Materials Risk

1) The Alchemy of Finance by George Soros

The key message is the one on reflexivity; that the price of an asset doesn’t just reflect the market it represents but also influences it as well. According to Soros “When events have thinking participants, the subject matter is no longer confined to facts but also includes the participants perceptions. The chain of causation does not lead directly from fact to fact but from fact to perception and from perception to fact.” Although it is some 30 years old now its still as relevant, if not more so today than ever.

2) The Most Important Thing: Uncommon Sense for the Thoughtful Investor, by Howard Marks

Marks was one of the first fund managers to produce content for investors way back in the 1990’s and still does to this day. This book is a collection of his best notes, organised into 20 succinct and compelling chapters.

3) Reminiscences of a Stock Operator by Edwin Lefèvre

Probably one of the timeless books on how markets actually work. This book teaches you that the real money to be made is in following long trends, rather than trying to time the bottom. It teaches you to focus on where you have an edge, and not to take tips from other people.

4) Anatomy of the Bear: Lessons from Wall Street’s Four Great Bottoms by Russell Napier

Napier provides the structure for financial bear markets. Key point from the book is that investors are typically too keen to get back into the market. Central bank and government intervention in a market typically don’t bring much in the way of lasting enthusiasm.

5) Principles For Navigating Big Debt Crisis, by Ray Dalio

Dalio outlines Bridgewater’s research on more than 50 debt crisis that have occurred over the past 100 years, drawing together the remarkable similarities. It provides a consistent playbook for how crisis play out, how policymakers respond (who often make the same mistakes) and what it means for investors. This article pulls together some of the main insights I took away from the book (emboldened text mine).

6) The Big Reset, by Willem Middlekoop

A well written book with lots of useful insights about how central banks intervene in gold markets. Author outlines how and why we are getting close to a global monetary reset akin to the end of the Gold Standard and the adoption of fiat.

7) Why Stock Markets Crash: Critical Events in Complex Financial Systems, by Didier Sornette

The author outlines the basic structure of financial markets. The book outlines the structure of past crashes in detail. It’s a useful guide for navigating perilous stock-markets – with the caveat that past performance is no guarantee of future results.

8) Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets by Nassim Nicholas Taleb: 

Probably the most useful book I’ve ever read. My measure by which I find a book useful is the likelihood that I am going to read it again and again and again. For that to happen a book has of course to be well written but has to also hold lots of nuggets of information and insight that I use again and again. For a complete answer as to why I found the book so useful check out my answer on Quora.

9) The Black Swan: The Impact of the Highly Improbable, by Nassim Nicholas Taleb

Outlines the precautionary principle in which bad but highly uncertain outcomes have potentially ruinous consequences. This book is a great insight into how we all tend to underestimate the likelihood of tail risks – both positive and negative.

10) Pay Attention: 101 Ways To Tame The Narrative Machine, Be A Smarter Media Consumer And Stop Outsourcing Your Thinking, by Peter Sainsbury

Finally, an unashamed shout-out to my recently published book. In this world of in which we look to the media – both mainstream and social networks – for guidance it is more important than ever to be a smarter consumer. My book will hopefully help guide you on that journey.

Stagflation is a situation where inflation soars, economic growth slows and unemployment spikes. It presents the worst of all dilemmas to policymakers. Efforts to control inflation tend to make unemployment worse, while targeting unemployment tends to result in higher inflation.

The 1970’s marked the last period of stagflation. An expansive monetary policy during the 1970’s combined with a supply shock (a surge in oil prices) resulted in high inflation. Cost push inflation combined with increased competition decimated many energy intensive industries. Collective wage bargaining and unionised labour resulted in strikes and other restrictions on the supply of labour as people attempted to recover their lost purchasing power. The result was a deep recession.

Fast forward to 2020.

The global pandemic has evidently resulted in a demand shock. Consumers face lock-down in many countries. Unable or unwilling to frequent areas with large numbers of people, travel has dropped like a stone while discretionary spending on eating out and other services has been decimated. Manufacturing activity related to travel (cars, planes etc.) face a particularly perilous future. Unemployment is set to soar as companies face the prospect of months of demand destruction, uncertain of when or even if demand will ever return (chart below shows the forecast for US unemployment).

Meanwhile consumers face shortages of basic essentials in the shops. What began as panic buying of toilet rolls, pasta, bread and tinned food is morphing into a supply shock as logistical operations are put under immense strain. Border closures, staff sickness and lack of spare capacity mean that essential products are not in the right place at the right time.

Luckily, global stocks of agricultural commodities are healthy. According to the U.S. Department of Agriculture (USDA) global wheat stocks at the end of the crop marketing year in June are projected to rise to 287.14 million tonnes, up from 277.57 million tonnes a year ago. Meanwhile, rice stocks are projected at 182.3 million tonnes versus 175.3 million tonnes a year ago.

