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DAVID KRUSE

By Staff | Sep 3, 2010

So we all know what I am talking about, a “black swan” is an unforeseen event that wrecks havoc on financial markets. The housing bubble, mortgage meltdown and credit crisis were black swan events.

Being unforeseen is a reach as many investors do anticipate them and black swan events have created some billionaires in the midst of the all the carnage. Black swans are rare in the physical world and in markets. European explorers thought all swans were white until they discovered black swans in Australia.

There are now hedge funds that focus and prepare to capitalize on potential black swan events often using options so that a very small amount of investment can return large gains from major events. Others protect a large cash war chest waiting for a black swan event to generate an extra ordinary buying opportunity as happened when bank stocks collapsed. There are many fundamental candidates that could develop into black swan events.

ZeroHedge.com wrote, “The inevitable restructuring of untenable sovereign debt, the nearly $5 trillion in new global debt that needs to be issued just to plug near-term deficits, the joke that was the European stress test and the ongoing insolvency of the European banking system, which is times bigger than its U.S. equivalent, the imminent downward revision of Q2 GDP to sub 1 percent, the Fed’s conflicted position as a political authority whose sole purpose now is not to keep inflation and unemployment low, but merely to keep interest rates as low as possible, as even the slightest shift to higher short end rates will be seen as a black swan, (indicates) the Fed is losing control over the economy and ultimately the futility of Keynesian theory band-aiding of a world caught in a toxic debt death spiral.” Take a breath. Now exhale.

Then there is the Hindenburg Omen. Jim Miekka, gleaned five technical signals from historical market data that preceded stock market declines greater than 5 percent – dubbed the Hindenburg Omen.

The WSJ noted, “The confluence of data used by the Omen was officially tripped this week.” Market analysts argue over the Omen’s track record, claiming 75 percent accuracy, but only 25 percent that would be labeled major crashes. I think the political climate is disconcerting enough to become a black swan. The public is not happy yet and they really don’t have a clue how to fix the things giving them angst nor has any leader or political party or movement really done more than tap into the public discontent. Nobody has the answers and most talking are only competing to exploit the mess for political gains.”

Our political system has denigrated into a contest over tying blame for everything going to heck on the other political party rather than something designed to address problems fixing anything. In fact, if any political party does have a solution to an issue, the other focuses on undermining it so it doesn’t concede credit for good solutions. The government’s ability today to respond to a recurrence of a financial crisis may have become politically impossible.

This may be just a Great Recession and not a Depression, but conditions are ripe for a trade war that could become a black bwan event. High unemployment rates, trade deficits and widely fluctuating currency valuations breed protectionism. The housing market has still not confirmed a bottom. If housing values stopped declining and consumer confidence was restored in the value of what, for most, is their primary asset, their homes, consumer attitudes would improve immensely.

It may not be a depression, but interest rate markets are acting like they did in the 1930s. Back then they fell to 2 1/2 percent and then stayed there. 10-year treasuries traded to 2.21 percent in January and are retesting that low this summer. Some can re-finance, but credit worthiness has deteriorated and credit rules tightened so that many who want to refinance can’t.

Junk bond sales are hitting records as investors succumb to trading risk for yield. Fitch Ratings noted, “When you take into account other investment options for investors, and a benign default rate, the high yield asset class is still pretty attractive.” Bear in mind ratings services thought subprime mortgages were a good deal too.

One can see how one black swan could become two and under the right circumstances what would have been individual swans could become a flock. The Fed is worried enough that St. Louis Fed President James Bullard said, “The Federal Reserve may need to ramp up its purchases of U.S. Treasury debt if price levels in the U.S. economy continue to show a sign of softening.”

Reuters noted, “The move was aimed at sustaining an economic recovery that looks increasingly troubled, with persistently high unemployment and a battered housing market denting consumer confidence and inhibiting business investment.”

Throw in the record floods, record droughts occurring worldwide and gargoyles showing up perched on public buildings would provoke little surprise, perceived as a natural phenomenon akin the economic environment joining the black swans and omens.

David Kruse is president of CommStock Investments Inc., author and producer of The CommStock Report, an ag commentary and market analysis available daily by radio and by subscription on DTN/FarmDayta and the Internet.

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