Geopolitical Alpha: An Investment Framework for Predicting the Future (Papic, Marko)
Notes from relevant books on Foreign Policy, Diplomacy, Defence, Development and Humanitarian Action.
Papic, Marko. Geopolitical Alpha: An Investment Framework for Predicting the Future. Wiley, 2020.
These are my personal notes from this book. They try to give a general idea of its content, but do not in any case replace reading the actual book. Think of them as teasers to encourage you to read further!
A manual on how to incorporate the geopolitical component to investment decisions, focusing on strategic constraints, economic and political, that can determine the behavior of agents more forcefully than ideology.
Introduction
There was a sense that history had ended in Europe and that Jean-Claude Juncker was its Last Man.
The framework boils down to this: Niccolò Machiavelli was wrong. No amount of Virtù will help the Prince overcome Fortuna. So don't study the Prince. Study his constraints.
After downloading the constraint-based framework, the reader will be able to stop relying on the news flow for analysis. Much as an anchor keeps a ship from being blown to the sea, constraints anchor the smart investor to a subjective probability grounded in material reality.
Preferences are optional and subject to constraints, whereas constraints are neither optional nor subject to preferences.
Part One: SCAFFOLDING
The End of the Goldilocks Era
By “Eurasia,” Ian Bremmer–the firm's founder and a visionary in the field of political risk analysis–meant the frontier markets of the former Soviet Union. In 1998, Bremmer's vision was that political risk analysis would matter for “the Stans” and few others.
The Nail in the Coffin: COVID-19
The COVID-19 crisis may have accelerated the inevitable, but America's turn from a laissez-faire economy into a dirigiste one had begun much earlier.
Welcome to Oz
With geopolitics and politics on autopilot, running a business or a portfolio became routine, iterative, and mathematical.
The 2010 financial industry–and the business world as a whole–found itself inadequately staffed for the paradigm shifts to come.
with politics and geopolitics stuck in their Goldilocks settings, the finance profession turned to modeling based on macroeconomic and market inputs, because exogenous factors like elections and wars largely ceased to matter for the most liquid markets.
This investor is like the engineer who constructs the most durable bridge by best accommodating actual Newtonian laws of physics. But the laws of economics are not so fixed, and they are subject to change along with everything else when a paradigm shift occurs.
laissez-faire ideology often comes with a disdain for government and politics that denigrates the very act of political analysis.
In 2020, it is obvious to most of us in finance that we're not in Kansas anymore.
Beware of the Wizards
Selling political analysis is not new. Henry Kissinger set up Kissinger Associates soon after he got out of government, in 1982. The aforementioned Eurasia Group has been around since 1998, and Stratfor, the shop where I began my career, opened its doors in 1996.
the political consultancy business is dominated by advocates of the “intelligence model.”
This is because of the Maxim That Shall Forever Be Bolded: Preferences are optional and subject to constraints, whereas constraints are neither optional nor subject to preferences.
Chapter 2: The Constraint Framework: Three Pillars
Other than the 1973 Yom Kippur War, few geopolitical events since the Second World War have been disastrous for the markets
“We are going to make market calls and forecasts based not on what policymakers want to do, but on what they must do given their material reality.”
The First Pillar: Materialist Dialectic
After exposing the system's inconsistencies, Marx concludes with a forecast: a crisis is coming.
The innovation of Marx's Das Kapital is that it rejects the notion that ideas dictate human history. Marx and his collaborator, Friedrich Engels, posited that the material world, not ideas, must be the starting point of analysis.
By focusing on the material world, Marx forecasted the tumult that would dominate the twentieth century. Yes, he got the final outcome wrong, and he was hopelessly prescriptive, but he correctly surveyed that the status quo of the nineteenth century–in which laborers had scant protections or political power–would not last.
Second Pillar: Diagnosticity of Constraints
“Judgement is what analysts use to fill gaps in their knowledge.
