Are Black Swans Proliferating? You Decide! Take The ATCA Test

London, UK - 7th January 2010, 5:30 GMT

Dear ATCA Open & Philanthropia Friends

[Please note that the views presented by individual contributors are not necessarily representative of the views of ATCA, which is neutral. ATCA conducts collective Socratic dialogue on global opportunities and threats.]

Black Swans are the existence and occurrence of high-impact, hard-to-predict and rare events that are beyond the realm of normal expectations. Black Swans in global parlance now refer to unexpected events of large magnitude and consequence. They are characterised by the dominant role they play in shaping history. Such events are considered extreme outliers. All major scientific discoveries, historical events and many artistic accomplishments can be regarded as "Black Swans" because they were undirected and unpredicted, and had massive impact. The rise of the Internet, the personal computer, World War I and 9/11 are examples of Black Swans.

Which is a Black Swan or Unknown Unknown?

Element of Surprise

The perception of Black Swans depends on the level of collective consciousness and the observer perspective. Suppose a bellwether stock declares an exceptionally bad result out of the blue and subsequently loses 90% of its market capitalisation in a short space of time. Given that the majority of the investors are unaware that this might happen, for them the bad result comes as a complete surprise with big impact, hence it becomes a Black Swan event. However, for the CEO and the board of directors, who were aware of the announcement, much before it was made, the event was NOT a Black Swan at all. This explains: what might be a Black Swan for some may not be a Black Swan for others!

The question is for how many players, is the event a complete outlier, when manifest? If the majority of players are aware that something like an extremely bad financial result could be announced, then it is not a Black Swan at all. However, if the collective consciousness of the majority of players is NOT aware then it becomes a Black Swan event as it initiates an immediate panic sell of that given stock. Further, if the panic spreads like contagion to other stocks in that particular sector then that has created other Black Swans, ie, follow-on unanticipated events for different yet involved parties and players.

What may be a Black Swan for the majority of the common collective consciousness, may not be a Black Swan at all for a tiny minority of key decision makers, executives and involved parties.

Unknown Unknowns, Known Unknowns and Known Knowns

The level of collective consciousness of different groups of players determines:

1. What may be an unknown unknown event with high impact, ie, a Black Swan; 2. What may be a known unknown -- low probability high impact -- event but NOT a Black Swan; and 3. What may be a known known event for the key decision makers and executors as well as their friends.

Were "The Great Unwind" and "The Great Reset" Black Swans?

When the financial markets went into a tailspin in 2007 and 2008, followed by a severe contraction in world trade, for the majority of market participants these events appeared to be a series of Black Swans. Headlines in newspapers and their editorials stated, "Who could have predicted this...?" (Well, Hello?) The events were treated as unknown unknowns by the media and the market participants as a majority, so they became part of the collective myth and folklore that they were Black Swans. The truth is that they were NOT!

For anybody paying attention to ATCA Briefings between 2005 and 2007, The Great Unwind (2007-?) and subsequent The Great Reset (2008-?) were NOT black swans! Many savvy experts around the world, distinguished ATCA participants included, had already put it down in writing that events similar to The Great Unwind and The Great Reset would be the logical consequence of the bursting of multiple bubbles followed by the deleveraging of the credit pyramid.

Many distinguished ATCA members discussed the strategic, operational and systemic risks within financial institutions and markets between 2005 and 2007 and have continued to discuss them in 2008 and 2009. So the eight bubbles which were building up and partially burst, were known and even quantified in scale by the ATCA community. At best, the label known unknowns may be apt, but definitely NOT unknown unknowns or Black Swans!

New bubbles are building up once again in 2009 and 2010, whilst the older eight bubbles identified by ATCA have not completely burst. What we are not able to do, is to predict the timing of the bubbles bursting, and in this way, it would be more appropriate to say that events over the last few years in financial markets should be in the category of known unknowns to ATCA participants, rather than unknown unknowns or Black Swans.

For the mi2g Intelligence Unit (mIU) and The ATCA Research and Analysis Wing (A-RAW) involved in modelling the past bubbles, the more recent eight bubbles, and the subsequent additional bubbles formed in the last few years, there is a clear understanding that financial markets will not be able to defy economic fundamentals, ie, gravity, ad infinitum. The Great Unwind and The Great Reset are simply a confirmation, and hence they fall into the category of known knowns. As indeed, does a 1932 style financial markets correction post the rally of 1930-31 that followed the 1929 crash!

