There are certain books that hit you at just the right time and became a big part of how you see the world. For me, one of those books is Nassim Taleb’s The Black Swan. The Black Swan has become a widely used (and oft misused) term, but Taleb’s intended definition was simple: A black swan is something that is both highly improbable and highly impactful.

As Taleb points out, “known unknowns” tend not to be that impactful because we can prepare for them. Y2K was a big scare that happened in the late 90s when people worried that all the computers were going to implode. It ended up being a non-issue, not because it wasn’t problematic (it was), but because there was plenty of time to prepare for it, which companies did.

By contrast, the 9/11 terrorist attacks of blow-up of Long-Term Capital Management were impactful in large part because very few saw them coming.

The unforeseeable nature is an important element of it. Your parachute failing to open when you are skydiving is not a black swan, it’s an obvious risk. Having a skydiver fall on you while you are mowing the grass is the black swan.

Our world is becoming more and more dominated by black swans. Because most people tend to underestimate the impact of the highly improbable, we end up actually creating Black Swans. We are living in what Taleb calls Extremistan, not Mediocristan. From my post, Welcome to Extremistan:

Mediocristan … reflects how the world has operated for the vast majority of its history and it is, judging by first, though not correct, appearances, how the world operates for most people.

…
Your calorie intake is a biological system that lives in Mediocristan. No matter how much you put down at that Chinese buffet, you can’t double your weight in a single day. You can’t double it in a month. It would be extremely difficult to double it in a year, no matter how much you ate.

This is how biological systems operate and it’s how most of the systems in the world have operated until relatively recent history.

Non-biological systems, man-made systems, modern systems like our businesses and careers, don’t live in Mediocristan.

They live in Extremistan.

Many people have doubled (or lost all of) their net worth in a single moment: a company goes public or announces bankruptcy. A stock quintuples or crashes.

Vast man-made empires have been toppled by a single event—the storming of the Bastille, the signing of The Declaration of Independence. These events are what change looks like in Extremistan.

Sudden, violent, irreversible. Most of all, unforeseen.

A lot of my writing boils down to trying to provide strategies and approaches for living in Extremistan, a world dominated by black swans. I’ve written about investing in Extremistan, careers in Extremistan, marketing in Extremistan, and running a business in Extremistan. My writing on Bitcoin and cryptocurrency is heavily rooted in the notion of a more Extremistan-esque world defined by black swans.

The role of Black Swans and the extent to which our world is more like Extremistan than Mediocristan is underappreciated. I keep writing about it because if more people understand the logic of black swans and the complex systems that create them, a lot of potentially bad outcomes are preventable. Once you make the invisible visible, it won’t affect you too much and you will call it a nothing burger.

And, a lot of potentially great outcomes are more achievable. Black Swans are typically cast in a negative light but the history of human progress can also be read as a history of positive black swans.

Antibiotics are arguably the greatest advance in Medicine in human history and they were discovered on accident. Returning from holiday on September 3, 1928, Alexander Fleming began to sort through petri dishes he had left out containing colonies of Staphylococcus, a bacteria that causes boils, sore throats and abscesses.

He noticed one petri was dotted with colonies of bacteria, save for one area where a blob of mold was growing. The zone immediately around the mold—later identified as a rare strain of Penicillin—was clear, as if the mold had secreted something that inhibited bacterial growth.

The tremendous increase in human wealth is the result of what economist Joseph Schumpeter called Creative Destruction. Who would have thought that some weird government agencies tinkering around with this thing called “the internet” which seemed like a useless toy would spawn an economic revolution?

With all that being said, it’s still possible to take the logic of black swans too far. Some people are so focused on preventing black swans, that they get hit by its polar opposite: The White Moose.

The White Moose is when you keep waiting and betting on the next black swan to materialize and it never does. If the black swan hits you as a single mortal blow, the White Moose is death by a thousand cuts.

My favorite example of this is from the wonderful Alice Schroeder biography of Warren Buffett, Snowball. There’s a scene set in 1951 where Warren is going to see Doc Thompson, his future father-in-law, to ask for his blessing to marry his daughter. This is how it went down:

Warren went to talk to Susie’s father to get his blessing. This, he already knew, would be easily had. But Doc Thompson took a while—quite a while—to get to the point. The government was downright ineffectual—or worse—when it came to dealing with Communism. Truman had lost China for democracy. The Communists were taking over the world, and stocks were going to be nothing but valueless bits of paper. So Warren’s plan to work in the stock market was going to fail. But Doc Thompson would never blame Warren when his daughter starved. He was a smart young man. If not for the Democrats ruining the country, he would probably do all right. The miserable future that awaited Susie wouldn’t be Warren’s fault.