Heuer dealt with political analysis and forecasting throughout his nearly 50-year tenure at the CIA. He thrived on uncertainty, paucity of high-quality information, and concept-driven (as opposed to data-driven) analysis.
Heuer introduces two concepts for all political and geopolitical analysts to keep in mind.
· First, having more information does not necessarily help one's forecast. More information sometimes only contributes to a higher level of conviction, not necessarily forecast accuracy.
· Second, the quality of data is what matters. And the key determinant of quality is diagnosticity, the second pillar of the constraint framework. Diagnosticity is “the extent to which any item of evidence helps the analyst determine the relative likelihood of alternative hypotheses.”
Diagnosticity helps analysts eliminate unlikely, or competing, hypotheses (a process known as “competing hypotheses analysis”).
Third Pillar: The Person versus the Situation
The situation is a better indicator of the outcome than the person.
Russia faces numerous constraints. Its symbiotic economic relationship with Europe is a major constraint. While most pundits see Moscow dominating that relationship, it is actually Berlin that has Russia by the … pipelines.
Another subtler constraint is the state of Russia's military.
The third pillar of the constraint framework is the recognition and avoidance of fundamental attribution error. To forecast politics and geopolitics, analysts have to avoid the fundamental attribution error and focus on the situation, not the person.
And Now for Some Math
There are lot of situations in the NBA today where it appears that a fight is about to break out. And yet, there are few fights. Instead, there are a lot of “hold-me-back” incidents that only appear aggressive. In fact, they involve two players jawing aggressively but patiently waiting for their teammates and referees to separate them so that they can yell at each other from a safe distance.
Chapter 3: The Wizards of Oz
break open the black box of consultants,
The False Expert
Philip Tetlock, the expert on experts, stresses in his book Expert Political Judgment that analysts who frequently appear in the news media are especially bad at forecasting. Because the media's endgame is entertainment, clicks, and eyeballs, it wants its experts to be pithy, glib, extreme, and highly confident.
The Funnel
On its own, the misery index is a crude measure of political risk.
Most blamed a polling Black Swan event. Nobody admitted they had fallen victim to insiders who sold them a great story laced with potent “insights from the ground.”
The Spy
$ 60 billion that the US government spends on intelligence agencies, of which roughly a third goes to the CIA.
You Cannot Outsource Your Fiduciary Duty
For an epistemic community that has its bullshit detector set at high when it comes to the markets, investors are awfully gullible when it comes to insight from smoke-filled rooms in DC.
There are three types of experts that I recommend seeking out
· Academics: Reach out to the ones passionate about their research and willing to take the time to connect the dots for you. Just be careful to put their views into your own constraint-based net assessment. Don't let the actual expert tell you what the market is going to do. They do not know.
· Technocrats: go for the second-and third-tier technocrats and bureaucrats rather than the top dogs.
· Regulators: Sector-specific insights do exist and are valuable.
Part Two: THE CONSTRAINTS
Chapter 4: Politics
the worst forecasters are those who “know one big thing,”
Tetlock, the high scorers are those who “know many small things (tricks of their trade), are skeptical of grand schemes, see explanation and prediction not as deductive exercises but rather as exercises in flexible ‘ad-hocery' that require stitching together diverse sources of information.”
Not all constraints are created equal, and power is the most important constraint –a lesson learned from years of applying the framework. Power is more important than wealth, the economy, markets, geopolitics, demographics, etc. It also dominates individual policymaker preferences, particularly as they cannot pursue their intentions without political capital.
“You May Have All the Money, Raymond …”
One of the best scenes in House of Cards: “You may have all the money, Raymond… but I have all the men with guns.”
Political power is difficult to quantify or–most relevant for investors–compare across economies. It is simpler to compare countries' material power.
Policymakers with ample political capital can expend it on unpopular policies, such as structural reforms.
structural reforms–or any controversial or unpopular policy–in terms of a “J curve”
no widely accepted way to measure political capital.
