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Geopolitics, Predictive Analytics & Risk Management

Earlier this week, we published the blogpost below on Interactive Brokers. It provides insight and suggestions for how to minimize exposure (and maximize alpha) associated with headline risk. The high level analysis (derived from our platform, written on Monday, published on Tuesday) delivered predictive analytics regarding the geopolitical situation in the Middle East and its links to transatlantic trade policy.


Our patented data platform provides the ideal tool for how to implement the strategies suggested below. For more information on how our platform can help you during 2020, please join our Data Disruption Tribe by completing this form: https://outreach.bcmstrategy2.com/learn-more


Strategic investors seeking solid gameplans for their first quarter returned from year-end holidays to be buffeted anew by geopolitical risks. We end the first day of the first full working week of the year with escalating tensions stemming from spiraling reactions to the storming of the U.S. Embassy in Iraq and the subsequent assassination of a senior Iranian military figure. The troubled Joint Comprehensive Plan of Action (JCPOA) lies in tatters as Iran now rejects limits on uranium enrichment.


Monday alone saw the main geopolitical parties jousting in the Security Council and various official sector entities issuing statements from NATO to the Sultan of Oman. An emergency foreign minister meeting has been called in Europe for Friday. Chancellor Merkel flies to Moscow on Saturday. And then there are the Tweets from the President of the United States.

Amid significant policy volatility and market reaction cycles, priority attention must go to implementing Rule 1 (Be Objective) and Rule 10 (Distinguish Between Action and Rhetoric).


Rigorously implementing these rules now will enable a savvy trader to identify when – and if – a trend is developing that creates alpha generation opportunities or hedging imperatives. This post explains how to do that in the current situation.


Be Objective


When heated rhetoric starts flying on social media and broadcast media, it is easy to get caught up in the moment. Everyone will have opinions about how the US responded to its Embassy being raided, how China and Russia responded in the Security Council, how European leaders are responding. Oil prices of course have jumped.


Avoid the temptation of jumping to conclusions about what happens next.


Implement Rule 1. Be objective about what these events hold for your specific portfolio. If you are not heavily invested in energy, renewables, or currencies/gold, then these geopolitical developments will not have an immediate impact on your holdings. You have time to evaluate potential pressure points on your portfolio to identify both alpha generation opportunities and hedging imperatives.


A situation like this is NOT resolved in a week. More importantly, this kind of situation will have a material and lasting impact on the interactions between regional economies and major trading partners globally. Given the pre-existing economic sanctions on Iran, the economic impact will fall heaviest on nations that have spent the last few years positioning to increase economic ties with Iran under the JCPOA (Joint Comprehensive Plan of Action).


As an investor, your personal opinion about the merits of the JCPOA much less the Embassy raid and the assassination must take a back seat to a clear-eyed assessment of whether or not the still-developing situation will impact your specific positions. Questions to consider right now include:


When you entered the position or portfolio structure, what was your intended holding period?How exposed are your positions to volatility in currency and energy markets?When algo bots respond to headlines, are you exposed to the resulting volatility or is your portfolio structured to withstand periodic reactions?Did any of your trades incorporate as an implicit underlying assumption that European economic growth in any way would be materially impacted in a positive way by growing trade with Iran during 2020?Are any of your positions implicitly exposed to transatlantic trade tensions (more on this below)?


Evaluating your headline risk in this manner will help you form a strategic action plan now. This requires implementing Rule 10 right away as well.


Distinguish Between Action and Rhetoric


Implementing Rule 10 is the most important to implement just as it becomes the hardest to distinguish between action and rhetoric. In geopolitics, what policymakers say quickly crosses the boundary from rhetoric into action. Efforts to be relentless (Rule 5) can generate confusion, not to mention information overload.


Step away from the news stream and take a deep breath. We have two pieces of advice:

Focus on formal statements, not off-the-cuff loose language on social media.


Focus on activity that crosses boundaries. For example, a statement or a leak from an Economy Minister picking a fight or ratcheting up pressure regarding a key policy priority unrelated to the geopolitical situation at hand is actually a move by that policymaker to trade off support in the geopolitical battle for concessions on the issue.


In the current news cycle on Monday, this meant placing a higher priority on the NATO statement, the EU foreign minister meeting called for Friday in Europe and the French Economy Minister’s leaked letter than activity in the United States. Why?


–A Friday meeting means the situation will linger through the week as European foreign ministers prepare a united position. It creates a policy trajectory guaranteed to deliver intensification throughout at least the next 10 days.


–The French Economy Minister’s leaked letter (discussed briefly HERE in our Quote of the Day) suggests strongly that policymakers in Europe are prepared to bargain hard in exchange for diplomatic support of U.S. policy priorities. It suggests that if France will be asked to relinquish its economic growth priorities associated with trade with Iran, it will seek to recoup some of the economic activity through a digital tax without any adverse impact from U.S. retaliatory action. Presto….suddenly luxury goods, digital goods, and French wine are in place even through they have absolutely nothing to do with the Middle East.

–The NATO statement supporting the United States means that at least for this week angry rhetoric at the transatlantic level can be downgraded. It also suggests strongly an intensification of the situation in the Middle East which will not dissipate quickly.

Distinguishing between rhetoric and action while being objective means a savvy investor has the opportunity to find alpha this week (and hedge exposures) in areas outside the geopolitics spotlight like French luxury goods.


Conclusion


The policy process re-sets every day. This means that every day must begin with a fresh commitment to implementing Rules 1 and 10….and all the others in between. Powered by advanced technology and clear strategic vision, people can connect the dots faster and better than computers…..which means you can out-smart algo-powered bots programmed to trade the headline. Rules 1 and 10 are a great place to start your road to smarter trading.


If you prefer a video-based refresher on Rule 1, please see the YouTube video below:



Each Rule has its own short on Traders Academy at Interactive Brokers.

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