There were no bargains in Russia- Robert Armstrong

I am not in the habit of wholesale theft, but on this occasion I am stealing the entire first part of Robert Armstrong’s email “unhedged” which hits my inbox nice and early and helps me understand world markets – as far as my brain allows.

Thanks for this Robert, I’m sharing with my readers because many of us will be non-plussed that we got Putin and his intentions so wrong- and find our investments depleted as a result. Of course, this is not the main event right now, but we are probably at one of those learning moments, which it is best to grab before we move on to other crises!

In late-January I wrote a piece called “Bargain Hunting in Russia”, a phrase that, a month later, I do not enjoy typing. The article pointed out that a combination of high energy prices and tensions on the border with Ukraine made Russian stocks look very cheap. The piece concluded as follows:

Unhedged is not in the business of assessing geopolitical risk. But if the situation on the border cools, someone is going to make a lot of money in Russia.

This statement is hedged twice, first by saying that on the most relevant risk I had no idea what I was talking about, and second by deploying the journalist’s loyal friend, a conditional. But all the same, the piece looks awful in retrospect. Conditionals aside, the piece did not take the risk side of the ledger remotely seriously enough.

How much of an idiot I am is not, in itself, an interesting topic. What is interesting is whether there are lessons to be learned from the widespread credulity about a certain account of what was happening on the border of Ukraine, and whether those lessons might have broader application. After all, a lot of global investors owned Russian equities and bonds last week. The country’s fiscal and current account surpluses made the bonds attractive, and exposure to inflation-hedging commodities did the same for the equities.

My piece characterised the case for Russian equities as follows:

The . . . argument from Russia bulls has two parts . . .

One: Moscow is genuinely concerned with its own security, and has neither domestic support for nor geostrategic interests in an annexation of Ukrainian territory. If the US and Nato cool it, offering assurances about missiles and a pause in Nato’s expansionary aspirations, de-escalation would follow.

Two: even if things do get worse, financial sanctions against Russia are likely to be too weak to threaten its economy, unless they stopped the country from selling its oil and gas abroad — which would hurt Europe as much or perhaps more than it would Russia.

Argument one overestimated Vladimir Putin’s concern with domestic support and geostrategic interests as conventionally defined. The failure of argument two followed directly. Once Putin chose outright war, scepticism about the power of sanctions was falsified. Russia’s foreign currency reserves were effectively destroyed by sanctions on the central bank, and its broader banking system is on its knees already.

The first point to make here — by way of clarification, not mitigation — is that very surprising things do happen. If someone says, “I’m 95 per cent sure that X” and then not-X occurs, the probability estimate may still have been correct. The only way to assess this, as the psychologist Philip Tetlock points out, is to see if a given person’s probability estimates come in about right over time — that is, for example, the things that they say have a 75 per cent chance of happening, come to pass roughly 75 per cent of the time.

But that doesn’t let me or anyone else off the hook for doubting that an outright invasion was going to take place. I think part of my problem, and a lot of other people’s, was which experts we talked to. All the people I spoke to were strategists and portfolio managers who have been following Russia and Russian stocks for a long time. But when thinking about risk, it is dangerous to depend only on these sorts of insiders. Here is what one investor, who lives in Russia, said to me:

One [worst-case scenario] is an invasion of Ukraine where Russian tanks cross the border and take a large territory. That is very very unlikely: there is not support for this among the Russian people. There was support for the annexation of Crimea. Of my friends in Russia, maybe 10-15 per cent have Ukrainian passports — there are lots of friendly ties, with family in one place or the other. It’s like Norway and Sweden. So I would write that scenario off.

Tetlock likes to recall how seasoned CIA experts on Germany had no clue that the Berlin Wall was about to fall. It was only the newbie analysts who noticed something was amiss. Lesson: when doing a hard risk assessment, include both seasoned pros and people who bring fresh perspectives and don’t make the standard assumptions.

In recent days a lot of foreign policy types have been talking about how Putin has changed and become more irrational — that he is “not the Putin we knew”. It may be that Putin is more risk-seeking now. But attributing this to mental illness, Covid isolation or age is also a way for people who have been surprised to reduce their own cognitive dissonance. As Tetlock put it to me in an email, this line allows surprised experts to say “well, he would have done what I expected if he weren’t suffering from xx”.

There is another problem here, too, I think. Once we assign an outcome a low probability, we often stop thinking hard about the consequences of that outcome. In this case one of the strategists I talked to said that “it’s hard for something worse to happen than what is already priced in” — a familiar refrain when beat-up assets are pitched. Well, it’s starting to look like, from the point of view of foreign investors, many Russian assets may be worth little or nothing, if bonds default and dividends are blocked. Even if you “punted” on high-risk, high-return Russian assets with a tiny percentage of your portfolio, a wipeout hurts. Did I think enough about that?

A final thought. What has happened this week has made me wonder anew about uninvestable risk. Are there risks that are simply too complex to be analysed with the degree of precision investment requires? Should we have known in advance that military conflict in eastern Europe was one of them? Are there other, analogous uninvestable risks in the world at present? Warren Buffett has a “too hard” tray on his desk, alongside the usual “in” and “out” baskets, where these risks go. I would be curious to hear what readers currently put in that category.

About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
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