Multiple factors help me gauge political capital:
· Popularity:
· Time in power:
· Legislative math:
· Economic context:
· Special interest group support:
· Global momentum:
An analysis that factored in political constraints would have urged the analyst to ignore Johnson's rhetoric when determining the likelihood of a no-deal Brexit.
Introducing the Median Voter Theorem
Investors were “traveling with events.” News coverage directed their journey, and it kept up a barrage of the outdated Eurosceptic narrative–while ignoring the populist revolt brewing in the two English-speaking countries. My alarmist view instead relied on the median voter theorem (MVT).
to win an election or stay in power, parties and politicians approximate the policy choices of the median voter. Empirical work since the 1950s has both confirmed and challenged the theory.
Another way to think of the median voter is as the political zeitgeist of the nation.
Predicting the Long-term: Welcome to the Buenos Aires Consensus!
I have dubbed this move away from laissez-faire policies of the Washington Consensus the Buenos Aires Consensus.
Washington DC, the city where the two institutions most responsible for propagating its policy recommendations–the World Bank and the IMF–are headquartered. The consensus was defined by a set of policies that sought to remove democracy from economic policy. Independent central banking, counter-cyclical fiscal policy, laissez-faire regulatory framework… all of these policies have a singular point in common: they remove the role of elected officials from economic policy.
The transition from the Washington to Buenos Aires Consensus will dominate markets over the next decade. This transition is more relevant than the US-China geopolitical rivalry, risks to European integration, and technological change.
With US profit margins and valuations at historical highs, long-term investors should probably begin underweighting US assets on a multiyear horizon. The dollar has probably peaked in 2020 with a long-term decline ahead.
The median voter is the price maker in the political marketplace; in the long-term, politicians are mere price takers.
MVT in a Vote-less Nation: Does China Have a Median Voter?
Beijing is once again taking advantage of its abundance of short-term political capital for long-term gain. Although real estate stimulus is the most efficient way to jumpstart the economy, if Xi Jinping permitted real estate prices to rise in middle-class-laden coastal cities, it would create a longer-term political risk.
Because votes and polling are not options, the closest representation of the Chinese median citizen is popular middle-class support.
The absence of short-term competition provides Chinese leaders with the luxury of time to enact policies that are sometimes painful at first but that have long-term rewards; they are less subject to the “time-in-power” constraint.
With a GDP per capita of just under $ 10,000–and with many of its large, coastal provinces well beyond that–China appears to be right below the level where most effective democracies find themselves.
keeping its middle class happy takes precedence over world domination.
Beijing is far more constrained than US policymakers seem to think.
If the US pushes Beijing too hard on trade and the economy, it will threaten the primary directive for China: escaping the middle-income trap. And that is when Beijing would have to respond with aggression.
Political Constraints: Takeaway
The median voter is the price maker in the political marketplace. Politicians are price takers.
When a constraint is so powerful that it bends all other factors to it, I refer to it as a “fulcrum.”
Fundamentals at Work: The German Question
For the next hundred years, the state bureaucracy focused on turning “peasants into Frenchmen,”
While Germany is a formidable country, it is no match for the rest of the continent united against it.
For Germany, unification with would-be opponents–the EU and the European monetary union–is an alternative path to resolving the German Question.
By pegging its currency to the other Euro Area currencies, the deutschmark was devalued by roughly 20% vis-à-vis its competitors. Think of the euro as a currency smoothie.
Germany's dependence on Euro Area countries–which comprised 42% of its total exports–constrained policymakers from exiting in 2010, regardless of their preference.
What Merkel has understood for some time is that Europe is on its own.
I do not see risks to European integration over the course of the next decade.
The geopolitical imperative is clear: integrate or perish into irrelevance.
giving up sovereignty–out of weakness and fear. Unions out of weakness are often the most sustainable over the long term.
