đđŒ Hello friends! Let's enjoy a leisurely Sunday Drive around the internet.
đ¶ Vibin'
Recent comments from Federal Reserve Chairman Jerome Powell highlight the challenges of navigating a financial and economic world in transition. To what is anyoneâs guess. Itâs quite a tricky road indeed that policy makers must walk.
So, giving thought to these uncertainties, this week Iâm vibinâ to an awesome live performance (from Austin, TX!) of Tightrope by the legendary Stevie Ray Vaughan. RIP, SRV. đ
đ Â Quote of the Weekâ
BONUS QUOTE OF THE WEEK
âHowever fat you think the tails are, they're fatter than you think.â
â Jerome Powell
đ Â Chart of the Week
Fat Tails and Fat Pitches
In a recent speech, Jerome Powell invoked a concept that rarely gets airtime in central bank press conferences: fat tails. Itâs not just economic jargonâitâs a signal that weâre in a market regime where the unexpected isnât just possible, itâs likely. Fat tails are a statistical way of saying that extreme outcomesâpositive or negativeâare more probable than traditional models suggest. In other words, the world is weirder than the bell curve wants to admit.
Powellâs fat-tail warning came against a backdrop of policy uncertainty: shifting U.S. trade dynamics, immigration reform, regulatory whiplash, and unpredictable geopolitical tensions with China and Russia (Axios). When foundational assumptions are in flux, standard forecasting tools break down. And thatâs the key insight behind Powellâs statement: we need to be more humble about our models and more prepared for what lies outside the norm.
When Tails Are Fat, the Middle Gets Taller
Itâs a paradox worth understanding: as the tails of a probability distribution get fatter, the curve itself becomes taller in the middle. That is, not only are extreme outcomes more likely, so is the most average one. Fat-tailed distributions pull probabilities into both extremes and the center. This dualityâgreater risk at the edges, greater likelihood of mean-reversionâis a subtle but crucial insight for investors. It means we should prepare for shocks, but not bet exclusively on them.
Fat Tails = Fat Risks
In financial markets, fat tails manifest as elevated volatility. Crashes and melt-ups happen more often than normally distributed models predict. Risk metrics like Value at Risk (VaR) dramatically underestimate this kind of behavior (Bookmap, MacroSynergy). This leads to an under-appreciation of tail risk and creates fertile ground for false confidence.
For risk managers and asset allocators, this means two things: (1) traditional diversification isnât enough, and (2) alternative toolsâMonte Carlo simulations, tail-hedging overlays, long-volatility strategiesâbecome essential components of a robust portfolio.
Fat Tails = Fat Pitches
But fat tails donât just pose threatsâthey offer opportunities.
In baseball parlance, a âfat pitchâ is one right down the middle of the plateâeasy to swing at and easy to drive.
In investing, a fat pitch is an opportunity where the odds are so skewed in your favor that not swinging becomes the mistake. In a fat-tailed world, these opportunities show up more often than youâd expectâbut only if youâre paying attention.
When volatility is mis-priced, when consensus becomes too confident, or when tail events scare capital away from solid assets, fat pitches appear. Examples include March 2020 after the COVID crash, the 2022 tech-wreck aftermath, or periods of forced deleveraging, as in the case of the 2008-2009 Great Financial Crisis. These moments donât just offer valueâthey offer asymmetric upside.
But identifying a fat pitch in a fat-tailed world requires both judgment and patience. You need to (a) distinguish real dislocations from value traps, and (b) have the behavioral fortitude to act when others wonât. Many of the best long-term returns are born from decisions that feel very uncomfortable in the moment.
Preparing for the Extremes
Jerome Powellâs message is clear: our economic and market environment is now defined by wider dispersion. The probability of both explosive growth and destabilizing inflation (or deflation) has increased. So too has the likelihood of a dull, grinding normalcy. Fat tails imply more noise, more outliers, and more complexity. Investors who rely on simple mean-variance optimization or historical Sharpe ratios might be playing yesterdayâs game.
Instead, investors need to think probabilistically. Build convexity into portfoliosâaccounting for the change in the rate of change. Hedge tail risk. Stay open to both chaos and boredom.
Importantly, be on the lookout for a fat pitch, and when it comes down the middleâtake the swing.
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đđŒ Parting Thought
On Friday, we lost yet another of my childhood heroes. He was beloved for what he was, and also for what he became. RIP, George Foreman.
If you have any cool articles or ideas that might be interesting for future Sunday Drive-by's, please send them along or tweet 'em (X âem?) at me.
Please note that the content in The Sunday Drive is intended for informational purposes only, and is in no way intended to be financial, legal, tax, marital, or even cooking advice. Consult your own professionals as needed. The views expressed in The Sunday Drive are mine alone, and are not necessarily the views of Investment Research Partners.
âI hope you have a relaxing weekend and a great week ahead. See you next Sunday...
Your faithful financial provocateur,
-Mikeâ
If you enjoy the Sunday Drive, I'd be honored if you'd share it with others.ââ
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