Perspective on Risk - 1/5/22
What to Expect for 2022; They Say Crime Doesn't Pay; I Invest With My Friends; More on Liquidity Driven Markets; A TMI story, but with an observation or two
What to Expect for 2022?
The S&P 500 had a 28.7% return for 2021 - what’s next?
Who the hell knows.
Eurasia Group 2022 Top Risks
“All top risk lists suck, some can be worth a read”
Remember:
That said, this is a nice read from Eurasia Group. I recommend a full read.
I thought I would pull out Ian Bremmer’s comments on China, as they are clearly calling a turning point for China with increased headwinds to follow:
[Introduction]
China is the second most powerful country, but after 40 years of extraordinary growth it faces steep hurdles to keep the momentum going while enhancing social harmony and maintaining political stability. The world’s fastest economic reopening and most expansive international aid campaign during the first months of the pandemic has given way to the longest lockdown and most intense inward focus, with “zero Covid” policies keeping China’s leader Xi Jinping—and most of its citizens—in China. Continuing to use aggressive lockdowns to halt transmission will lead to greater public backlash and economic disruption. Indeed, the government has grown more authoritarian and state capitalist, rather than less. And especially in the run-up to Xi securing a historic third term at this fall’s 20th Party Congress, Beijing’s energies will be focused firmly on tests at home.
[Risk #1 - No Zero Covid]
Critically, China’s zero-Covid policy will fail.
China is in the most difficult situation because of a zero-Covid policy that looked incredibly successful in 2020 (please see Risk #4), but now has become a fight against a much more transmissible variant with broader lockdowns and vaccines with limited effectiveness. And the population has virtually no antibodies against Omicron. Keeping the country locked down for two years has now made it more risky to open it back up. It’s the opposite of where Xi wants his country to be in the run-up to his third term, but there’s nothing he can do about it: The initial success of zero Covid and Xi’s personal attachment to it makes it impossible to change course.
China’s policy will fail to contain infections, leading to larger outbreaks, requiring in turn more severe lockdowns. This will in turn lead to greater economic disruptions, more state intervention, and a more dissatisfied population at odds with the triumphalist “China defeated Covid” mantra of the state-run media. The country will be stuck in this position at least until it can roll out domestically developed mRNA shots and boosters across the population—at the end of the year by the earliest. That means a particularly tough time for what preCovid had become the world’s primary engine for growth.
[Risk 2 - Technopolar World]
“China is not immune to the challenges of a brave new digital world. True, Beijing has the world’s most sophisticated internet firewall and surveillance apparatus, and Xi hasn’t hesitated to crack down on companies he thinks are getting too big. But the Chinese Communist Party needs robust economic growth to sustain its legitimacy. If Xi clamps down too hard on the likes of Jack Ma and Alibaba, China won’t be able to develop the digital infrastructure it needs to boost productivity and living standards over the long haul. The very companies Beijing sees as potential threats to the regime are also indispensable pillars of the Chinese economy—a core dilemma for any country, autocratic or not.
[Risk 4 - China at Home]
US-China relations won’t reach crisis levels this year, and domestic conditions within China won’t undermine the country’s political stability—or derail Xi’s bid for a historic third term. But set against an increasingly burdensome zero-Covid policy (please see Risk #1), the charged political atmosphere leading up to the 20th Party Congress will hang over the Chinese economy.
Beijing faces all sorts of challenges in delivering on Xi’s promise to “make China strong.” These include increasing pushback from the West, an exhausted growth model, an overleveraged and unbalanced economy, and a rapidly aging—and soon to begin declining—population. The most acute risk comes from the country’s approach to the pandemic, with a zero-Covid policy that will weigh on consumption and growth while fostering greater social frictions. The additional policy stimulus needed to address Omicron dislocations will force officials to backtrack on reform goals such as controlling financial risks, exacerbating these broader vulnerabilities. This is unprecedented territory for Xi.
To achieve his vision of technological self-sufficiency, economic security, and social harmony, Xi intends to force all elements of Chinese society to accept a new normal of tightened regulation that spans the political, ideological, social, and economic spheres. With few checks left on his power, it’s a policy mistake-rich environment.
Expect fresh measures intended to reduce inequality, improve quality of life, and tighten the party’s grip. The focus will be on firms and sectors that Beijing considers too politically powerful, systemically risky, or socially harmful— most notably, finance, property, energy, healthcare, and technology. China will also take steps to shore up domestic supply chains and consumption as part of its “dual circulation” agenda. The goal is to reduce dependence on the West and leverage China’s internal market to develop self-reliance. The party will advance this agenda despite the economic tradeoffs, underpinned by Xi’s belief that entrenched inequality, environmental degradation, excessive debt, speculative investment, and social disharmony threaten China’s political stability Xi’s campaign will create market uncertainty and distortions.
