The Art of the Possible…

With “The Art of the Deal” now probably required reading for many of those who wish to divine the President-elect’s psyche, we thought we would write a few lines about the realities and risks of implementing stated policies.

“The tactical result of an engagement forms the base for new strategic decisions, because victory or defeat in a battle changes the situation to such a degree that no human acumen is able to see beyond the first battle. In this sense one should understand Napoleon’s saying: “I have never had a plan of operations.” Therefore, no plan of operations extends with any certainty beyond the first contact with the main hostile force”.

The above quotation from the military unifier of Germany, von Moltke, (with added Napoleonic bonus!) could easily be applied to the situation facing the President-elect, a man who famously believes in “negotiation” (on his terms). One can take one’s pick of who the “main hostile force” might be, but clearly Mr. Trump’s notoriously combative style has created more than a few potential candidates, while his supposedly unambiguous pronouncements on a number of topics have created several hostages to Fortune.

As students also of military strategist von Clausewitz, we are also tempted to adapt one of many quotations from his treatise “On War” as being quite apt in the current circumstances: “Many intelligence reports in war are contradictory; even more are false, and most are uncertain”. Politics is often “war” continued in another guise!

In the real world in which Mr. Trump will have to function (and not some form of the Truman Show), he will very quickly face situations which he cannot control, and in which threats will be counterproductive at best (and truly dangerous at worst), such that his “negotiating” side will have to come to the fore if he is to achieve any of his stated goals to a significant extent. However, given his background in real estate, in which he has had to deal with actors who are both more powerful than himself and outside his control, this will not be an unfamiliar environment.

Of course, as President, he will have the power, through executive authority, to create, amend or remove many areas of regulation, thereby moulding outcomes in areas from climate change risk and energy to trade policy. However, there is a whole host of areas in which he will be faced with the need to compromise if he is to achieve any of what he intends.

For example, in the area of tax reform, even with a Congress with Republican majorities in both chambers, he faces dealing not with monolithic voting blocks that can be coerced into voting as “ordered”, but with individuals and coalitions of interests holding a wide range of views and having disparate priorities. Thus, he will have to deploy all his self-vaunted skills to achieve desired outcomes, because it is Congress that ultimately controls the “purse strings”.

At Awbury, we have always taken the view, that, while one should never lose sight of one’s goals, one needs to realize that outcomes are often uncertain and fraught with hazard, and that one has to have a full range of skills to deploy to achieve what one intends, because there are always numerous factors involved. Assuming that one’s “plan” will remain untouched or unchallenged is foolish- and we are not fools!

And we cannot resist finishing with a quotation from the legendary Sun Tzu: “Victorious warriors win first and then go to war, while defeated warriors go to war first and then seek to win.”

The Awbury Team

Pass the sal volatile- investors get the vapours…

Like periodic crises, catastrophes and taxes, regulation is reality for all banks, insurance and re-insurance companies. Even so-called NBFIs rarely escape entirely; and while regulation is normally “packaged” in the form of an impersonal bureaucratic and administrative construct, the underlying driver is almost invariably political. And until the world is run by algorithms, regulators and politicians are also very human, with all that entails.

So, in the wake of the election of Donald Trump as the 45th President of the United States; the resulting ramping up in the public marker values of many banks; and the attendant frenzy of speculation about what a Trump Administration, in “alliance” with a Republican-controlled Congress might do, we thought it would be worthwhile to make a few points.

Firstly, while there is much comment about Dodd-Frank being repealed, it is, not surprisingly, as yet unclear what the President-elect’s legislative and policy priorities are in terms of timing.

Secondly, it is easy to make sweeping statements about the “repeal” of Dodd-Frank; but that assumes that there is agreement amongst all the parties involved. There is not. Wholesale and outright repeal of Dodd-Frank, would, in any case, be a complex and difficult exercise, not only because it would, almost certainly, face staunch opposition from Senate Democrats using the filibuster rule, but also because it is an immensely complex and inter-locking construct, to which banks and the others affected have gradually adapted. Simply de-constructing and removing all its components would be far easier said than done.

Thirdly, the President-Elect should not be assumed to be a friend of banks without condition. He has advocated the return of the Glass-Steagall era separation of commercial and investment banking. If that occurs, commercial banks will still be eager to lend money and provide transactional services; while it is likely that, as a quid pro quo, for some loosening on constraints, capital requirements will be increased for investment banks.

Fourthly, many of the rules that are applied to US banks stem from directives made by the Federal Reserve/OCC/FDIC. While political pressure might be brought to bear and personnel changes made with appointments to vacant positions or as mandates expire, it is likely that institutionally they would jealously try to safeguard their independence.

Fifthly, it is one thing to state blithely that the repeal of Dodd-Frank and other relevant legislation is a “good thing”; it is entirely another to assume that weakening the capital requirements and other constraints placed on banks post-crisis would be seen as positive in terms of protecting the taxpaying public against the effects of a future financial crisis. There would be significant opposition from many quarters.

Sixthly, so far as US-based (re)insurance companies are concerned, while there may be pressure to remove the Fed or Federal Government from oversight of the largest companies, most of the applicable constraints stem from state-level regulation coordinated by the NAIC. There seems little likelihood of any material change to that arrangement.

