How to Predict Policy Decisions — Focusing on Europe
One way for investors to gain an edge is through accurate forecasting of policy decisions. The edge is great because the investing community — traders, bloggers, pundits and TV talking heads — emphasize problems and ignore solutions.
There are many reasons for this, including the following:
- Problems are more obvious
- Problems make a better story – -more page views, more comments
- Repeating information about problems caters to reader preconceptions. Reinforcing this makes the writer seem smart. Both writer and reader are happy.
- There is an active market for bad news and criticism. If you are tempted to disagree, watch some ads on financial TV–the single best measure of what is working. Or try this thought experiment about two headlines:
Bernanke's Crisis Leadership
Bernanke's Failed Legacy
Putting aside the merits, which do you think would get more attention?
Applying this to Europe
For investors to get an edge, you need to have information or analysis that is not widely known. The European problems and attendant stories occupy hundreds of columns each week in the financial press and even more blog posts. There is a general consensus about what will happen if there are no policy changes.
The media highlights pundits who predicted something or other in the multiple years before 2008, implying that there is some special skill in the hunting of black swans.
One of the many differences between now and 2008 is that this problem is vastly more analyzed and understood. There is not an unknown market in synthetic securities, rated AAA, that dwarfed the underlying market.
To get an edge this time requires a different skill. You need to think not about the problem, but about the solution. To do this, let us look for the best source on solutions in 2008. Who accurately predicted the alphabet collection of programs? The determination to avoid disaster? The willingness of doctrinaire Republicans to intervene? The willingness of the Fed and the Bush Administration to stretch the law to aid financial institutions? The extension of this by the Obama Administration to non-banks?
Was there such a source? If so, let me know.
The Winning Perspective
In this series about Europe I do not expect to provide a complete answer in any single article. I do hope to nudge thinking in the right direction.
I suggest that we view the various political leaders as intelligent, informed, and acting in the interest of their constituents. I'll go into this in more detail in the next installment, but here are some examples.
Merkel — understanding the value of the eurozone to Germany and eventually supportive. Meanwhile extracting every concession possible.
Draghi — cognizant of the problems. Under no pressure from the single mandate of price stability. Unwilling to be pressured into abandoning long-term principles. Stumbling a little in conflicting statements. Requiring institutional change before any commitments.
Lagarde — posturing for an international constituency. Highlighting the risks. Willing to be part of the solution, but pressing for cooperation.
Geithner/Bernanke — emphasizing the risks, but limited in policy alternatives. Operating from a perceived "glass house."
Chinese leaders — enjoying the bully pulpit and the ability to lecture the West. Unwilling to take the lead role in a bailout. Understanding that Europe is their biggest export market. Knowing that a European recession is against the Chinese self-interest. Willing to join in a solid investment program that is not a pure bailout.
And many other participants, creating ideas that have not even been discussed.
Here is another question. The latest European Summit suggested avoiding the problems of a full treaty via various bi-lateral agreements. Which of the political science or legal amateurs — hedge fund managers who are reading treaties and deciding what can be done — even considered this possibility? That would be no one. Just as they did not consider TARP, TALF or any other such program in 2008.
My working hypothesis is that there will be a messy negotiated compromise to the European problem. It will include many participants and some leverage. Austerity. Sale of public assets. Haircuts on debt. Eurobonds. ECB bond buying. It will include everything that has already been mentioned and some things we have not yet heard about.
European bank capital will increase. Confidence will gradually be improved and interest rates on sovereign debt will fall. It may take years to accomplish in full.
There will be no single meeting with a final plan announcement. Each incremental step will be met with skepticism from the usual suspects, beginning with the fact that it is not comprehensive.
If you wait to invest until this is all solved, you will be buying Dow 20K.
Investors need to learn how to measure progress and risk. It must be a measure, not a binary choice influenced by headlines.
Next installment: Why leaders seem dumb — start by calling them politicians.