Greece After the Euro: The Land of Milk and Honey?
The economists cheering “Greek exit” did so in a ceteris paribus world, which only exists in their social science laboratory.
To blame Greece's currency for its uncompetitive economy is a straw-man argument. The currency is the straw man, and structure was Greece's real issue.
Greece had no manufacturing base left to take advantage of currency devaluation.
Argentina, a commodity exporter, had the good luck to default and devalue in 2001, at the beginning of a commodity bull market unlike any in history.
Even the least likely of politicians–Trotskyite communists like Tsipras–turn into Thatcherite supply-side reformers when faced with constraints. Material constraints force policymakers down the path of least resistance.
Geopolitics versus Economics: Is Trade War Sustainable?
forecasters underestimate economic and market constraints is the US–China trade war.
potential “Silicon Curtain”
Power Dynamics and Ancient Greece: A Theory Interlude
The “tragedy of great power politics” is that the established power does not react to intentions, it reacts to capabilities. The intentions of the newcomer are immaterial
Relative Gain: Why Trade Wars Fizzle in a Multipolar World
Whether 2020 China is a challenger or status quo power depends on historical perspective.
two rival states that only care about relative gains produce a zero-sum game–along with zero room for cooperation. It is a “prisoner's dilemma” that can lead to suboptimal economic outcomes because both actors chose not to cooperate.
The hegemon is concerned more with absolute gains, [but] smaller states are more concerned with relative, so they are tougher negotiators. Cooperative arrangements favoring smaller states contribute to relative hegemonic decline.
small states are initially more concerned with relative gains because they are far more sensitive to national security than the hegemon.
In a multipolar world, Snidal concludes, “States that do not cooperate fall behind other relative gains maximizers that cooperate among themselves. This makes cooperation the best defense (as well as the best offense) when your rivals are cooperating in a multilateral relative gains world
The US–China relationship does not occur in a vacuum. It is moderated by the global context, which in 2020 is one of multipolarity
A multipolar world is the least ordered and the most unstable of world systems for three reasons:
· Math: Multipolarity facilitates the creation of more potential “conflict dyads”
· Lack of coordination: Global coordination suffers in periods of multipolarity as there are more “veto players,” or actors with sufficient power to strike down a global initiative.
· Mistakes: The multipolar system is far more accident-prone and dynamic and thus unpredictable.
The World Wars: Economic Constraints in a Multipolar World
In hindsight, the alliance structure was an obvious solution to Germany's meteoric rise from unification in 1871. However, I do not underestimate the magnitude or ingenuity of these geopolitical events. For the UK and France to formalize the 1904 alliance, they had to overcome half a millennium of conflicts, many of them resolved in the past with blood. Their alliance signaled a tectonic shift—one that they undertook against the grain of history, entrenched enmity, and ideology.
Either naïve policymakers blind to the impending war led all three states into trading with the enemy–unlikely given the empirical record of war foreknowledge–or they could not afford to lose to each other the gains of trade with Germany. The allies were scared of losing absolute trade gains to each other. This fear kept them trading with the enemy.
Political science theory explains why London and Washington continued to trade with the enemy despite the clarity of the threat. The systemic nature of the multipolar economic constraint means policymakers are less sensitive to relative economic gains. Multipolarity confronts states with a collective action problem thanks to changing alliances and the difficulty of disciplining allies' behavior.
I foresee two possible scenarios:
· Attempted Damage Control: US leadership will become aware of the systemic multipolar economic constraints under which they operate and trade with China will continue.
· Doubling Down: US leadership will fail to correctly assess that they operate in a multipolar world and will give up the highlighted trade gains from Figure 5.10 to economic rivals such as Europe and Japan.
on a long enough time line, the ignorance rate for policymakers falls to zero.
As such, the trade war between China and the US is unsustainable. There are many things for investors to worry about in the 2020s, but the trade war is not one of them.