And lastly, perhaps the most consequential potential change in economic terms would be a long-mooted attempt by Republicans to remove the GSEs from their dominant role in the residential mortgage market. Perhaps, in this case, conservatism will finally triumph over socialism.

So, in reality, regulated FIs are going to have to continue to try to read the political and regulatory tea leaves, and be prepared for inconsistent and potentially contradictory statements and actions from the incoming Administration and Congress. Nothing changes in that regard!

From Awbury’s point of view, long experience has taught us, on the one hand, to expect volatility, policy swings and unintended consequences; and, on the other, that substantive change is harder than forecast- all of which tends to create new opportunities for those with a flexible and adaptive business model.

The Awbury Team

Ye shall know them by their fruits”, or l’appel du vide”?

Naturally, we could not resist penning (or keystroking), a post on the outcome of the US elections. We shall not opine on the supposed “rights or wrongs” of the outcomes, as we have no interest in being seen to meddle in politics, but are focused on identifying and managing consequences, risks and opportunities.

However, we would observe that recent behaviour by a broad spectrum of those who supposedly have the interests of the Republic and its citizens at heart, seems more in keeping with what the French tellingly call l’appel du vide (strictly-speaking “the appeal of the void”, but probably better rendered in plain, colloquial English as “having a death wish”), having overstepped the usually accepted boundaries of civilized political debate and demonstrating a remarkably nihilistic mindset. As we have written before, cooperation and trust are essential to sustainable economic growth.

Matthew 7:16 also came to mind, as quoted in the title; because, while rhetoric has consequences (as was amply demonstrated by the outcome of the elections), policies and actions ultimately matter more; and the (re)insurance industry will have to adapt (as always), even if some two thirds of those polled beforehand by industry publication Intelligent Insurer apparently would have preferred Secretary Clinton as US President rather than Mr. Trump.

It is also worth pointing out that almost all the “experts”, pundits and prognosticators, as well as “mainstream” media got it very wrong (Does that remind anyone of another recent “shock”?). A review of Nassim Taleb’s polemic “The Intellectual Yet Idiot” (https://medium.com/@nntaleb/the-intellectual-yet-idiot-13211e2d0577#.uf2rc8eb2) may also be in order for purposes of re-education.

Naturally, at Awbury (as with Brexit), we had been reviewing our portfolio of risks and opportunities before the elections; because, in the real world of risk management one has to be prepared to contemplate all realistic outcomes. Readers will, no doubt, have their own views as to the potential impact of what transpired; and there have, of course, been numerous immediate predictions as which industries and/or trade relationships will benefit or be negatively impacted (Mexico, anyone?). All flippancy to one side, the reality is that it is far too early to be certain of much, because campaign rhetoric and pandering have to translated into a ranking of legislative and executive authorities. Less febrile speculation and more rational Bayesian probability weightings are in order.

Nevertheless, it does seem reasonable to assume that the “hydrocarbon industrial complex” will benefit overall, as will spending on infrastructure, broadly defined. The former may be slightly more “ideological” than the latter, which is generally viewed as non-controversial; but both, in our opinion, represent solid longer-term opportunities. It is also likely that a Trump administration will take a more relaxed view on the permitting on new or extension pipelines.

Also, while Mr. Trump has spoken in the past in favour of a possible return of the separation between commercial and investment banking, it seems likely that the financial industry will get some respite from being a regulatory punch-bag, with repeal of most if not all of the Dodd-Frank Act on the agenda. So, we expect some reduction or at least slowdown in regulation; with the US removing the keystone from the global regulatory arch. As always, this will create unintended consequences and unexpected opportunities for the adaptive and nimble.

Interestingly, unlike post-Brexit, domestic markets have (after an initial bout of nerves overnight) reacted fairly positively to the outcome (with some single counter exceptions), so there is perhaps some hope that those involved have realized that a knee-jerk reaction is often not the correct one.

We would be happy to discuss our views in more detail with our partners and clients.

The Awbury Team

Of cliffs and contraltos:

Over four months have now passed since the shock outcome of the UK’s “Brexit” vote. The immediate panic has subsided, and a situation resembling a phoney war has ensued, in which each of the “direct combatants” (the UK Government and the sundry components of the EU’s governance structure) as well as the “rest” (the other 27 EU countries) makes occasional threatening noises, the odd feint, and generally tries to lay down a smokescreen about its likely strategy (assuming it has one!)

And to compound the confusion, 3 of the most senior judges in England and Wales recently lobbed a grenade into the UK government’s not-sufficiently-carefully-thought-out approach for triggering the so-called Article 50 mechanism, with a judgement that many commentators believe is “appeal-proof”. We shall see.

The problem is that no-one really knows how the process will look if, as and when it starts; what the likely outcome will be; and over which timeframe. Will it be “hard”, or “soft”? Will there be a new “sterling crisis” as Cable sinks (not so) slowly in the west?