But it doesn’t matter if there is enough for everyone if no one can get hold of it. Countries concerned about supplies available to their citizens may make the situation worse.

“All you need is panic buying from big importers such as millers or governments to create a crisis,” said Abdolreza Abbassian, chief economist at the United Nations’ Food and Agriculture Organisation (FAO).

“It is not a supply issue, but it is a behavioural change over food security,” he explained in an interview with Reuters. “What if bulk buyers think they can’t get wheat or rice shipments in May or June? That is what could lead to a global food supply crisis.”

Other commodities face similar supply-side constraints. Mining operations – typically operating in remote regions – are cutting operations to protect their staff from a virus outbreak. Even those mines which are not labour intensive face the same logistical issues as agriculture. A lack of labour to drive trucks and delays or closure of port facilities.

The trick to navigating crises is not necessarily the crisis itself but how policymakers respond: the mistakes they inevitably make and the second order consequences of their actions. With that in mind consider the barrage of monetary and fiscal stimulus that countries are injecting into the economic patient.

Last week The International Monetary Fund called for a “coordinated and synchronised global fiscal stimulus” to bolster the world economy. While the economic ‘flywheel’ has come to an abrupt stop, giving people more money and cutting interest rates will not be enough to get things going again.

The evidence from China suggests that it is only through state directed activity will economic growth get back to any semblance of normality. In the absence of private sector demand governments everywhere are going to have to introduce massive infrastructure spending to restart the economic ‘flywheel’ and unplug the logistical bottlenecks that have infected supply chains.

Prominent Chinese economist and former central bank adviser Yu Yongding argues that while China has more fiscal and monetary policy room to manoeuvre than its counterparts in Europe and the United States, the country’s top priority should be to focus on epidemic control and the full resumption of production in factories closed during the height of the outbreak.

The lesson from the 1970’s is that it is only through supply side measures will you be able to bolster the economy while avoiding rampant inflation. The viral pandemic which has swamped the globe and may involve more than one wave of infection. In much the same way shortages will burst open and spread across the globe. In turn this will drive prices higher as people and countries fear not being able to secure the products and resources they need. Injecting the economy with trillions of more dollars is like throwing kerosene on the fire.

The humble toilet paper is just the first symptom of the economic malaise to come.

Not all market moving news is made equal. The tone or sentiment of the news, whether positive or negative can have a big impact on market prices. This is being demonstrated at the extreme in real time. As COVID-19 spread its tentacles around the world and infected both people and markets, global media news sentiment became increasingly negative as developed economies began to be hit.

Analysis carried out by the IMF and the World Bank assessed the impact of media sentiment on global equity prices using more than 4.5 million Reuters articles published across the globe between 1991 and 2015. They constructed a measure of news sentiment weighing articles with the frequency of positive (strong, gains, recovery etc.) and negative words (crisis, losses, deficit, etc.). They found that changes in news sentiment can predict movements in both advanced and emerging equity markets over a period of a few weeks.[i]

As you might expect they found that investors are more sensitive to global news sentiment (i.e. news affecting more than one country) during periods when the price of global equities are in a downturn. Investors typically weigh the prospect of losses much more heavily in their minds than wins. The research found that the impact of sentiment was four times more powerful in bear markets than bull markets.

Global news sentiment explains more of the variance in equity returns across the world than other typical measures of global risk aversion. In turn, global news sentiment is driven by multi-country news, which tend to be broader, longer and with a stronger tonality than local news articles.

The analysis also found that the content of the news varies significantly with the direction of global news sentiment. When sentiment is strongly positive, global news coverage tilts towards positive financial and corporate news in advanced financial markets, especially in the US. By contrast, the coverage tilts strongly towards economic and political news in emerging markets when the global news sentiment goes into negative territory.

Chinese economic activity (using coal consumption for power generation as a proxy) has arguably been on an upward trajectory over the past two weeks. Since early March, newspapers (both Chinese and non-Chinese) are using more positive words (picks up pace, recovery, return to normal) suggesting that economic growth may have some momentum.

Watch for similar stories in Iran, Italy and elsewhere over coming weeks. The lesson from this research is that it won’t be until the USA has seen the full force that the negative news sentiment will abate. The media is a giant mirror on ourselves. It pays to look at it sometimes to see what it is telling us.

[i] Fraiberger, Samuel P. and Lee, Do Q and Puy, Damien and Ranciere, Romain, Media Sentiment and International Asset Prices (December 2018). IMF Working Paper No. 18/274. https://ssrn.com/abstract=3314609