Economic and Market Constraints: Takeaway
These constraints operate according to the well-known Keynes adage: “If you owe your bank a hundred pounds, you have a problem. But if you owe a million, it has.” The Economist later added a corollary: “If you owe your bank a billion pounds everybody has a problem.”
With such a TARGET2 imbalance, the lender–not the debtor–has the most to lose. The biggest casualty of the euro's disintegration would be Germany, as it would effectively mean Italy had declared bankruptcy and canceled its payment plan.
Forecasters misuse economics and markets in their own analyses for reasons aside from insufficient expertise:
· Outdated knowledge base.
· Assumed 1:1 Constraint-Policymaker Relationship. other policymakers, constraints, and market influencers guarantee that the relationship is rarely linear.
· No Perception of Subtlety: Analysts often fail to consider the less flashy but discoverable aspects of a global crisis. Greece's problems were much deeper than what was flashing on the screen. They were structural and fundamental. Ultimately, the Greek people themselves understood this, which is why they did not choose the “easy way out” of leaving the Euro Area.
This tendency toward doomsday predictions is why my two main case studies in this chapter–the Euro Area crisis and the US–China trade war–demonstrate how economic and market constraints strong-armed policymakers into action that resulted in crises ending, not deepening.
The absence of constraint-sensitive market feedback can often delay the necessary corrective policies
Chapter 6: Geopolitics
Friedman founded Stratfor, the geopolitical intelligence firm, in 1996. It was the absolute worst time to start a geopolitical analysis firm. American power was at its zenith, globalization was in full swing, and few people cared about geopolitical risk. Nonetheless, visionaries such as Friedman and Ian Bremmer, who founded Eurasia Group in 1998, saw an inefficiency in the market and sought to fill it with rigorous analysis.
At Stratfor, I learned how to read the news, ignore the “quality of the players,” and focus on the system.
Origins of Geopolitical Theory
Relying on geopolitics in isolation is like driving a car with a rearview mirror, a GPS system, and a pitch-black windshield. The driver knows where he's been and the final destination, but he's completely blind to what is right in front of him.
The Trump Doctrine
The Trump Doctrine ignores the entire twentieth century, during which the US had to intervene in Europe twice and Asia three times–at a huge cost of blood and treasure–to prevent the continent from unifying under a single hegemon.
The Trump Doctrine raised a specter, however faint, that has not existed seen since the Molotov–Ribbentrop Pact between Russia and Germany in 1939: a united Eurasian continent marshalling all its human, natural, and technological resources against the US. The last time that happened, around 400,000 Americans lost their lives to preserve US security. Loss of America's Eurasian anchor–NATO and European alliances–would prove too great a shock to American hegemony. It would also spell the end of Western dominance over the world that has been a fait accompli of geopolitics since 1492.
Russia's Constraints Abroad
Russia's intervention in Crimea was part and parcel of the same geopolitical constraints that motivate other powers to pursue spheres of influence. Geopolitical constraints also dictated its actions in Donbas. Russia's Crimea military intervention was symptomatic of its fulcrum geopolitical constraint: Moscow has very little to offer to the members of its sphere.
Ukraine is the backbone of Russia's Eurasian Union project for a few reasons.
The nominally pro-Russian Viktor Yanukovych was victorious. Moscow had (successfully) meddled without military intervention. Why, then, did Moscow feel such an urgency to act militarily in 2014? The answer to this question lies in the appeal–or lack thereof–of being inside Russia's sphere of influence.
As a result, there were far more pro-West citizens than a simplistic, single-dimension analysis of the polls would indicate.
Ukraine's experience relative to the economic performance of its two former communist peers: Poland and Romania
Russia had no carrot, so it had to use the stick.
Three main constraints prevented further Russian aggression:
· Economic
· Political: Russia has a spotty history regarding public support for failed military campaigns
· Geopolitics
Two constraints held Russia back from more military action: the geography of its sphere of influence and its own hard power capabilities, which fell well short of the glory days of the Soviet Union.
