The Stock Market's Biggest Black Swan

by Daniel Carter
The bull market has continued to rip on the hopes that this Republican administration can lower taxes and add more stimulus to the economy. Once an outspoken critic of the obscenely high valuations in the stock market, President Trump now cheers every time we reach another all-time high. With stocks near all-time highs and volatility near all-time lows, investors don’t seem worried at all about risk. However, I can’t help but feel that there is a Black Swan lurking right around the corner.
Typically, a Black Swan event is viewed as a major unforeseeable risk. However, the degree to which the Black Swan is unforeseeable depends on perspective. Thanksgiving Day is a Black Swan for the turkey but not the butcher. We have enough market data to infer that it’s just a matter of time before the next Black Swan event arrives. When it will occur and what form it will take are the most difficult questions to answer.
“When” may be a little easier to answer. All bull markets eventually come to an end. We have never seen an exception to this rule, and we should not expect to see exception to this rule in the case of this bull market. Because we are in one of the longest bull markets in recorded history, we should expect the Black Swan to arrive sooner rather than later.

We can also see that options market traders are signaling an increasing likelihood of a Black Swan Event.

The much more difficult question to answer is: “what form will this Black Swan take?”
We have seen it take many forms in the past; subprime mortgages, tech stocks, tulips and many others. However, I believe that the greatest risk the market is not paying attention to is the possibility of large-scale war. The market was at first startled by Kim Jong-un’s nuclear tests and harsh words toward the west. But now the market discounts all that news and continues to push higher.
According to William Strauss and Neil Howe’s Generational Theory a society goes through a major war every 80 to 100 years. The American Revolution, the Civil War and World War II were the most significant wars in US history. They all occurred 80 to 100 years apart. We are now 78 years past the beginning of WWII. Generational Theory is well-known in the investment community, and I encourage all readers to do their own research on it. The theory is explored in detail in the book The Fourth Turning.
During the time leading up to war, and the war itself, society will become a very volatile place. Ideologies will battle it out. Old institutions will be destroyed and new institutions will be built. These periods of time are very messy, and the stock market usually reflects that. Here is a long-term stock chart with the major wars labeled:

You can see that war time is usually in close proximity to extreme lows in the stock market. Are we approaching another major war? Only time will tell. By the looks of the massive militarization around the world, things are not looking good. A Black Swan can come from many places, but I believe the market is most heavily discounting the possibility of a large-scale war. Be cautious while investing in stocks, and keep a close eye on the geopolitical situation.