“Civilization is hideously fragile… there’s not much between us and the horrors underneath, just about a coat of varnish”- CP Snow
Reading Seth Klarman’s (of Baupost fame and fortune) year-end letter set us thinking about how fragile seemingly stable environments can be.
Those of us who are fortunate to live in what are considered well-ordered and reasonably well-governed societies, tend rather smugly to believe that “‘twill ever be thus”. This is a good example of recency bias and the availability heuristic in action: because it is so, and has been for a long time (in our terms); because our experience has always been the same, we find it hard to bring ourselves to believe that our world will not simply continue as before. In market terms, for example, there has been an almost 36-year bull market in US bonds. Careers have passed without the experience of a real bear market. Knowledge has been lost. What happens when a true reversal starts?
As the CP Snow quotation warns, there is often a fine line between order and chaos- systems or trends are stable, until they are not. Disruptive forces can evolve remarkably quickly, such that seemingly invincible and secure companies, long-standing markets or even governments find themselves at risk of degradation, dissolution or irrelevance. Who would have thought that December 2018 would bring the worst final month for major equity indices since 1931- the depths of the Great Depression?
In this context, the quality, agility and effectiveness of analysis and decision-making become paramount.
Unfortunately, as Klarman pointed out in his letter, there are signs that US markets in particular are leveraged not just in monetary terms, but also in structure, algorithmic bias and investor psychology, such that the historic tendency to “herd” becomes potentially even more exaggerated in scope. For example, if trading algorithms are designed by human beings (as they still are) and those human beings share the same experiences and biases, the speed of algorithms once put into use can overwhelm markets given the fact that the majority of US stock trading (and probably increasingly that in many other markets) is actually initiated and conducted by algorithms.
Turning to government (and no matter what one’s political affiliations may be), there are also worrying signs of a deterioration in the quality and rationality of policy- and decision-making in many jurisdictions. Of course, politicians acting irrationally and for partisan purposes is not exactly a new phenomenon, and by the standards of history, political discourse is actually quite restrained in most true democracies. However, in a complex world, where new media enable the dissemination of thoughts almost instantaneously, the risk of a statement or assertion causing disruption rises inexorably. By the time anyone actually stops to think it is too late. The Latin tag “festina lente” (literally “hurry slowly”- more haste less speed) is worth bearing in mind in this context.
And what of the world of (re)insurance? In a still consolidating industry, as market power becomes ever more concentrated within the traditional business models (and perhaps more volatile in the realm of alternative capital), there is a risk (always present in the industry) of doing what everyone else is doing, because “the market” cannot be wrong, when clearly it can. As we have written before, unbridled enthusiasm for certain types of risk (e.g., cyber) can lead to a deterioration in the quality of thought being applied to understanding, defining and managing the risks entailed.
We are in no sense saying that the “end is nigh”. However, we do think that, for example, (re)insurers should constantly re-assess and test the robustness and continuing fitness for purpose of their decision-making systems and processes to minimize the probability of tipping over into the abyss of fundamental error or misguided belief.
The Awbury Team