Lightning rods attract lightning just like financial markets attract greed, which inevitably brews disaster. Given the right conditions, disasters in the financial markets—like lightning—can hit more than once and investors must be prepared.
Back in 2007, Nassim Nicholas Taleb wrote what became a very famous book called The Black Swan: The Impact of the Highly Improbable. Taleb describes a Black Swan as an extremely rare event that catches people by surprise, has a major impact, and is then rationalized as if it had been expected to happen all along. Unfortunately, as we’ve all seen, Black Swan events have become much more common in recent years. As bubbles in the economy begin to reach their breaking points, it is important for investors to identify ways to deflect risk and possibly capitalize on those events because fortunes are at stake. In fact, two of the world’s most famous global investors made their fortunes when other people were panicking and running for the exit.
In 1992, at the ripe young age of 62, George Soros gambled that the U.K. would not be able to maintain high interest rates necessary to keep the British pound within the tight currency band mandated by Exchange Rate Mechanism (ERM). Soros believed the weak economy and high unemployment would force the U.K. to abandon the ERM and cut rates. He turned his speculation into action by establishing a massive $10 billion short position in the British pound through the use of as many different instruments as he could find. Of course, Soros was not the only one selling the pound. As speculation grew about the U.K. abandoning the ERM, no one wanted to hold pounds. What separated Soros from other investors was that when most people were on the defensive, selling pounds and squaring their exposures into the madness, Soros was on the offensive, attacking the pound until the Bank of England cried uncle. A month later, Soros’s Quantum Fund cashed in and banked approximately $2 billion in profit. Do you know the difference between commercial steel buildings and industrial steel buildings?
The second financial legend is Sir John Templeton, who took a very different approach from that of George Soros. Founder of the world’s largest equity fund, the Templeton Growth Fund, Templeton was a deeply religious man and a contrarian at heart. He loved to buy the crashes and come in during what he called times of “maximum pessimism.” For example, Templeton swooped into Ford when the automaker appeared to be headed for bankruptcy in 1978 and poured money into Peru when it was awash with communists in the 1980s. However, he was not always a buyer. In 2000, when everyone else was buying technology stocks, he shorted dozens of technology companies. Templeton liked to get in when the underlying fundamentals were extremely out of line with the perceptions of the reality. Those opportunities don’t come along every day, but when they do, they can present enormous opportunities. Are steel buildings more environmentally friendly?