Are Black Swans Extinct?

The New Zealand Black Swan was hunted to extinction in New Zealand in the early 1800's, but in 1864 the Australian Black Swan was introduced to New Zealand and is thriving there now along with its Australian cousins. In fact, the Black Swan species has a large range and the current global population is estimated to be up to 500,000 individuals. No threat of extinction, or significant decline in population has been identified with this numerous and widespread bird.

Of course, the title of this blog was not meant to lead a discussion about this relatively common bird, but instead refers to a metaphor that describes unexpected large scale events that can have an extraordinary impact on financial markets. The Black Swan Theory is mostly identified with Nassim Nicholas Taleb, a prominent scholar and statistician (and hedge fund manager), who wrote the 2007 book appropriately entitled "The Black Swan". His book focuses mostly on problems of randomness, probability, and uncertainty as they apply to the financial markets.

Several major U.S. stock market indices posted all-time record highs last week. These include the popular S&P 500 Index (1850.84), the Russell 2000 Index ( 1173.37) and the Dow Jones Transportation Average (7508.74). 

As more than a casual observer of the financial markets, it looks to me like most popular valuation metrics are now at extreme levels and that the overall U.S. stock market is therefore "priced to perfection". In this environment, "good news" (i.e. positive economic news) seems to have a bullish impact on stock prices most of the time as one would normally expect, but "bad news" (i.e. negative economic news) also seems to have a bullish impact on stock prices (presumably because investors then expect even more monetary accommodation from the Federal Reserve). I can only conclude from this price action that most investors now believe that "Black Swans Are Extinct"!

Unfortunately, for many investors, the hard lessons from the last great Black Swan event (the Lehman bankruptcy of September 2008) have been conveniently forgotten or never actually learned. Another Black Swan event is inevitable, and my strong feeling is that it will unfold sooner rather than later.

As of Friday's close January 17th, according to my proprietary valuation screen, here is the list of the 25 most overvalued U.S. stocks:

The average stock on this list trades at 149x Forward 12-month earnings estimates (F P/E), 12.06x Sales (P/S), and 16.63x Book Value (P/B). At one point in 2014, I believe that most of these stocks will be down as much as 50% or more. Biotech and drug-related companies have been purposely excluded from the above list given the need for special valuation metrics to analyze this particular sector.

In the interest of full disclosure, I am NOT short any of the stocks on this list, but I do currently hold a large position in the Pro-Shares Ultra-Short S&P 500 ETF (symbol SDS) in one of my managed accounts.

Shares of Gold/Silver mining stocks have rebounded sharply so far this year from the panic lows that were posted in the last week of December 2013. Major silver producer First Majestic (AG) has jumped 25% from its December low, major gold producer Barrick Gold (ABX) is up 23% from its recent low, and junior gold/silver miners Primero Gold (PPP) and Endeavour Silver (EXK) have surged 28% and 38%, respectively, from their recent lows. These astounding results have been closely correlated with a 5.66% rebound in the most popular Gold ETF (GLD) and a 6.85% rebound in the most popular Silver ETF (SLV).

Bottom line: I firmly believe that the recent extraordinary rebound in Gold/Silver mining stocks is just the beginning stage of a major bull market in this "out-of-favor" group. In the interest of full disclosure, I am long First Majestic (AG), Goldcorp (GG), Primero Gold (PPP), and Endeavour Silver (EXK) in one of my managed accounts. In all of my managed accounts, I have a large precious metals allocation using actual gold/silver mining stocks and/or precious metals sector mutual funds.

Gold ETF (GLD) with Proprietary Computer-generated Buy & Sell Signals