IT’S WHAT YOU KNOW YOU DON’T KNOW THAT COUNTS
The Zeitenwende brings huge opportunities. Sectors with shortages, including energy and commodities, offer high cash flows and capital expenditure opportunities. Defence is also a growth industry – though mix is important, with drones, long-range precision munitions and targeting systems, space and deeper inventories all big winners. Climate pressures and sluggish productivity both demand an infrastructure push. As financial repression deepens, capital will flow to countries offering positive real returns. Gold’s long-term lustre looks even brighter as inflation, geopolitics and the weaponised dollar focus minds: emerging market central banks are already voting with their feet. Valuable niches in semiconductor supply chains offer ways to play the exponential growth of the Machine.
At both country and company level, shifting critical goods and commodity supply chains will produce winners: small caps could be a place to start. Services globalisation will continue apace. Companies favoured by activist governments’ fiscal firehoses and credit guarantees – often in pursuit of resilience – will gain a competitive advantage.
Yet more important than any particular idea is an appreciation of the range of possibilities a volatile era presents. One of the right hemisphere’s defining features is an appreciation of what it does not know.
“The core business of active investment management is simple. Identify the gaps between reality and the markets' perception of it. Then exploit the difference."
Obviously, we can’t know what we don’t know. But we can make a start by preparing our playbooks for ‘known unknowns’ in the new era, many of them whens, not ifs. Where will inflation pressure and rising rates trigger crises next? Private markets? The eurozone? Perhaps Japan’s government bond market? Who wins from political change in Russia, China or Iran? Or from an extended tactical rally in a long-term geopolitical bear market? What happens in a new Taiwan crisis? In exchange for drones and ammunition, Russia is reportedly boosting Iran’s nuclear weapons programme, so is this the year Israel and the Gulf States decide to intervene? And what does that mean for oil? What if the yuan is suddenly accepted more widely for commodities? Or plunges to address debt deflation in China? Could the CCP’s control of the economy echo its ‘control’ of covid? Or will Beijing’s tactical retreat from magical thinking prove more enduring? What do you buy in the next liquidity seizure or deflationary lurch?
ASYMMETRY AND ALPHA
The core business of active investment management is simple. Identify the gaps between reality and the markets’ perception of it. Then exploit the difference.
Divergences caused by magical thinking provide the biggest risks – and the richest prizes.
The new, more volatile era naturally offers more opportunities for such gaps to be exploited, aided by a greater chance of policy error by our emperors in their various states of undress.
But recent events illustrate an even bigger risk and opportunity: the chance to arbitrage a way of thinking which is over-reliant on abstract ideas and models, fails to see connections between events or objects and has a narrow, inflexible focus. An approach compounded by the nature of the Machine and by financial industry incentives for short-term performance and investment herding.
In short, it is the chance to take on the Emissary and his ally the Machine in markets by emphasising the Master’s big picture vision, flexibility and focus on not being eaten. Live to fight another day by focusing on not being completely wrong, rather than trying to be completely right. This is the essence of our focus on capital preservation through absolute, rather than relative, objectives.
As apex predators return to markets, it’s never been more important.
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