Beijing will direct capital away from some of China’s most dynamic firms (especially consumer-facing e-commerce platforms) into areas he considers strategic priorities but that face longer paths to profitability (such as semiconductors, biotech, and clean energy). This will breed speculative excess and stretched valuations in favored sectors that will end badly when the inevitable reckoning occurs.
China’s private companies, and their partners and investors, will face pressure to focus on “specialized and innovative” sectors. For Xi, small and specialized firms are useful and politically manageable; big and broad firms are dangerous. Companies that become too powerful will face growing political and regulatory risk—as the tech, tutoring, property, and gaming industries did in 2021. Smaller firms will have less incentive to grow to scale, hurting their profitability and competitiveness, especially abroad.
For China’s economy, Xi’s emphasis on political and geopolitical goals in the allocation of resources will undermine productivity growth and deleveraging when it’s needed the most—as the current growth model fueled by favorable demographics and capital accumulation runs out of gas. Xi’s policies accordingly increase the risk of stagnation at a time when the Chinese economy is on weak footing. Foreign firms will face an increasingly difficult environment inside China. The “two-way political risk” of operating in both the US and China—the task of keeping both Washington and Beijing happy—will become harder to manage as sensitive political issues continue to dominate headlines. China’s drive toward self-reliance and technology decoupling will put additional pressure on these firms, as will Beijing’s sensitivity to the poor performance of its vaccines in comparison to Western shots.
But this isn’t a moment of US-China confrontation, and foreign investment in the world’s soon-to-be-largest economy will continue to grow. Xi is not “making China Maoist again” or ditching state capitalism for orthodox Marxism. Some of his policies, such as the clampdown on tech giants, would be popular in the West, in terms of their ends if not means. Think less Mao Zedong and more “Elizabeth Warren with Chinese characteristics.”
And while the shifts outlined above are meaningful, Xi will stop short of a radical reorientation of economic policy, not least because he wants to ensure the economy remains stable heading into the party congress and given the threatening overhang of Omicron.
They Say Crime Doesn’t Pay
But evidently the returns to education among the criminally minded do:
Returns to education in criminal organizations: Did going to college help Michael Corleone?
We estimate the returns to education of Italian–American mobsters using the 1940 Census to be close to 8% per year.
We find that mobsters involved in illegal businesses, like racketeering, loan sharking, bookmaking, etc., exhibit the largest returns to education.
I Invest With My Friends
When I saw Doug joined the Board of BridgeBio, decided to do my due diligence. Interesting looking biotech. Put down a little (NOT INVESTMENT ADVICE).
Oops. Walked into a little idiosyncratic risk. Show you the importance of position sizing. (BBIO had an adverse clinical test results; these things happen)
More on Liquidity Driven Markets
Supporting
Contradicting (but troubling?)
A TMI story, but with an observation or two
OK, so for me, a properly crappy end to a crappy year.
Was down in Miami. Had trouble sleeping the last few nights, waking frequently to urinate (typical guy prostate stuff). Get on plane home, start to run a fever, then chills hit, headache, body ache. Shit. Shit Shit. Got the Cron.
Go home; isolate. Now getting up to painfully attempt (without success) to urinate every 15-30 minutes throughout the night. OK, maybe should see a doctor. Ends up I don’t have the Rona, but a UTI. But then the generic broad-spectrum antibiotic doesn’t seem to work, so here I am a week later getting grumpier than ever.
But it strikes me that we’ve become conditioned (in the behavioral psychology sense) to view all health issues through the Coronavirus lens. Good and bad in this. Some people (like me) will be inherently more cautious as soon as they see symptoms. But it also goes the other way: how many devout anti-vaxxers who claim to have survived the coronavirus actually had something else, but are now convinced they are protected and that it’s not that bad?
The fever dreams also got me thinking about using the coronavirus experience as a teaching tool. It struck me that there are many similarities between evaluating the initial virus, and its delta and omicron variants that are analogous to capital modeling.
What is the probability that someone exposed to the virus will become infected?
What is the chance that if I am infected others (perhaps similar to me) are infected? How contagious is it? What are the drivers of the contagion?
Once I’m infected, what are my chances?
These three seem roughly equivalent to PD, correlation, and LGD.
Then one can ask:
Are spillovers that we need to consider?
This is “externalities.” When hospitals become full and otherwise preventable non-Covid deaths occur, this is clearly a negative externality.
Contagion~Correlation is the primary difference between the variants. Delta is twice as contagious as the OG virus; the CDC has not opined officially on how contagious omicron is relative to the other variants, but has suggested it is 1.6x as contagious as Delta.
In terms of mortality, Delta had increased mortality in unvaccinated population, but the effect of increased levels of vaccination have reduced the overall mortality rate. Less people are dying from Omicron, but it is not yet clear whether this is because the variant is less lethal or because of more wide spread vaccination.
Of course, Omicron could pose more risk of preventable non-Covid deaths (externality) than Delta or the OG virus despite lower direct Covid deaths if the contagion-correlation overwhelms the healthcare system.