Given the stalemate in Ukraine and the paltry territorial gains in Donbas, President Putin pivoted to countering Islamic terrorism. On September 30, 2015, Russian military intervention in Syria began. Russian state-controlled TV also got to elegantly pivot its coverage away from a theater of war where Moscow was geopolitically constrained and where its military prowess fell short to one where it was not and did not.
Euro Area Crisis Averted
The constitution is not a suicide pact that dictates the operation of a country.
Trump and Trade
On the hierarchy of constraints, constitutional and legal issues take the bottom rung. If these are the fulcrum constraints of your forecast, you are probably wrong.
How to Peddle a Budget-busting Tax Cut
Policymakers' path of least resistance, therefore, was to bust the budget. That couldn't be helped.
Constitutional and Legal Constraints: The Takeaway
Be wary of any macro investment view that is overly technical, legal, or reliant on constitutionality. Remember the hierarchy of constraints.
Chapter 8: The Time Constraint: When Preferences Run Down the Clock
“Falsehood flies, but truth comes limping after.”
I expect the world to continue deglobalizing. I expect laissez-faire to give way to dirigisme. I expect Europe to remain integrated and in fact accelerate the process. And I expect the US and China to remain at each other's throats–albeit constrained from full economic bifurcation by multipolarity.
The COVID-19 pandemic will likely only reinforce and accelerate these themes–particularly the move away from the Washington Consensus and toward the Buenos Aires Consensus, especially in the US and UK.
the link most vulnerable to time is the zeitgeist of the median voter.
The predictability of the link weakens when the collective responds irrationally, en masse, to a single issue. Or when a few Twitterati dominate the discussion by “shouting” over the median voter. The outlier becomes the median in those moments of panic.
median voter preference gone wild.
the latest cases of mass irrationality: terrorism and the COVID-19 pandemic.
Material Constraints Versus Terrorism
underestimated the impact that social media would have on collective psychology.
demonstrates the constraint framework's potential to be overly forward-looking for its own good.
markets will respond to the narrative, not necessarily the constraint-based long-term forecast.
React as a tactical investor to the narrative and as a strategic investor to the constraints.
Material Constraints Versus COVID-19
Policymakers may therefore pause before handing over the keys of public policy to epidemiologists (and bloggers).
Gargantuan Stimulus: Nuthin' But a G Thang
What most bears missed is that the main story of 2020 is not COVID-19, but the gargantuan stimulus that has followed it. In particular, that stimulus did not merely rely on the Fed. Monetary stimulus has been subservient to the fiscal, which is real and fundamental. This isn't a “money printing” rally. It is a rally based on fundamentals. The fiscal side of the economy is the definition of economic fundamentals.
This is a fiscal-led market.
Time is the Achilles' Heel of the Constraint Method
Even an irrational policymaker cannot run through a wall. The framework focuses on material constraints, and no amount of irrationality can alter reality.
In 2014–2015, I held a controversial view that Western populations–particularly Europeans–would become desensitized to terrorism. I believe that a similar desensitization is now occurring with the coronavirus.
high-volatility context for narratives. It is a narrative accelerant, an amplifier of the most extreme ones.
investors will look back at 2020 and realize that it was the beginning of a new paradigm.
In 2020, monetary policy is a slave to the master of fiscal policy. The two lines are moving in lockstep
sentiment among median voters that the tenets of the Washington Consensus–namely fiscal prudence–are no longer relevant.
Part Three: OPERATIONALIZATION
Chapter 9: The Art of the Net Assessment
The first step is to learn the art of the net assessment. The term comes from the US Defense Department's work on long-term strategic analysis, produced by the Office of Net Assessment (ONA). A net assessment nets out the conclusions of competing analytical approaches.
The different time horizons, or lenses, for geopolitical forecasting each require a different kind of net assessment.