Systemic Failure

The main idea behind the concept of Black Swans is not to attempt to predict Black Swan Events, but to build robustness and resilience against negative ones that may occur and be able to harness the opportunities created by positive ones. According to the Black Swan thesis, banks and trading firms are very vulnerable to hazardous Black Swan Events and are exposed to losses beyond that predicted by their defective models, which pay inadequate attention to outlier risks. When concatenated across multiple entities, the manifestation of such outlier risks may cause systemic failure.

The ATCA Black Swan Proliferation Test

Before concluding that Black Swans are proliferating, please answer the ATCA Proliferation Test Question:

Which category do you feel most comfortable with?

Category 1: Black Swans occur rarely.

OR

Category 2: Black Swans occur regularly and with increasing frequency.

Before committing to either category, please make sure you understand the definition of a Black Swan, as presented in the opening paragraph of this ATCA Briefing.

Choice Analysis

If you chose Category 1, either one or more of the characteristics below may be true:

a. Independent perspective and successful imagination with quality inputs may strengthen the capacity to connect the dots on most occasions;
b. Willingness to change mindset -- less vested interests to protect prior decisions;
c. Less myopia and a wider angle of vision with lateral thinking;
d. Healthy curiosity to question facts, figures, procedures and assessments;
e. Strong willingness to listen and to learn from a wide variety of sources;
f. High comfort level with multiple scenarios and possibilities in thinking and future projections;
g. Lack of comfort with a fixed single scenario;
h. Acceptance with balanced accommodation of contrarian views from colleagues, friends and advisors who may not always agree;
i. Assimilation of multi-faculty knowledge; and
j. Regular immersion in a diverse peer group with varying demographics.

If none of the above items hold true for you, then we would like to ask:

Why do you believe Black Swans occur rarely? Can you please provide some examples of Black Swans?

For Category 1 players most events are not Black Swans and either known unknowns or known knowns. For such players, Black Swans are a rare occurrence, and when such events take place, Category 1 players are able to harness the opportunity whilst minimising the down side risk through adequate preparedness, robustness and resilience.

If you chose Category 2, either one or more of the characteristics below may be true:

a. Group-think perspective and momentary failure of imagination with weak inputs may reduce the capacity to connect the dots on occasions;
b. Resistance to change mindset -- more vested interests to protect prior decisions;
c. More myopia and a narrower angle of vision with vertical thinking;
d. Curtailed curiosity to question facts, figures, procedures and assessments;
e. Limited willingness to listen and to learn from a wide variety of sources;
f. High comfort level with a fixed single scenario in thinking and future projections;
g. Lack of comfort with multiple scenarios and possibilities;
h. Resistance with limited accommodation of contrarian views from colleagues, friends and advisors who mostly agree;
i. Assimilation of domain-specific knowledge; and
j. Regular immersion in a like-minded peer group with similar demographics.

If none of the above items hold true for you, then we would like to ask:

Why do you believe Black Swans occur regularly and with increasing frequency? Can you please provide some examples of Black Swans?

For Category 2 players most events appear to be Black Swans and less known unknowns or known knowns. For such players, Black Swans are a frequent occurrence, and when such events take place, Category 2 players are unable to harness the opportunity and may not be able to minimise the down side risk because of inadequate preparedness and lack of robustness and resilience.

The following are the key questions to ask upon contemplating the "Choice Analysis" of The ATCA Black Swan Proliferation Test:

1. Are you and your team primarily composed of Category 1 or Category 2 players?
2. If you and your team are primarily Category 1 players, what are you and your team doing to retain competitive advantage?
3. If you and your team are beginning to slip towards Category 2, how can the team members go back to being Category 1 players in the near future?.

[ENDS]

We welcome your thoughts, observations and views. To reflect further on this subject and others, please respond within Twitter, Facebook and LinkedIn's ATCA Open and related discussion platform of HQR. Should you wish to connect directly with real time Twitter feeds, please click as appropriate:

. ATCA Open

. @G140

. mi2g Intelligence Unit

. Open HQR

. DK Matai

Best wishes