What to make of foreign policy "experts"

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  What to make of foreign policy "experts"

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Read more on - Polity | Economy | Schemes | S&T | Environment

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• Experts experts everywhere: Those dealing in global financial assets are often surprised by how many "armchair generals" exist everywhere. Almost every crisis has many experts, and every expert has many crises to talk about!
• Three latest crises: Geopolitical risk is on the rise after a pause for the pandemic, concludes a recent paper from BCA Research. Three proto-conflicts in particular are making headlines and testing Biden's administration - (i) Russia has deployed enough troops to stage fresh incursions into eastern Ukraine, (ii) Iran has stepped up its nuclear programme, to the ire of Israel and (iii) China is menacingly carrying out drills around the island of Taiwan.
• Geopolitical alpha: An escalation of these tensions has the potential to knock markets sideways. And it is tempting for investors to try to anticipate a flare-up, so as to harvest “geopolitical alpha”, the excess returns from bearing conflict-related risks. But trading successfully around geopolitics is a lot harder than it looks.

1. The most seductive idea to repel is that you have some expertise. Genuine experts are not in short supply. Just about anyone who spent time at the State Department or as a national-security adviser appears to have set up a consultancy. But 
2. The first thing to remember is that former intelligence agents no longer have access to latest classified intelligence. Investors have to especially be wary of high-conviction views. 
3. Consultants tend to exaggerate the likelihood of the worst outcomes, because it is a good way to showcase their insight. A true expert will be circumspect, setting out scenarios and pinpointing the factors you need to monitor.

• Very few mean much: Few geopolitical events have a lasting impact on stockmarkets. The pattern from the 1962 Cuban missile crisis onwards is for a short-term fall in America’s stockmarket to be followed by a rally over the following year, and often quite a strong one. An exception is the Yom Kippur war and the subsequent oil embargo. But in general, markets regain their poise. The economy carries on. From this we might grope towards the germ of a useful trading rule. The best way to profit from geopolitical risk might simply be to trade against the excessive fears of others.
• How it unfolds: At the outset of a geopolitical crisis, events move more quickly than you can trade on them. You read of tensions in the Middle East. So you buy oil futures. But algorithmic traders will beat you to the punch. You could chase the escalation. But now you are a momentum trader, rather than a geopolitical-risk trader. And sometimes there is no obvious trade to execute. When North Korea stepped up its missile testing in 2017, a popular trade was to buy credit-default swaps, a form of insurance, on South Korean government debt. But a sensible trade must ask whether a debt default would really be the biggest concern in the event of a nuclear strike.
• US and Russia: Tensions between Russia and America could easily worsen. If you want to “buy the dip” in this way you should have a theory of how things might eventually be resolved, based on informed judgments about what each party to a conflict wants and what their political and economic constraints are. You would need to map the potential flashpoints from here to there. If you judge that a conflict cannot de-escalate easily, the wiser course might be to stay away.
• Summary: In geopolitics, a little knowledge can be a dangerous thing. Yet investors cannot be entirely agnostic about the broad sweep of international relations. The long boom of the 1990s is not easily detached from the fall of the Berlin Wall. China’s accession to the World Trade Organisation in 2001 ushered in a commodity super-cycle. Avoid the narrow purview of the typical spreadsheet jockey. But beware the armchair geopolitical strategist—especially if it is you.

Read more on - Polity | Economy | Schemes | S&T | Environment

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