Black To me the biggest assumption about financial markets is that history will repeat. The second biggest assumption is that the Great Depression won't.

At least in terms of volatility, it looks like we are going to test both these assumptions soon.

VXO is recently over 50, which has occurred infrequently since inception in 1986. But this is a short time when studying mass-extinctions, so to study volatility over longer periods I used DJIA daily returns 1928-present, and for every non-overlapping 10 day period I calculated the STDEV. This chart shows the recent 10 day/daily STDEV is >3%, which occurred recently only in 1997, 1998, and 2001. Prior to this, all the instances were in the 1920s and 30s.

Mark Isbic writes:

Today here in Israel, the mother of all swans started with the TA 25 and 100 down 7% and the Tel Tech down over 11%. If this is any indication, tomorrow will be very ugly unfortunately. I say to myself it will be a great time to jump in. Unfortunately I have been doing this for several months and have taken a beating!

Jason Shapiro remarks:

Anybody see the Bloomberg story about how current financial conditions are a black swan event? Statistically they say this is rarer than a comet's destroying the earth. And the data they used go all the way back to 1993!





Speak your mind

5 Comments so far

  1. Rocky Humbert on October 5, 2008 9:37 pm

    I’m sorry to say that this is the sort of fear-mongering that is neither constructive nor intellectually honest. A black swan is only a black swan if YOU didn’t expect it.

    First, one must put things into historical context:

    From 2004 to 2007, DJIA volatility was persistently below 10% annualized, and this period included among the longest periods without a 10-15% price correction. Applying Kim’s logic might have caused one to predict a new utopian era without economic cycles. Obviously an incorrect conclusion.

    With 20:20 hindsight, we realize that CDO’s and other parts of the debt market were behaving like giant capacitors — absorbing more and more charge — and now that energy is being violently dissipated. Eventually the energy will dispersed, and the voltage will equalize.

    It’s always been the case that fear is a greater motivator than greed. “Get Me Out! Get Me Out!,” yells the investor to his broker. Noone except a short (or a character in “Trading Places”) would collapse in a panic yelling “Buy, Mortimer, Buy!) Stocks crash downwards. They don’t crash upwards. It’s the long bias structure of capital markets. But it’s certainly not predictive of anything.

    Can we have a deep and protracted recession? Of course. Can stocks decline a lot more? Sure. But so long as the central banks continue to expand their balance sheets, it’s simply impossible to have a “great” depression.

    I remind you that from 1930 to 1933, M1 declined by 23% and M2 declined by 30%. Right now, M1 is expanding by 8% (annualized) and M2 is expanding by 2.4% (annualized). See: http://www.federalreserve.gov/releases/h6/Current/

    There are myriad other differences from the 1930’s. Most pronounced is the socialist bias.

    Furthermore, let us not forget that in their October 31, 2007 post, Steve Leslie and Victor crowed about the wisdom of owning Google as it crossed $700 ($387 last) and Apple as it crossed $200 ($97). Now that the valuations are finally becoming appealing (GE at 10x earnings!!!) is Kim’s panic demonstrating the worst aspect of herd behavior? Note that that Berkshire Hathaway is comfortably beating the S&P over the past 1, 3, 5 and 10 years … the more things change, the more they stay the same.

    Bottom line: When things look great, they are never that great. And when things look awful, they are never that awful. In my trading book, I’ll admit that I am short stocks and commodities. But in my long term investing portfolio, I am buying world class companies at valuations that I only dreamed of several years ago. So long as America maintains its core values of liberty, justice and rule of law, patience and discipline is how great fortunes have always been made and will continue to be made. Panic is for losers.

  2. Leonardo Cecchini on October 6, 2008 8:50 am

    Does history repeats itself or maybe is it we that repeat history? Irrespectively, those who do not learn from the past are doomed to repeat it….

  3. Marco Loureiro on October 6, 2008 1:57 pm

    It seems ironic…but last week I just had a surgery that left me with some difficulty to walk.

    Today, my wife went out shopping and bought me to my surprise…a pair of canes.

    Mr. Humbert is correct…panic is for losers. Given that the spread of the implied volatility on the NASDAQ 100 and its realized volatility is now above its 2.5 std. deviation band…one has to wonder if this is the time to panic or to exercise some “caneology”. How much premium can we pump into the option spectrum I’m not sure, but the incentive to buy quality stocks and sell this volatility along with it has never been better for the past several years.


  4. Marco Loureiro on October 6, 2008 2:54 pm

    On a different note, I would suggest that for those under stress at a time of elevated herd behavior to take a look at some of these articles in behavioral finance. This is a great source of insight and trading ideas. http://www.behaviouralfinance.net/

  5. Some measures indicative of the financial turmoil « American Armageddon on December 8, 2008 11:11 am

    […] Kim Zussman, in “Mother of All Swans,” has also put together a long term historical chart measuring volatility. Zussman used the daily returns of the Dow Jones Industrial Average from 1928 to early October 2008 and calculated the standard deviation for every non-overlapping 10 day period. The Crash of 1987 is still at the top of the charts on this one. […]


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