“Some see private enterprise as a predatory target to be shot, others as a cow to be milked, but few are those who see it as a sturdy horse pulling the wagon.”
-Prime Minister Winston Churchill
Winston Churchill smoked cigars effusively, ate almost whatever was put in front of him, came under fire in armed conflicts more than 50 times, and engaged in many political battles over the course of his life. Despite these potential health risks, Churchill lived to the ripe old age of 91. He was, by almost any estimation, a sturdy horse.
As it relates to his health, many observers often commented on the generous amounts of alcohol that Churchill drank. In fact, Sir Alexander Cadogan, head of the Foreign Office, noted at the Yalta conference in 1945 that the Prime Minister was “drinking buckets of Caucasian champagne which would undermine the health of any ordinary man.”
Churchill himself was not shy about acknowledging aggressive consumption of spirits and once said:
“Always remember that I have taken more out of alcohol than alcohol has taken out of me.”
For those of you that have been over served, and I will include myself in that camp, you know full well that to gain the upper hand on alcohol, and in particular hangovers, indeed requires that one have the constitution of a sturdy horse.
But the purpose of this note is not to delve into the fine details of Churchill’s bad habits, but rather to delve into the realm for which he is most well known – foreign policy. Based on traditional measures of risk, like volatility, many markets are signaling a future without any major foreign policy blow ups. In particular, U.S. equities, as highlighted in the Chart of the Day are making new lows in terms of volatility.
This, of course, is not to say risk has gone away, but currently equity markets are certainly discounting lower global risk in the future. As a result, it is probably a sign to be even more diligent when searching for TAIL risks. In the realm of international security, we see a number of red lights on the horizon that are worth monitoring closely, specifically:
1. North Korea – Even if Dennis Rodman has improving relations with this Communist nation, the rest of the world’s relations are deteriorating on the back of a nuclear test that coincided with President Obama’s February State of the Union address. This followed a long range missile test in December. In combination these two tests are an attempt by Kim Jong-un to show to the world that North Korea has, or is developing, the ability to launch long range nuclear missiles.
In recent history, North Korea has been more of rhetorical threat than a tangible one, but both the United Nations and United States are taking the most recent actions increasingly serious. As well, Defense Secretary Chuck Hagel indicated he intends to re-allocate $1BN+ to build a missile shield in Alaska to bolster defenses focused on North Korean threats. This morning the North Koreas upped the ante once more in announcing that they have placed military units tasked with targeting U.S. bases under combat ready status.
2. Iran –Iran has remained largely out of the headlines in the last few months, but this will likely change with the upcoming Presidential election in June 2013. Current Iranian President Mahmoud Ahmadinejad is barred for running after being President for two terms and has taken to saying “long live Spring” at recent events, a cryptic phrase that is being interpreted as a call for change in the face of the Ayatollah’s attempts to manage the outcome of the election.
We emphasize the election because the last Iranian election is generally perceived to be the most tumultuous period of mass protests in Iran since the Iranian revolution. Since that election in 2009, international sanctions on Iran have had their intended impact with oil subsidies falling and prices of basic foodstuffs accelerating. So, even as the Ayatollah attempts to manage this election proactively, primarily by jailing potential reformist candidates, he can’t jail every citizen and the citizenry is much worse off now than in 2009.
3. Syria – Since the start of the Arab Spring more than two years ago, Syria has been a hot spot on the political map. Unlike some of its neighbors in which a change in leadership was relatively swift, Syria continues to be ruled by President Assad, with the ongoing goal of the rebel forces to overthrow Assad by any means. In fact, as recently as in the last couple of days there have been rumors that Assad had been assassinated.
The reality is that Assad remains in power and the rebels remain disorganized with leadership largely in disarray since the resignation of Syrian National Coalition chief Mouaz al-Khatib. The other reality is that military activity appears to be accelerating with the worst bombing in Damascus since 2011 over the weekend. Further, there were rumors this weekend that there was a gas attack near Aleppo. Although even here confusion reigns as no one is sure whether it was the rebels or Syrian government that used the gas.
Churchill was well known for his interventionist leanings and once said about Russia that:
“Bolshevism must be strangled in its cradle.”
In contrast, the current leader of the free world, United States President Obama, has been decidedly non-interventionist. Over his first term, this has certainly not impacted the United States in the short term as the most prominent threat when Obama was first elected, Al-Queda, has been largely contained and there have not been other imminent threats to the United States or global peace. That said, any acceleration of events in North Korea, Syria, or Iran may be cause for increased U.S. intervention abroad.
As we think about managing risk prospectively, especially at lower levels of implied volatility, keeping key areas of potential international conflict front and center will remain critical. As it relates to our investment themes, accelerating international conflict is actually positive for the sturdy horse of international currencies – the U.S. dollar.
Our immediate-term Risk Ranges for Gold, Oil (Brent), Copper, US Dollar, USD/YEN, UST 10yr Yield, VIX, and SP500 are now $1, $106.76-108.64, $3.36-3.47, $82.69-83.34, 94.01-96.72, 1.89-1.97%, 10.79-14.96, and 1, respectively.
Keep your head up and stick on the ice,
Daryl G. Jones
Director of Research