miércoles, 19 de mayo de 2021

miércoles, mayo 19, 2021

Buttonwood

The pitfalls of trading geopolitical risk

Beware the armchair general—especially if it’s yourself


Talk to those who regularly buy and sell financial assets in the world’s trouble spots and you soon come across a perennial source of irritation. 

Everybody is an expert. 

The prospect of conflict turns every know-nothing spreadsheet jockey into a military strategist or Kremlin-watcher. 

Buttonwood shares this indignation on behalf of newspaper columnists everywhere. 

Making bold statements based on a little knowledge is our racket. 

Move along, please. 

We’re already working this corner.

There is plenty just now to occupy the armchair general. 

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 hogging headlines and testing the resolve of the new administration in Washington. 

Russia has deployed enough troops to stage fresh incursions into eastern Ukraine. 

Iran has stepped up its nuclear programme, to the ire of Israel. 

And China is menacingly carrying out drills around the island of Taiwan.

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. 

By and large, the temptation should be resisted. 

Trading successfully around geopolitics is a lot harder than it looks.

Perhaps 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 there are pitfalls for the unwary, as Marko Papic of Clocktower Group, an alternative-investment firm, argues in his book “Geopolitical Alpha”. 

The first thing to remember is that former intelligence agents no longer have access to classified intelligence. 

Be especially wary of high-conviction views, says Mr Papic. 

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.

In fact few geopolitical events have a lasting impact on stockmarkets. 

As Mr Papic shows in his book, 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.

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—or the seemingly obvious trade doesn’t entirely make sense. 

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 you might reasonably ask whether a debt default would really be your biggest concern in the event of a nuclear strike.

If you instead decide to look for oversold assets, you still have some thinking to do. 

You might, for instance, decide that Russian assets are cheap. 

The trouble is that 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.

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.

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