemplate what lies ahead or envision a return to the way things were. That is the challenge we face as investors trying to make decisions about investments when there is so much uncertainty that it would be easy to retreat and wait for greater clarity. Unfortunately, that may be many months in the future and, in the interim, various investment opportunities may be missed. However, now may not be the time to go “all in” and hope for the best.

Some might say that the opportunity for big gains has been missed as the S&P 500, after dropping more than 34% from its February peak (February 20, 2020) to the March trough (March 23, 2020), has rallied back more than 26% as of April 30, 20202. There is enough skepticism and uncertainty about this recovery that a reversal in the near future is a reasonable possibility. Missing out on the first stage of a market recovery after a sharp decline can be vexing for some, but looking back at data from many recoveries shows that considerable gains have the potential to be made as markets move through the recovery cycle of:

period of “uncertainty” -> “less uncertainty” -> “optimism”.

At this point in early May, we are still in a period of uncertainty, with occasional blips of less uncertain exuberance sparked by small “wins” that are extrapolated into bigger outcomes than are justified by evidence and facts. Being patient, prudent, and disciplined continues to remain a very good course of action for investors.

1National Bureau of Economic Research, April 2020
2Harbor Capital Advisors, Inc., April 2020

Be careful about overlearning from these events

Much has been already written about the long-term effects of the Global Pandemic, which is interesting given it only started three to four months ago. Much of what has been and will be said will eventually be viewed as wrong. In situations when there is so much being put forth as fact without sufficient or proven support, it is hard to focus your thinking. Over the last couple of weeks, one phrase that has come up repeatedly that links back to the Gray Swan is, “be careful about overlearning from these events”. A critical aspect of the phenomenon of the Black Swan, and its related Gray Swan is the obviousness of the event only becomes apparent after it has occurred. If someone has only ever seen white swans, the sight of a black swan can be so surprising that it may cause one to question their ability to believe anything with certainty. While this may seem extreme, think about the current situation – is this the end of:

  • Face-to-face meetings?
  • Crowded restaurants?
  • Air travel?
  • Large scale sporting events?
  • Concerts?

This economic event is not a common event that could not have been predicted. In fact, many did predict a global pandemic would wreak havoc on economies. What was not known with any certainty was how it would wreak havoc and to what extent. The risk we face now is extrapolating what is occurring now and in the near-term to be a permanent change in the long-term and possibly forever. This is an example of the overlearning previously referenced as well as recency bias that too often causes poor decisions. These risks exist for both fundamental and quantitative managers who may place too much weight on near-term market data and cause their models to shift too quickly or sharply. This action ignores the possibility that the long-term relationships that underpin their models or assumptions may still hold.

Looking beyond the Gray Swan

A common refrain we hear across our diverse array of subadvisers is that they are focusing on what they can reasonably assess about the future earnings capabilities of portfolio companies and how this is reflected in current valuations. While some potential investments may look cheap, their assessments must consider what the current market valuations suggest about the companies’ future prospects. Many of our subadvisers have already gone through an initial triage of their portfolios’ companies. They’re making determinations of whether the company is likely to survive through the economic shutdown and in the new economic environment that emerges. They’re also evaluating what companies are most likely to thrive no matter what economic environment we will experience in the future. This “survive-and-thrive” approach has been successful during and coming out of prior economic downturns, and we expect it will be more significant now. I have been a firm believer in the premise that great companies are resilient and are skilled at adapting to change, and that great business leaders find ways to lead their companies to profitability no matter the environment.

Many business models and companies that are unlikely to thrive and may not survive have been identified and have seen their share prices plummet. These may have been formerly great companies that are not able to adapt or may be led by business leaders that cannot see new ways to be profitable in the new environment. Additionally, the markets could be extrapolating near-term issues into permanent fatal flaws. Accurately assessing these risks has the potential to lead to significant returns for investors.

Further to this point, I believe in the skill of our managers to find those great companies who are led by capable leaders who will adapt their business models to seek to generate attractive returns for their shareholders. It is these companies that will not only survive but thrive during and after this Gray Swan event has faded from our memories and before the next Gray Swan swims by. Perhaps this time is different (a four-word phrase that often scares most investors), but until I am proven wrong, I believe the combination of science, innovation, and motivated people will have the potential to find ways to address and beat this pandemic.

  • Focus on the long-term
  • Stay disciplined
  • Make prudent decisions that reflect a reasonable degree of certainty in the likely outcome, and…

align with those investors who are best positioned to see the Gray Swan for what it is, and more importantly, take advantage of the opportunities it presents.



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Past performance is no guarantee of future results.

The information shown relates to the past. Past performance is not a guide to the future. The value of investment can go down as well as up. Investing involves risks including loss of principal.

The views expressed herein are those of Harbor Capital Advisors, Inc. investment professionals at the time the comments were made. They may not be reflective of their current opinions, are subject to change without prior notice, and should not be considered investment advice.

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