Is This Crisis Really a “White Swan”?

In a recent article for the CFA Institute Conference Proceedings Quarterly, James Montier, Societe Generale Cross Asset Research’s global strategist, argues that the recent economic crisis and market plunge were not, as many have said, an unprecedented, unpredictable “black swan” event. Instead, he says the events have the characteristics of what psychologists call a “predictable surprise” — a “white swan”.

“Volatility has indeed been higher historically, so today’s situation is not unprecedented,” Montier writes. “Furthermore, in the 1930s, not only was volatility higher, it remained higher. … Nor is the situation unpredictable. Each of the spikes we have witnessed in volatility occurred when investors went from losing their minds at the top of the market to losing their nerve at the bottom — a kind of bipolar or manic-depressive reaction to the market.”

According to Montier, this crisis possesses the three characteristics of a “predictable surprise”:

1. At least some people were aware of the problem before it really hit. People like Jeremy Grantham, Robert Shiller, and Whitney Tilson all realized, to one degree or another, that we were in a bubble that affected just about every asset class before the current crisis hit.
2. The problem has gotten worse over time. That “has been a hallmark of the current environment,” writes Montier. “We have seen a slow transition from ‘do not worry; the subprime problems are contained’ to ‘oh no, they are not contained’”.
3. It has “explode[d] into some form of crisis”.

The reason so many failed to see this “predictable surprise” coming involves behavioral impediments or mental barriers, Montier says. He lists five examples:

• Overoptimism
• The illusion of control
• Self-serving bias
• Myopia
• Change blindness (he offers some particularly interesting study results on this lesser-known behavioral tendency)

Montier also offers insight into whether the current climate is a good one for value investors, using Ben Graham’s tenets. And he offers some interesting results from a study he performed examining where the market’s current value comes from.

“Earnings may drop significantly during the next few years, but that should not matter to a long-term investor because equities are inherently a long-duration asset,” he explains. “They are a claim on long-term future cash flows.” His study of the S&P 500 found that only 10% of the index’s value is derived from the succeeding three years of activity. The next five years add no more than another 15%. “In fact, 75% of the value comes from the long term, that is, the period beyond which I was modeling,” writes Montier. “My conclusion is that the vast majority of my return is driven by long-term earnings power. Therefore, investors should not obsess about short-term results. Unfortunately, that is exactly what they do.e