In financial market vernacular, the term “black swan” is not to be taken lightly. With 2018 capping off what’s been the worst year for stocks since the financial meltdown in 2008 and a United States-China trade war hanging in the balance for 2019, the term has been resurfacing as of late, which makes the Amplify BlackSwan Growth & Treasury Core ETF (NYSEArca: SWAN) a prime play to consider.
Global markets have all felt the pangs of the United States-China trade war in 2018. Last year saw the Dow fall 5.6 percent, while the S&P 500 lost 6.2 percent and the Nasdaq Composite fell 4 percent–the worst year for stocks since the financial crisis more than 10 years ago.
U.S.-China Trade War Escalation a Worry
In early December 2018, the capital markets breathed a sigh of relief as U.S. President Donald Trump and Chinese president Xi Jinping agreed to cease fire on their tariff-for-tariff battle, giving the markets hope that a year-end rally could ensue. However, December alone resulted in the Dow falling 8.7 percent and the S&P 500 losing 9 percent, making it the worst December since 1931.
The truce reached at the G-20 Summit didn’t quell investor fears as markets fretted on the notion that a trade deal can only materialize after lengthy discussions between the two economic superpowers. Furthermore, contentious topics like forced technology transfer and intellectual property could also derail negotiations.
Trump and Jinping met at the G-20 Summit in Buenos Aires, putting global markets on pause as the two economic superpowers met to hopefully ameliorate their trade differences. As part of the agreement, both nations agreed to withhold imposing further tariffs on each other for 90 days while they work out a firm, ironclad deal.
Until then, trade talk could continue to permeate the markets through 2019 and top Australian economists are already predicting that a trade war could trigger the next black swan event.
“More overt retaliation from China to the US and Western developed countries more broadly, in part fuelled by trade and IP tensions, is a key risk,” RBC Capital Markets chief economist Su-Lin Ong said.
Just how bad can this trade war get? According to adjunct professor at UTS Business School Warren Hogan, military confrontation could be the byproduct of escalating tensions between the two largest economies in the world, triggering global economic risk exposure to a black swan-type event.
“In the realms of geopolitics, there can be no guarantees that the US-China relationship does not deteriorate further to the point of military confrontation,” said Hogan. “An erratic and unpredictable US president facing a possible defeat at the 2020 election may become increasingly adventurous in its foreign policies.”
So how can investors prepare themselves and protector their portfolios from a potential catastrophe?
Getting Defensive with SWAN
SWAN seeks results that generally correspond to the price and yield of the S-Network BlackSwan Core Total Return Index. SWAN will invest at least 80% of its total assets in the securities that comprise the index, which will primarily include U.S. Treasury securities and long-dated call options (“LEAP Options”) on the SPDR S&P 500 ETF Trust (NYSEArca: SPY).
Furthermore, the index is a rules-based, quantitative index that seeks to provide capital protection against the unpredictable, rare and highly disruptive events referred to as “black swans.”
According to the Corporate Finance Institute, the following can portend a black swan event–the term popularized by former Wall Street trader Nassim Nicholas Taleb in his book Fooled by Randomness:
- A black swan event is an event that is unpredictable to the observer.
- A black swan event results in severe and widespread consequences.
- After the occurrence of a black swan event, people will rationalize the event as having been predictable–also known as the hindsight bias.
A prime example of a black swan event would be the 2008 financial crisis, but more recent events like the United Kingdom’s Brexit could also be deemed a black swan-type event.
SWAN seeks to buffer the impact of a black swan event since 90% of SWAN will be invested in safe-haven U.S. Treasury securities, while approximately 10% will be invested in SPY LEAP Options in the form of in-the-money calls. This gives investors exposure to capture any potential upside by staying invested in the S&P 500 if, for example, a permanent trade deal is negotiated between the U.S. and China.
The market volatility seen towards the end of 2018 was absorbed using SWAN’s strategy, resulting in only a 4.9 percent loss during December while the loss in the S&P 500 was doubled.
As mentioned, SWAN will absorb any negative market downturns by investing in the tried-and-true safe haven of Treasury notes if negotiations happen to go awry between the U.S. and China–due to their negative correlation with the S&P 500. Of course, anything can derail a 2019 comeback of U.S. equities, but however a black swan manifests itself, SWAN has investors prepared at a low cost with a 0.49 percent expense ratio.
“Investors are increasingly looking for rules-based equity strategies that can adapt to various equity market conditions,” said Christian Magoon, CEO of Amplify ETFs. “We believe SWAN offers investors the ability to participate in S&P 500-like returns over a market cycle, while systematically limiting equity market downside.”
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