There’s young Warren Buffett nervously sitting on Doc Thompson’s couch. Meanwhile, Doc Thompson is lecturing the person that is going to become the most successful stock investor of all time about how it won’t work because of all the crazy things happening: China is falling to the communists and the whole world seemed set to fall apart.

Both Doc Thompson and Warren’s own father, Howard, “favored mining stocks and gold stocks and other investments designed to protect against inflation”. Howard “didn’t think any other kind of business would be a good investment, and he worried about his son’s future”.

There is young Warren just starting out on the compounding journey of a century, just hoping to get a word in edgewise about marrying his daughter.

Here’s how gold fared relative to equities since that 1951 day where Buffett found himself on his father-in-law’s couch.

Source: Long Term Trends. In contrast to the S&P 500 Price Index (red line) and the Dow Jones (blue line), the Wilshire Large-Cap (black line) is a total return index, in which all resulting cash payouts (including dividends) are automatically reinvested back into the fund itself. Therefore, it includes all capital gains and it allows for an accurate performance comparison with Gold (gold line) and Silver (silver line).

You can’t miss the black line for total stock return, but can you see the line for gold? It’s there, barely visible at the bottom of the chart.

I think it’s fair to say that Doc Thompson and Howard Buffett got hit by the White Moose. In waiting for everything to collapse, they missed one of the greatest growth periods in any country in the history of the world.

If a black swan is being taken out by an unpredictable or unforeseen event, a White Moose is being taken out by an extremely predictable and easy to see event. When an investor keeps betting on a black swan coming and watches their portfolio slowly bleed away when one doesn’t materialize, they’ve been hit by the White Moose. If you always believe the sky is falling, you are bound to be right eventually but likely will do poorly over the long term.

The wrong takeaway from this chart (though the most often used one) is that “stocks always go up” or “stocks always outperform gold”.

Well, the investor that heeded Doc Thompson and Howard Buffett’s advice and sold all their stocks for gold (purple line) on Jan 1, 2000, has outperformed stocks (blue line) for over two decades.

Source: Koyfin

The proper takeaway is that it’s impossible to predict whether you are more likely to get hit by the black swan or the white moose so you should think about how to do well in either situation.

In the context of investing, this means having a well-diversified portfolio that can handle either the black swan or the white moose. Investing (and life) is not an either/or proposition but a yes/and no.

I believe effective diversification should include assets for each of the four possible macroeconomic environments:

  • Growth
  • Decline
  • Deflation
  • Inflation

This four quadrant framework was first put forth by Harry Browne in the 1970s as a way to be prepared for both the White Moose and the Black Swan, what he called the Permanent Portfolio.

It included offensive assets to defend against the White Moose:

  • Stocks tend to do well in Growth
  • Bonds tend to do well in Deflation

And, it included defensive assets to defend against the Black Swan:

  • Cash does well in Recession
  • Gold does well in Inflation

A somewhat more updated version of the permanent portfolio might include long volatility or other commodities in addition to gold, but the basic framework is the same: you need to be prepared for both the Black Swan and the White Moose.

I believe this type of diversified portfolio is the best an investor can do to protect themselves from both the black swan and the White Moose. It’s a portfolio that doesn’t depend on picking the future but focuses on including something that will do well regardless of what the future brings.

This is applicable beyond investing to our careers and lives in general. Some businesses get killed by black swans, others by white moose (meese?).

In my essay A Big Little Idea Called Ergodicity, I gave one example of how this could be applied:

I often advocate an 70/20/10 marketing approach where you focus 70% of marketing spend on the most predictable, boring channel then get progressively more experimental with the 20% and 10%. If the experimental stuff fails, you’re still in good shape, but you have upside exposure if it works.

A 70/20/10 approach is a way to do well regardless of whether the black swan or white moose shows up. You spend 70% of your resources on products and marketing channels that are already working and likely to continue to work: protecting yourself from the white moose.

You spend 20% of your resources on experimental but reasonably likely to work initiatives. You spend 10% on long shots: the black swans.

There is nothing magic about these ratios, Taleb advocates for a barbell approach of 80%/20% and that’s a perfectly fine way to go about it as well. The point is that we don’t know whether the black swan or the white moose is more likely to strike and we want to prepared for either.

Whatever field you are in, there is likely some new interesting stuff bubbling on the surface. Will it ever turn into anything interesting and worth pursuing? It’s hard to know but taking a barbell approach means you’ll be in a good position no matter what.

I have often quoted the Vladimir Lenin line “There are decades where nothing happens; and there are weeks where decades happen.” The focus in there tends to be on the black swans: “weeks in which decades happen.” Just as important is surviving the white moose: “decades where nothing happens”.

h/t to Jeff Malec of RCM Alternatives for the term White Moose.