Three Lenses of Geopolitical Forecasting
three lenses of forecasting that investors have to become comfortable with:
· Discrete Event: Frame your questions so that the answers they provide inform your constraint framework:
· Cyclical: The second type of net assessment is focused on the cyclical time horizon. Assign someone on your team to produce a calendar of all political and geopolitical events that may be market-relevant: elections, summits, referenda, budget deadlines, fiscal cliffs, notable military exercises, etc.
· Around the Curve: For long-term forecasts, I like to focus on themes, not country-or region-specific economies. Will the Euro Area survive and European integration continue? My forecast was a 2011 analysis titled “Europe's Geopolitical Gambit: Relevance Through Integration.”
But it is useful to purposefully focus on the themes that are out of sight, especially if they have lain dormant for a while. Their expiration date may be closer than the consensus thinks.
Net Assessment: The Bayesian Prior
A solid net assessment sets “priors” ahead of any forecasting exercise.
The fancy term for the method I used is finding the Bayesian prior, or Bayesian probability. A net assessment sets the “prior probability”: the subjective process through which the analyst assigns the probability of an event occurring based not on the historical record but a thorough net assessment.
The net assessment produces a fulcrum constraint on which to focus. It can suggest the critical pieces of data to monitor that would indicate a change in the net assessment,
To keep track of those “data streams,” I suggest keeping a checklist.
In the case of the 2020 COVID-19 crisis, where median voter opinion is the fulcrum constraint, a critical data stream might be the number of op-eds lamenting the economic costs of curve-flattening policies, coupled with Google Trends mentions of “depression,” “back to work,” or “why is my internet slow.”
The net assessment is not where constraint-based analysis ends, but where it begins.
The real key is that it identifies the data streams that will impact the fulcrum constraint of any given geopolitical activity. If the data flowing through those streams change, probability should change with it,
What Is Keeping India from Mean Reverting?
But India is not the only heterogeneous country in the world, a fact that the typical narrative does not account for. There is a simpler explanation for India's relative modern poverty: imperialism.
Underinvestment is the fulcrum constraint that has held India back
Underinvested: India's Fulcrum Constraint
Mauritius is India's largest source of FDI … by far!
The Modi government focused on the easiest reforms that it could accomplish specifically to move up in the rankings, not to actually fix the underlying problems in the economy. In doing so, Modi transformed India into a good test-taker, but not a learned student of structural reform.
Why Is Investment the Fulcrum Constraint?
Dani Rodrik's 2015 thesis of premature deindustrialization
Rodrik argues that services-led growth–particularly IT and finance–could replace manufacturing for India. But such industries “do not have the capacity to absorb–as manufacturing did–the type of labor
Every month, close to a million youths reach working age in India. It is difficult to see how the services sector will be able to absorb all of them over the next decade.
investment community is putting too much faith in the man and his preferences, and not enough in the power of the median voter.
India Net Assessment: Investment Implications
The first fork in the road is that its fulcrum constraint to high-quality growth, and thus profitable investment, is … the lack of investment.
The verdict? As of early 2020, investors should not invest in India yet. Regardless of valuations.
The point of an investment-relevant net assessment is to boil everything known about an economy down to the fulcrum constraint.
War in the Middle East: Net Assessment
The US–the only actor in the region with enough firepower to counter Iran–has geopolitical constraints preventing it from fighting a major war against Iran in 2020.
US will eventually (again) accept Iran's regional hegemony.
The JCPOA was a “bad deal” because the US was never negotiating from a position of power.
It can no longer maintain enough troops in the region to deter Iranian influence in Iraq, which is the geopolitical epicenter of the region.
US is constrained into reducing its physical presence and settling for a détente with the Islamic Republic.
It was the optimal path of least resistance,
Israel has no strategic bomber force that would make an air war against Iran feasible.
