Richard Breslow is out with his latest daily missive and it serves as a good reminder for investors that it’s hard to price geopolitics.
On of the themes I’ve been keen on pushing this week is the extent to which the increasingly shrill rhetoric emanating from Kim’s foreign minister and Donald Trump’s Twitter feed has combined with the AfD’s strong performance in Sunday’s German election to force investors to take inventory of a series of geopolitical risks that are not only not new, but have in fact been lurking in the background for years (decades in some cases).
This is how it goes with investors and geopolitics, especially in an environment where central banks have engaged in a years-long effort to break the link between “exogenous” (and that’s a misnomer – nothing is “exogenous” if you are a macro-focused investor) event risk and prices for risk assets. Although things like the Kurdish independence push, the separatist movement in Catalonia, and political jockeying in Italy have never gone away, investors have been so numbed by monthly injections of monetary heroine that it takes a better-than-expected showing by Nazis in a German (note: a German) election and North Korea threatening to shoot down US war planes to make everyone step back and catalogue the geopolitical risk factors.
Breslow touches on all of this below and it’s a great piece with one exception. Breslow says this: “But trust me, very few of us really have any clue about North Korea or Kurdistan.”
Who is “us”? Because there are all kinds of people out there (including some market participants) who know a whole lot about North Korea and Kurdistan. Indeed, there are people who have dedicated their entire lives to understanding the West’s relationship with Pyongyang and as far as the Kurds are concerned, it would be difficult to find a subject that is more ubiquitous among scholars of the region. Again: who is “us”? Because if you are a macro manager, “us” better not be “you” and if it is, “you” need to go out and hire yourself a political scientist like, this afternoon.
Anyway, more below…
We’re getting some jockeying of positions as befits the lead-up to the start of the fourth quarter. And it’s happening with a very confused and confusing backdrop of conditions tugging in different directions. It will be especially important to avoid assuming the same causality in every trade. We will get meaningful periods of risk on or off, but that isn’t what we’ve been experiencing. Certainly not yet.
- The S&P 500 begins today within a stone’s throw of all-time highs. If you hate it, you haven’t missed the trade. If you like it, there’s plenty of technical indicators telling you it has still avoided doing anything wrong. The Korean won and Kospi index have ceded some ground but are trading, in orderly markets, at very familiar levels. They too have oodles of chart points to tell you when it’s time to panic. And if you think potential gap risk is too great, you shouldn’t be running the position to begin with
- So on the one hand, you have a global economy putting up some decent numbers. And when that’s a global phenomenon, it can be contagious. On the other hand, there’s a serious amount of scary, or at the very least, disappointing, happenings out there
- So what will it be? Look on the bright side or embrace your inner disgust? One thing you should know at this time of year is that there will be serial overshoots in price action and you’ll need to decide just what a particular day’s movements actually signify — opportunity to fade or trend extension. Take today’s move in kiwi as a good example where both sides of that question can be reasonably argued
- We often marvel at the difficulty markets have putting a price on geopolitical risk. Especially in a central bank world where they are only too happy to write puts for you. But trust me, very few of us really have any clue about North Korea or Kurdistan. Even easy ones like Venezuela keep tripping up smart people
- And now there is one new known unknown that, in theory, we should be pretty good at trying to analyze, and that is Sunday’s election results in Germany. I’m watching in fascination how investors take it. With remarkable sanguinity so far. But it’s no mean feat putting together a coalition with potential partners whose make-or-break conditions will undoubtedly affect European fiscal integration, energy policy, migration and a whole lot more. Including how the ECB tiptoes toward tapering
- This is a really big deal, no matter how you score it. Is Germany Europe? Will this make burden-sharing DOA or ultimately open the door? There are countless portfolios constructed with a view about the economy, central bank intentions and policies that will either be reinforced by business as usual or shot to pieces. What an interesting issue to contemplate as you await quarter-end rebalancing and the technical support the euro is trading right on top of
- But don’t ignore it: global markets are highly correlated no matter what anyone says and bund yields now trade back below 40 basis points. Which is something really important to contemplate as we anxiously await Chair Yellen’s speech on inflation, uncertainty, and monetary policy.