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The stories that matter on money and politics in the race for the White House
Sellside research does the heavy lifting for investors seeking to quickly get up to speed on a whole range of issues — be it expectations for a firm’s quarterly results, or the forthcoming euroclearability of Korean government bonds.
In theory, any topic that has salience to investors and financial markets is fair game. But is that the only limitation? Does the Street ever worry about looking a bit … silly?
Consider the US election.
Careful analyses have begun to land, picking apart the potential economic and market implications of different configurations of presidential and Congressional power. A recent note from Goldman Sachs is a good example, concluding that — in the grand scheme of things — the election won’t have a big impact either way on stocks, but that dollar and bond yields could be flung around by large tariff increases.
This is interesting big picture stuff. Is the analysis complete? According to Goldman, no. They write:
We do not explicitly consider the tail risks from geopolitics…
This sounds like an acknowledgment of tail risks that could matter to investors. Why exclude them? Maybe Goldman doesn’t want to waste resources fussing on things that they strongly believe will never happen. Or maybe they don’t want to write about things that would make them look alarmist?
What sort of tail risks could fall into this category? Concerns that a chain of events will lead to China invading Taiwan are not unheard of. And despite Nigel Farage getting Trump to commit to staying in NATO, fears that Putin would use the opportunity of a Republican victory to invade Estonia continue to crop up. But maybe the most tail risky of tail risks — that we’ve heard at least one fund manager publicly discuss, at least — is the prospect that the election kicks off a Second US Civil War.
Let’s imagine you’re a hungry young analyst for whom the Second American Civil War is the topic you Need to Cover. How do you persuade your boss it’s worth the time and reputational risk? In the spirit of seeking fuller waterfront research coverage, we thought we’d make the case for salience.
First up, does anyone actually think it’s a remote possibility?
Americans do, as it turns out. An Economist/ YouGov poll in 2022 that found forty three per cent of Americans said a civil war was ‘Somewhat’ or ‘Very Likely’ over the next decade. In May this year, Rasmussen Reports polled Americans on their five year outlook. They found that forty one per cent of likely voters believe the US is ‘Likely’ or ‘Very Likely” to experience a second civil war sometime in the next five years. Only twenty per cent say it’s ‘Not Likely At All’.
We all know that people can answer polls weirdly and hilariously. So it’s arguably irrelevant if hoi polloi report to pollsters that a civil war looks more likely than not over the next few years.
That said, the prospect of an upcoming civil war does seem to worry at least some elites. Given the whole was-it-or-wasn’t-it-a-coup thing, you don’t need to search hard to find politicians warning that a civil war is “a real possibility”. But politicians say all sorts of crazy things.
Perhaps more seriously, retired US Army generals have been warning about a risk of insurrection following a contested 2024 Presidential election. In their mind, rogue units might organise to support whichever ‘rightful’ commander-in-chief they wanted. “Under such a scenario”, they argue, “it is not outlandish to say a military breakdown could lead to civil war.”
And let’s not forget Ray Dalio. If the Founder and CIO Mentor of the biggest hedge fund in the world is giving out interviews saying there’s a maybe forty per cent chance of civil war, that’s surely going to persuade your firm that this is research clients will want to read? (Even if Dalio’s definition is fuzzy to the point of not actually being falsifiable.)
We at Alphaville would love to see investment banks churn out a “What a Civil War Would Mean for Markets” notes. This is partly because we can laugh at them when they turn out, in retrospect, to be alarmist. But, also, because there shouldn’t really be taboos around putting thought to, and publishing, tail risk scenarios.
And while forty per cent as a prospective probability for a Second Civil War sounds uncomfortably high to us, analysts can at least find safe harbour in the ‘forty per cent rule’. This is the idea, popularised over many years by friend of Alphaville Lorcan Roche Kelly before being formalised by TS Lombard’s Dario Perkins, that analysts can safely discuss big, non-consensus calls while hedging themselves against the danger of looking like a muppet by assigning a less than fifty per cent probability that the event being discussed occurs. As Dario puts it:
40% means the odds will be greater than anyone else is saying, which is why your clients need to listen to your warning, but also that they shouldn’t be too surprised if, you know, the extreme event doesn’t actually happen.
It’s been rolled out by major firms to forecast the chances that the European Stability Mechanism wouldn’t get ratified, that the US would default on its debt, and that Le Pen would win the French presidency in 2017. Sure, none of these things actually happened. But scenario-planning is good.
So come on guys and gals — don’t let Quora noticeboards monopolise the investment advice on the issue. Send over your Civil War notes so we can see how you’d hedge the unthinkable.
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