So as your’e aware, these pages serve as a kind of compendium of geopolitical and policy risk factors for investors.
Generally speaking, markets don’t care about geopolitical/policy risk anymore. That’s the “great disconnect” – the detachment of market-based measures of implied vol. from what Immanuel Wallerstein in a recent commentary, described as “chaotic uncertainty.” To wit:
Are you confused about what is going on in the world? So am I. So is everyone. This is the underlying and continuing reality of a chaotic world-system.
What we mean by chaos is a situation in which there are constant wild swings in the priorities of all the actors. One day, from the point of view of a given actor, things seem to be going in a way favorable to that actor. The next day the outlook looks very unfavorable.
Furthermore, there seems to be no way in which we can predict what position given actors will take on the next day. We are repeatedly surprised when actors behave in ways that we thought impossible, or at the very least unlikely. But the actors are simply trying to maximize their advantage by changing their stance on an important issue and thereby changing the alliances they will make in order to achieve that advantage.
The world-system has not always been in chaos. Quite the contrary! The modern world-system, like any system, has its rules of operation. These rules enable both outsiders and participants to assess the likely behavior of different actors. We think of this adherence to the rules of behavior as the “normal” operation of the system.
It is only when the system reaches a point in which it cannot return to a (moving) equilibrium that renews its normal operations that it enters into a structural crisis. A central feature of such a structural crisis is chaotic uncertainty.
Yes, “a central feature” of the prevailing order (or maybe “disorder” is better) is chaotic uncertainty – and a “central feature” of markets is suppressed vol. Hence this:
Trump is, of course, making this situation immeasurably worse and his decision to cut off Obamacare subsidies could be especially disastrous given that it tosses (another) live bomb into the lap of lawmakers who were already trying to sort out the Iran deal, DACA, taxes, and all manner of other contentious issues ahead of a December deadline that happens to come days ahead of a Fed meeting where Yellen is supposed to hike.
Well, for those interested in a quick rundown of the geopolitical risk factors with the potential to derail the rally, Bloomberg’s Mark Cudmore has some bullet points for you below…
Critical Threats to the Equity Bull Market
The base case for the last 11 weeks of 2017 is that the global equity bull market marches on, or even accelerates. But it’s worth determining which known risks have the potential to significantly derail it and which ones can be mostly ignored.
- The MSCI All World Index has risen more than 40% from its February 2016 low without a 10% correction. What could cause one before year-end?
- Globally, the combination of good growth, solid earnings and excess liquidity remains supportive. Excluding true black swans (i.e. unknown unknowns), here are three critical candidates to keep an eye on:
- Military conflict in North Korea is the obvious one. Its potential for disruption is so massive it needs no further explanation
- With Spain threatening to seize direct control of Catalonia, large-scale civil unrest and martial law can’t be ruled out as a possibility. The looming removal of any autonomy for the region is unlikely to be accepted without a fight. The hit to European sentiment and assets has the potential to be severe enough to ripple through global markets
- A U.S. government shutdown into year-end during the illiquid holiday season is an entirely underestimated risk. Since at least a temporary agreement has always been reached in the past, investors are assuming the same again, especially with mid-term elections putting pressure on the major parties to compromise
- But Trump’s decision to undermine the Affordable Care Act by removing subsidies for health insurers has only increased the partisan divide. The official December 8 deadline isn’t a binary moment for markets, but as we get farther into December with no deal, the negative asset impact would be severe
- Other risks — including Nafta negotiations, China deleveraging, Brexit talks, U.S. tax reform failure, Kurdistan, German government formation and an inflation pick-up — will be discussed in this column tomorrow