Geopolitical Alpha

An Investment Framework for Predicting the Future

Marko Papic

• Publisher: Wiley
• Year: 2020
• ISBN:
  9781119740223
• Edition: 1
• Topic: Business
• Subtopic: Decision Making
• Index: Business

Forecast geopolitics and markets with this clear and insightful resource

Geopolitical Alpha – An Investment Framework for Predicting the Future provides readers with an original and compelling approach to forecasting the future and beating the markets while doing so. Persuasively written by author, investment strategist, and geopolitical analyst Marko Papic, the book applies a novel framework for making sense of the cacophony of geopolitical risks with the eye towards generating investment-relevant insights.

Geopolitical Alpha posits that investors should ignore the media-hyped narratives, insights from "smoke-filled rooms, " and most of their political consultants and, instead, focus exclusively on the measurable, material constraints facing policymakers. In the tug-of-war between policymaker preferences and their constraints, the latter always win out in the end. Papic uses a wealth of examples from the past decade to illustrate how one can use his constraint-framework to generate Geopolitical Alpha. In the process, the book discusses:

• What paradigm shifts will drive investment returns over the next decade
• Why investment and corporate professionals can no longer treat geopolitics as an exogenous risk
• How to ignore the media and focus on what drives market narratives that generate returns

Perfect for investors, C-suite executives, and investment professionals, Geopolitical Alpha belongs on the shelf of anyone interested in the intersection of geopolitics, economics, and finance.

Part One
SCAFFOLDING

Chapter 1
We're Not in Kansas Anymore

The world is undergoing paradigm shifts on multiple fronts: political, geopolitical, generational, and technological. What these changes are and their implications for the future are beyond the scope of this book. Instead, I present a framework that has helped me make sense of the world over the past decade. I hope it will prove helpful to navigate the paradigm shifts to come.

I use the term “framework” because it is less deterministic than a theory and not as prescriptive as a method. It is messy, full of contradictions, and much more art than science. It fits with forecasting geopolitics and politics because forecasting is similarly messy. There is nothing parsimonious about the constraint framework I present.

In the past 25 years, geopolitics and politics have switched from being tailwinds to the global economy and markets to being headwinds. For many in business and finance, it feels like a rug has been pulled out from under them. I know the feeling; I saw it happen to my family firsthand when I was eight years old.

Cut off from the Yellow Brick Road

In 1986, my 36-year-old dad joined General Export (Genex), the crème de la crème of Yugoslavia's corporate world. For my dad, it was the equivalent of landing a job at IBM in the 1950s-era United States.

Dad had made it. His life – and by extension my life – was going to be pure kajmak.¹ Step one: a four-year stint in the London office (“so you and your sister can learn English”). Steps two and beyond: an upgrade to our 505-square-foot “condo,” then maybe a car with more than two cylinders, a house on the Dalmatian coast, a year at a foreign university … culminating in an entrée into the upper echelons of socialist society.²

What was so great about Genex? At the end of 1989, the conglomerate controlled 12–13% of Yugoslav foreign trade and nearly a third of Serbian trade with the rest of the world.³

What did it manufacture? What services did it export?

Nothing and none. What Genex “manufactured” was pure geopolitical alpha.

The Soviets did not believe in running a trade deficit. So, every year, the USSR would produce a list of goods that it was interested in exchanging for barter. Because Yugoslavia was a promiscuous communist country – it played both sides of the Cold War – a company like Genex would sell Yugoslav and foreign goods to the Soviets in exchange for what the USSR was willing to export (mainly commodities). Genex would then sell the Soviet commodities in the global market, pocketing a hefty profit in hard currency.

Unfortunately for Genex, but fortunately for almost everyone else on the planet, the Berlin Wall fell on November 9, 1989. Two years later, the Soviet Union disintegrated. The geopolitical gravy train ended and Genex's edge with it. The firm's entire corporate strategy was leveraged to the geopolitical status quo. In fact, my homeland was basically living off the Cold War. When the geopolitical winds shifted, the end was nigh for both Genex and Yugoslavia.

Thanks to the combination of a massive geopolitical paradigm shift and epic mismanagement, Yugoslavia in the 1990s was worthy of a chapter in Jared Diamond's Collapse. The near-first-world life that my family built in Belgrade descended into hell in weeks.

The country's currency, the dinar, was devalued 18 times in seven years, with 22 zeros erased from its value.⁴ The monthly rate of inflation peaked at 313,000,000% in January 1994 – at the time the second-highest recorded rate of inflation.⁵ Between February 1992 and January 1994, the price level in Yugoslavia rose by a factor of 3.6 × 10²².⁶ I have an academic footnote to prove it.⁷

My hometown of Belgrade came fourth in the 1986 vote for the 1992 Summer Olympics. But by 1992, it had descended into an episode of The Walking Dead. In May 1994, my family left Belgrade with two suitcases. Destination? Amman, Jordan.⁸

Thankfully, my dad saw it coming, so he quit Genex a few years before the deluge. He got a job in a direct sales company selling cooking pots. He went from faux IBM to essentially Tupperware.

Many years later, whenever I fretted about my grades or school in general, he told me, “Relax. Why are you stressed? Do you know what Marx and Engels have to say about direct sales? Nothing. All my university exams and work experience are useless for the damn job I do today.”

If you are a CIO of an institutional investment fund, a portfolio manager in an asset management firm, or a C-suit executive, you also face geopolitical paradigm shifts that will, at best, make your work more challenging. At worst, they will collapse your civilization like they collapsed my father's. In this book, my intention is to offer you a framework with which to prepare yourself for the former possibility. For the latter, I've got nothing.

Investors are all in the same predicament that my dad faced at age 36. The training, certifications, and experience of the past 35 years have woefully underprepared the West's financial and corporate communities for the paradigm shifts that are occurring.

The End of the Goldilocks Era

Politics and geopolitics have shaped investment and business decisions for centuries. In his seminal work, The House of Rothschild, Niall Ferguson describes how the Rothschild family – well-versed in geopolitical analysis – became the richest and most powerful family of the nineteenth century. Adam Smith named the bible of economics An Inquiry into the Nature and Causes of the Wealth of Nations. Not people, not companies, nor corporations, but nations. And while John Maynard Keynes is most renowned for The General Theory of Employment, Interest and Money, he showed the range of his genius in The Economic Consequences of the Peace (1919), where he correctly forecasted the rise of the populist right, the Second World War, and even the European Union.⁹

For centuries, success in business and investing required the skills of both long division and sensitivity to political and geopolitical change. Yet today the curricula of most MBA programs – and the CFA curriculum in its entirety – ignore the latter.

For the better part of a quarter-century, between 1985 and 2008, election results in most large markets made little difference to the price of assets or company earnings.¹⁰ For the vast majority of investors, politics and geopolitics were worthy of a one-hour meeting at the start of the year or, at most, a small expense on the research/consulting budget.

Politics and geopolitics still played a role, but in the background, working as a tailwind in the sails of investors. Events and paradigm shifts played out into the hands of the multinational corporate and financial communities. As a result, a new crop of investors emerged out of this Goldilocks Era w...