The US is therefore constrained from taking the conflict to the kinetic level due to domestic politics and geopolitical logistics.
US has to come back to a détente with Iran.
non-negligible probability that the US and Iran engage in tit-for-tat retaliation that gets out of hand, crosses some undefined red line, and produces a prolonged kinetic action.
It is useful to organize the various possible scenarios into a decision tree. The diagram gives investors a visual representation of the constraint-defined path of least resistance to policymaker actions.
Net Assessment: The Takeaway
The purpose of a net assessment is to identify one or several fulcrum constraints that define one's forecast.
Tetlock posits that forcing forecasters to think in probabilities improves forecast performance.
The point of a net assessment is to produce the Bayesian prior–a probability or a bias–that is the starting point of the forecast.
Chapter 10: Game Theory – It's Not a Game!
The multiplayer and competitive factors in these circumstances make game theory a useful tool of analysis.
Precision is not the same as accuracy, and the presence of one (mathematical precision) does not guarantee the presence of the other.
how important it is to know something about the topic at hand–something concrete and empirical–before attempting to
formalize it.
Before You Play the Game, Set the Gameboard
When assessing relative power, investors should consider three factors that measure an actor's relative capability:
· Material balance of power:
· Risk tolerance:
· Credibility: The reputations of the players matter. Do the actors involved have follow-through? President Trump gained global street cred
They are playing a “two-level game.” 3 Two-level game theory posits that domestic politics creates acceptable “win-sets,” which are then transported to the geopolitical theatre.
Beware Simplistic Games
game of chicken is indeed the most dangerous form of game theory.
Chapter 11: Geopolitical Alpha
The market is not very good at pricing geopolitical risks and opportunities because its behavior is dictated by investment professionals (and retail investors), who all have different time horizons.
In contrast to politics, markets provide brutal, immediate feedback.
Chocolate Labrador Brian Versus Marine Le Pen
Le Pen's long-term support levels were almost the perfect inverse of the country's support level for the common currency
The market had lost its mind, and I was reaping all the benefits. Despite clear problems with electability and strategy, investors were distracted by poor-quality analysis reliant on historic stereotypes. They bet a 20%–30% electoral lead in the French election would evaporate in three months. I couldn't believe my luck. The bookies, overreacting to a Patriots loss the week before, were expecting the Miami Dolphins to beat Tom Brady … in New England … in December. Mortgage your house, pawn off your own mother, and put money on that line!
“So, You Want to Go Long Socialism and Short Capitalism”
Emotions, anti-French bias, headlines, and a focus on the broad set of the possible–rather than the constrained set of the probable
But the relative investor sentiment was overly bullish Bolsonaro versus AMLO, especially given both presidents' strong political constraints. Ever faithful to my constraint framework, I weighted those constraints more heavily than the leaders' stated economic preferences.
But his bias and ideology were his kryptonite on this trade.
Even some of the greatest minds in finance are shooting from the hip, relying on stereotypes and meetings in smoke-filled rooms with deputy finance ministers
all preferences are subject to constraints–not just those of the actors, but those of the analyst as well.
Geopolitical Alpha: The Takeaway
Preferences are optional and subject to constraints, whereas constraints are neither optional nor subject to preferences.
investors can make the final gamble and compare it to market pricing and action.
The constraint framework gives you an edge because it allows you to think outside of the preference-led box.
Chapter 12: Conclusion
“desensitization point for debtors” in Figure 12.1. While your sample may be skewed if your friends, family, and colleagues are “savers”–certainly if you are an investor they are–most people are “debtors” on the diagram. Twitter and Instagram are not representative of the median voter in this respect.
leave ideology and unfounded bias out of policy discussions.
The problem for investors is that, before the long-term arrives, you can lose all your money. As Keynes remarked in the 1930s, “markets can stay irrational longer than you can remain solvent.” Betting against time is the Achilles' heel of any investment framework and why investing is an art, not a science.