What is the Black Swan?

The problem is not the virus — the problem is complacency and ideological disregard for data driven analysis in our political institutions

When developing machine learning algorithms practitioners often struggle to explain how the algorithms actually work. One way to find out is to do so called adversarial attacks on the algorithms and see how they react. Their reaction reveals a lot about their inner workings. For example, when training a vision recognition algorithm you typically feed the machine lots of images. You can deliberately feed pictures with people with two heads or four legs and see how the algorithm will deal with this distortion. The central idea here is the same as in the famous supplemental question in math school exams. You ask all the questions and the student knows the answers. Then in the supplemental question you ask something they’ve never seen before, but it’s still related to the subject. The goal is to see wether the student just extrapolates linear learning or wether the student deeply understands the subject matter. This is the central idea behind adversarial attacks.

Financial markets are like algorithms. Data is fed into them and they spit out results which can be measured in financial data. And like math students so do financial markets have problems with adversarial attacks. They typically fail on them. One such attack is the corona virus. In one week alone the US stock market erased roughly 5 trillion Dollars in market cap. That’s a very expensive failure.

Nassim Taleb coined this type of adversarial attack the “Black Swan”. The essence of his argument is that markets are great at liner extrapolation of information. Data comes in, data gets processed and predictable financial outcomes follow. Black Swans are events that don’t fit the paradigm. They are something the market has not dealt with before. Hence, the extreme reaction.

It goes both ways. Black Swans can also happen on the positive side. Examples are Amazon, Lululemon, Tesla or Netflix. These companies have had extraordinary success and professional analysts have consistently been wrong on them. They apply novel ideas to business and technology and hence resemble the equivalent of the supplemental question in the math test. Investors don’t know how to deal with such companies and hence get them terribly wrong.

The Trillion Dollar question now is, what is actually the Black Swan in the corona virus case? The virus itself is a shock, but it’t not totally knew. The world has been attacked by viruses before. Zica, Avian Flu, Spanish Flu etc. The Black Swan here is the incompetence of US and global health care systems to deal with this issue. We spend trillions on health care delivery and we can’t deal with a virus outbreak. Federal government officials including the president as well as local leaders have no plan, no answers. They all spread words around like pandemic, which most of us have to google to understand. This type of Google diplomacy is not what people expect from leaders. They want concrete plans and actions. Instead they are left with the uneasy feeling of nobody really being in charge. This is the Black Swan. This is why the markets collapsed in the past week.

We’ve seen a particularly disappointing reaction from the White House. Quite frankly, it’s not surprising. Michael Lewis in his book “The fifth risk” talks about the systematic erosion of academic talent in government agencies under Trump. People with a clear sense of purpose and substantial technical and scientific know how are increasingly frustrated by the lack of respect and relevance they are given by Trump appointed officials. The lack of respect for science transpires in the climate change conversation While this is a serious topic, the nay-sayes have managed to strand the conversation into the swamp of ideology. This doesn’t work with corona virus. People are scared. They want leadership and they have no tolerance for ideological twitter-theater.

The lack of plan and leadership in dealing with the corona virus crisis is the real Black Swan here. The culture of ideological meandering around the problem and the complete complete neglect of data driven analysis and decision making doesn’t work in a real crisis. People want competence, data driven analysis and clear guidelines.

The recovery of the market will depend how fast this type of leadership is restored. The US economy has plenty of tools available. Advanced science and technology. Great leaders in academia and businesses to implement solutions. A vibrant venture capital and startup culture to surface new ideas and deliver innovative solutions. But we lack leadership from the top and we lack competence in the health care system. That has to change now and the corona virus has to be the catalyst for that change.

The problem is not the virus. The problem is the virus of complacency and ideological disregard for data driven analysis in our political and health care institutions.

There is risk and there is talk. If you want wealth follow the risk.