If you remember everything you ever learned about "bell curves" and "normal distributions" in statistics class...good for you.  But if you are like most of us who don't, here is what we believe the most important thing an investor needs to know about determining the risk of a particular scenario occurring - the ones that hurt the most are the ones that are least likely to happen...and then they do!
 
Perhaps you've become familiar with the metaphors "black swan," "100 year flood" and other references to rare events, such as huge moves in the stock market, or the Detroit Lions winning a football game, etc.  In statistical jargon, events like this are the "tails" of that bell curve - the skinny fragments at the end of the graph that represent things that happen infrequently, but they do happen. 
 
One could argue that in the last two years, we have seen two "tail" events.  From October of 2007 through early March of 2009, the S&P 500 Stock Index fell over 50%.  Then from that point in March through today, that same index is UP over 50% from the March low.  As you now know, a tail event can be a very positive outcome or a very negative one.  However, it is vital to understand that they can BOTH be very dangerous to one's investment psyche, as well as to the portfolio.
 
Where I live in South Florida, we have learned all about hurricanes.  One thing we learned the hard way this decade is that sometimes major storms come in bunches - that is, multiple major hurricanes occur in the same year or within a couple of years.  We think the possibility that this type of scenario could occur in the global equity markets is far from remote.  In fact, if you look at the period from 1960-1980, there were, according to data we sourced from stockcharts.com on the Dow Jones Industrial Average (the S&P 500 did not exist prior to 1970), several major market moves (of greater than 20%, though often much more), both up and down.  We counted six up and five down.  Compare that to the decades of the 1980s and 1990s, in which many of today's investors and financial advisors learned about investing.  During that period, we counted five up moves and only two down moves of at least 20%. 
 
So, what lessons do we extract from all of this? 
 
1.      Growing your wealth successfully may require you to take on a different mindset at different times. Putting all of your chips on "buy and hold" investing OR "tactical asset allocation" can leave you very disappointed, and perhaps feeling as if you are always a step behind...because you are.  Like everything in investing, it's an educated guess, but we feel that taking a "black-or-white" approach to anything in portfolio management today is a mistake. 
 
2.      Tail risk is something that every financial advisor had better have accounted for in the design of their client portfolios.  If you were "kind of conservative" when the stock market crashed in 1987, or Iraq invaded Kuwait in 1990, or the Long-Term Capital Hedge Fund crisis suddenly roiled the markets, was that good enough?  Or, do you need a consistently applied mechanism in your investment process that:
 
a. recognizes the existence of tail events, and
b. allows you to specifically designate a portion of your portfolio toward protecting against tail events?
 
3.      Do disruptive periods in history such as the current one, in which global conflict, financial stress and staunchly divided leadership represent environments in which the risk of tail events in BOTH directions are more likely?  We believe YES, so we are planning for it in the asset allocation portfolios we manage.  In some cases, that translates into a "barbell" approach to investing, where part of the portfolio is tilted toward a more aggressive posture, while another part is designed to hedge against temporary market disasters.  As our readers and investors know, we are 3-year bullish on many growth assets, but that does not mean a tail or two cannot whack us in the head along the way.
  
On our investment team at Emerald, we are fortunate to have Michael Kahn, a veteran technical analyst, writer, and prominent figure in the Market Technicians Association (MTA).  But lest you think Michael's insights blind us to the views and insight of other outstanding technicians, think again. (Okay, I did tell Michael I was writing this and he wholeheartedly agreed with the conclusions.)
 
In a September 25th interview with Bloomberg, another prominent technician, Louise Yamada, updated listeners on something she (and Michael) have written about for the better part of this decade.  Here are some quotes from the article Bloomberg published on this interview:   "U.S. stocks are two-thirds of the way through a "structural bear market" and will take at least four years to surpass their record levels of October 2007."   "The stock market is likely to alternate between cyclical, or shorter-term, bull and bear markets over that period."
"The profile of the next four years is about eight cyclical moves," Yamada said. The S&P 500's 12-year low in March "may well prove to be the pivot low, but that doesn't mean we're going to be roaring off in a new bull market yet. There's a lot of repair that has to take place following that kind of a decline."

A bull market is commonly defined as a 20 percent rally from a low, and a bear market is started by a 20 percent drop from a high.   Thus, our reference to the 20% moves in the Dow average above.

Our Investment Committee at Emerald, which I lead, has serious doubts that the U.S. Dollar will regain its prestige in the near future. We feel that favors gold and eventually, short positions on Treasury Bonds.  Ms. Yamada stated what we believe during the Bloomberg interview:

"We don't have great hope for the dollar in the long term," she said. "Growth driven by high levels of business investment leads to currency strength, but growth driven by strong consumption and government spending, which is what we're doing here in the U.S. now, leads to currency weakness, and somewhere that has to be reversed."   Here is an interesting irony concerning Louise Yamada.  Yamada founded her eponymous company in 2005 after Citigroup Inc. eliminated its technical research department, which she headed.  For those advisors with clients who may be out of work, there is a nice example of making lemonade from lemons! 

So, don't end up like the dog that constantly chases its tail.  Address tail risk, be resourceful about how to combat it, and keep searching for the next great idea to mix into your clients' portfolios.  That is what we are doing.