Most would also assume that there are no real precedents (Greenland aside in 1982-1985) However, this (a little tongue in cheek) is quite clearly not the case, as the fascinating graph shown below (posted by the Financial Times’ David Keohane and sourced from Nomura and the excellent Maddison Project) amply demonstrates:

The continuing stagnation and “dip” (prompted by a little local difficulty called the English Civil War) after the Acts of Supremacy in the 1530s should be noted, which gives a whole new meaning to: “Not in my lifetime”!

We suspect that the Brexit Believers would probably prefer to have us assume that: “Things can only get better”…

A little more seriously, there has to be a real concern that, although neither side would rationally wish for an outcome which, while “punishing” the UK for having the temerity to seek to “leave” the EU, would also harm many of the remaining members in one form or another (through loss of exports, or constraints on free movement of labour), this may well be the outcome. Recent political rhetoric from “the Continent” certainly gives warning of hardening attitudes.

Consider that, if Article 50 is not triggered, one enters a twilight world of perpetual uncertainty about intentions; whereas, if it is triggered (as is now supposed to happen by March 2017- unless delayed by the need to deal with the consequences of the above mentioned judicial decision), and the supposed 2-year “clock” starts to run, everyone knows that that timeframe is not remotely sufficient to negotiate a new arrangement given the astonishing complexity of the links, treaties, regulations, rules, guidance, working practices, dispensations and exemptions that have to be addressed. Severing the relationship in Gordian Knot fashion is likely to lead to some very unsought and unpleasant consequences.

And bear in mind that in the case of Greenland, a dependency of the Danish Crown, with a minute population and an uncomplicated economy, even that process took 3 years; while the CETA agreement between Canada and the EU, while “signed”, is still not fully in place after 9 years (after being Wallooned by a Belgian sub-sovereign)- and that is supposed to be a “friendly” negotiation! In addition, the UK will almost certainly have to re-negotiate hundreds of other existing agreements with non-EU states and multilateral organizations in concert with its formal Brexit ones. There will, undoubtedly, be a “run” on the services of experienced international trade lawyers and consultants- with HMG already scrambling to find remotely adequate resources for itself.

Britain famously ends and faces the Continent (a very telling term) at the White Cliffs of Dover. One hopes that the outcome of Brexit does not resemble falling off one of them.

Of course, at Awbury, we continue to monitor and assess Brexit as it unfolds, for the opportunities as well as the risks that result from all the dislocation and uncertainty.

The Awbury Team

Blood on the Tracks…

Those of you who were children of the 60’s probably grew up listening to, amongst others, the legendary, iconoclastic and now (rude!) Nobelist, Bob Dylan. Readers may recognize that the title of this post is an allusion to his 1975 album of the same name (Ah! The memories… vinyl, 33 1/3 RPM, and diamond styluses…). So, in reading through the track list, we were somewhat wryly amused to come upon #s 4, 9 and 10: “Idiot Wind”, “Shelter from the Storm” and “Buckets of Rain”- and, no, we are not making this up! Even # 2 (“Simple Twist of Fate”) has potential.

We propose that NatCat (re)insurance underwriters may wish to consider one or more of these titles as an anthem! “Blood on the Tracks” itself might not go down so well.

A little more seriously, the title of the album set us thinking about the strange and vaguely menacing geopolitical and economic environment in which much of the world seems to believe it is operating. We all know that “good” news does not really count; because we are actually programmed as human beings to focus on and react more to the “bad” as part of a survival mechanism- and predators come in many guises.

However, it all depends upon one’s perspective. Demonstrably, there are many threats of a political and economic nature that challenge us- and, if we were to catalogue them, we would, no doubt, reveal some of our own biases! However, it is also true that, collectively, Humanity is almost certainly better off now than at any time in recorded history. It just doesn’t feel like it.

And that is the point: it just doesn’t feel like it.

Of course, given what happened during the Great Financial Crisis and given the other, older financial and political shocks that the members of the Awbury Team have lived through, we would equally not advocate taking the “happy pills” either (and, yes, it is also said that Bob Dylan introduced the Beatles to certain illegal substances- vide: “Lucy in the Sky with Diamonds”), because they will also cloud and distort judgement- which is when that tail risk really will come and bite you! Cue the theme from “Jaws”, or “Blood in the Water”.

What matters is being as informed, unbiased and dispassionate as possible when it comes to understanding, analyzing and assessing risk; and also assigning realistic probabilities and weightings to particular risk factors; focusing on what is actually material and ignoring the inconsequential. In this world of constant sensory overload, there is a lot to be said for the old-fashioned “hot towel” in a quiet room, whether literally or metaphorically. Reacting to “the news”, as opposed to considering relevant information, is likely to lead to quick, intemperate decisions and to the mispricing and misallocation of risk and capital.

The paradox is that within the (re)insurance industry currently we suspect many are grasping at every piece of “good news” they can, because that is the only way in which they can justify writing business at premium levels which require a suspension of belief: “bad things will not happen”, whereas they almost certainly will- and that really will leave “blood on the tracks”

And for those who would like a non-Dylan [nostalgia] trip, may we recommend Simon & Garfunkel’s “A desultory Philippic”. Not much changes…

The Awbury Team