Nassim Nicholas Taleb coined the term Black Swan, which are rare outlier events that have an extreme impact. While black swans are in themselves unpredictable, they typically arrive during recessions or economic slowdowns. Why is this?
It's all about the cycle. During periods of high liquidity, money flows into speculative assets. When money is cheap and plentiful, virtually all asset classes rise. However, when liquidity is removed from the financial system, that is when bubbles burst and structural weaknesses are exposed. For example, Bernie Madoff's Ponzi scheme may never have been discovered if not for the redemption requests from his clients that needed cash because of the fallout from the Great Financial Crisis.
In recent weeks, cracks have been forming on the surface where we can see them. Across the pond, UK interest rates spiked after Britain's proposed “mini” budget revealed potential tax cuts during a period of high inflation. The sharp increase in bond rates wreaked havoc on British corporate pension funds revealing that some funds were leveraged as much as seven times! The dramatic move in rates suddenly brought on the risk of margin calls and the forced selling of assets. The Bank of England had to step in by buying billions of bonds while it is also hiking interest rates. This is like battling a fire by using water and gasoline at the same time.
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