Beyond the Black Swan

Welcome to Money Buff! Feel free to check out my other posts, and follow me on Twitter for more regular thoughts! For more about the hows and whys of investing, subscribe here:

It was the start of 2007 and something wasn't sitting well with Michael Burry. The neurologist-turned-hedge fund manager saw a bubble forming in the US housing market. He did something that few dared to do - he bet on its downfall by purchasing credit default swaps. In simple terms, he was essentially betting that the market was going to crash.

Now, you can imagine this move was met with a lot of raised eyebrows and jokes from his colleagues. But Burry was convinced he was right. When the housing market collapsed in 2008, his fund had returned over 489%. While most others were watching their investments go down the drain, Burry was sitting pretty.

It wasn't just his big bet that made him stand out from the rest. Burry was also known for his unorthodox style and quirky personality. He would often play electric guitar in his office and had a reputation for speaking his mind in meetings, regardless of what others thought.

Today, Michael Burry's name is synonymous with being a contrarian, a maverick, and thinking differently. His story was chronicled in a best-selling book "The Big Short" by Michael Lewis and later in a movie by the same name, where he was portrayed as a brilliant and eccentric hedge-fund manager.

We love these stories because they're outliers. Burry's precise knowledge made him rich. But success with one black swan caused him to look for black swans everywhere. You'll often see headlines such as these associated with Burry now:

When it comes to predictions about the economy, there are two groups dominating the airwaves: those who see a looming disaster around every corner, and the optimists who are certain that the next big thing is ahead. The former is proclaiming "This is 1929 all over again" and "1970s inflation is back", while the latter is labeling the next Warren Buffet and Google.

The age of the internet has bred a mindset that everything is momentous. It may not seem like it, but the stock market is not always a thrilling ride to the top or a stomach-churning plunge to the bottom. Most of the time, it’s just taking a leisurely ride. Thinking otherwise can lead to a chaotic portfolio that you're never quite comfortable with.

Michael Burry's radar is calibrated for outlier events. And the desire to parlay one win into another is simply human nature. The irony is that it was a big win only because it was rare, if not unprecedented. Once your identity is tied to a market crash, you see market crashes everywhere.

It’s not that we shouldn’t be mindful of the next crisis or dire situation. It’s that these are shockingly precise events, and by pursuing the rare and extreme, we lose sight of the more probable outcomes.

BlackBerry flopped because it didn’t innovate its core product enough. Apple has flourished by simply extending the battery life of existing product lines. On the surface, a lack of innovation would point to both companies failing. There are lessons to be learned from the success and failure of both, but they are precise and not broadly applicable. 

Black swans shape the world, and we should study the successes and failures they cause. But we can uncover more of the complex world by focusing less on specific lessons and more on timeless lessons, such as the power of economic moats, fostering trust, strong leadership, and managing risk effectively.

The story of Michael Burry serves as a reminder that while black swan events can be intriguing and even profitable, they are also rare and provide narrow learning opportunities. His bet against the housing market crash in 2008 may have made him a fortune, but it also created a cautionary tale for those who believe that market crashes are lurking around every corner.

For both companies and investors, success and failure come in many forms - often times the key is simply playing the long game. After all, you don't have to be a quirky hedge-fund manager like Burry to make smart investment decisions. As the saying goes, the simplest answer is almost always the best.

-Sam

If you liked this, add your email below to receive new posts!