"We’re in ‘black swan’ territory now, and diversified portfolios are a ‘big lie’," per Mark Spitznagel

The stock market took a nosedive last month over recession fears but has since surged to new record highs as the Federal Reserve cut interest rates and China introduced stimulus measures.

Mark Spitznagel, cofounder and chief investment officer of hedge fund Universa Investments, anticipated these developments. He had predicted that markets would rally during the Fed’s easing in what he called a "Goldilocks phase." However, he also warned that a recession is looming, and rate cuts signal potential significant downturns in the future.

In this context, Spitznagel believes the largest market bubble in history is on the verge of bursting, which will eventually push the Fed to take drastic action—though he fears this could trap the economy in stagflation.

During an interview with Bloomberg TV on Thursday, he suggested that while the market is experiencing "pure euphoria" for now, it will likely leave the Goldilocks zone toward the end of the year.

Spitznagel has long warned of extreme market events, and his hedge fund focuses on tail-risk hedging, a strategy designed to mitigate losses from rare and unpredictable economic crises, known as "black swans."

With the recent uninversion of the yield curve, after a prolonged inversion, Spitznagel believes we have entered black swan territory. "Black swans are always lurking, but now we’re in their territory," he said.

Rather than identifying a specific trigger, Spitznagel attributes the market's risks to the delayed effects of the Fed's aggressive rate hikes that began in 2022 to combat inflation.

Despite the current high-risk environment, he advised against traditional diversification strategies, claiming they often harm portfolios rather than help. "Diversification, ‘diworsification,’ modern portfolio theory—they’ve led people astray, focusing on risk-adjusted returns that have made people poorer over time," he explained. "Diversification isn’t the holy grail it’s made out to be—it’s a big lie."

Instead, investors should evaluate how their portfolios perform in both strong and weak markets and be comfortable with those outcomes.

Spitznagel acknowledged that hedging in today’s market is challenging, predicting that assets like gold and crypto will fall alongside stocks. However, he emphasized that the focus should not be on predicting the market but on understanding one’s own responses.

“We need to protect ourselves not from the market but from ourselves. We need to forecast not the market but our own behavior,” Spitznagel said. "We need to think about how we’ll react in two scenarios: markets booming and markets crashing. Markets zig to zag. It’s like poker—they try to squeeze us out of our positions, making us sell at the low and buy at the high. Let’s make sure we don’t fall into that trap."