As the dust settles on Japan, a clearer picture of the impact on the global economy is starting to emerge. The third largest economy and roughly 9% share of the world capitalization, the troubles in Japan, when combined to the ongoing debt crisis in Europe and growing tensions in the Middle East is likely to shave at least a percentage point from global economic expansion this year. Oil has once again broken the $100 barrier, reflecting not only the potential supply issues emanating from the Middle East but also Japan's woes as it contemplates switching to oil as a substitute to the shortfall created by the loss of nuclear power. As a rule of thumb, a 10% rise in oil typically shaves around 0.2% of growth.
But Japan's troubles stretch further than just oil. Japan is a major supplier of components for both the electronics and car industries. In the near term the shortfall in production will translate into a rise in component prices. For firms that don't have substitutes for the components, this will translate into reduced production.
Finally, the impact of uncertainty on businesses should not be underestimated. Typically when faced with uncertainty on the economic front, businesses tend to postpone projects and investments which will invariably have an impact on growth.
25 March, 2011
14 March, 2011
Black swan observations...
There are two particular observations of "black swan" events that tend to repeat themselves over and over again.
The first has to do with the fact that they occur more frequently than we think they do. Our cognitive brain has a way of erasing or minimizing unpleasant experiences, so we almost tend to forget that they ever occurred, unless something of that "unpleasant" experience persists. That probably explains why we tend to repeat the same mistakes or when the tide runs down, so to speak, a lot of people are caught swimming naked.
The second has to do with clustering or the fact that a negative event almost instantly tends to attract other negative events like a magnet, which means that the original event is subject to a snowball effect. Take the last two months as an example. It began with an uprising in Tunisia, rapidly spread to Egypt, and now Libya and other countries in the region. As if that was not enough, commodity prices have been surging (adding more fuel to the fire) and now we have the totally unanticipated quake/tsunami disaster in Japan and a growing risk of leaks from nuclear reactors in the region. Impressive and worrying series of events that have the potential of dragging the rest of the world into another slump.
So if there are certain "predictable" patterns built into black swans, can we do something about them? This is the topic of much debate, and there seems to be growing consensus that strategies can be built around them. I guess the first place to start would be to accept these observations as a given and to "strategize" accordingly.
The first has to do with the fact that they occur more frequently than we think they do. Our cognitive brain has a way of erasing or minimizing unpleasant experiences, so we almost tend to forget that they ever occurred, unless something of that "unpleasant" experience persists. That probably explains why we tend to repeat the same mistakes or when the tide runs down, so to speak, a lot of people are caught swimming naked.
The second has to do with clustering or the fact that a negative event almost instantly tends to attract other negative events like a magnet, which means that the original event is subject to a snowball effect. Take the last two months as an example. It began with an uprising in Tunisia, rapidly spread to Egypt, and now Libya and other countries in the region. As if that was not enough, commodity prices have been surging (adding more fuel to the fire) and now we have the totally unanticipated quake/tsunami disaster in Japan and a growing risk of leaks from nuclear reactors in the region. Impressive and worrying series of events that have the potential of dragging the rest of the world into another slump.
So if there are certain "predictable" patterns built into black swans, can we do something about them? This is the topic of much debate, and there seems to be growing consensus that strategies can be built around them. I guess the first place to start would be to accept these observations as a given and to "strategize" accordingly.
10 March, 2011
Risks on various fronts...
From inflation fears triggered by a surge in commodity prices to growing tensions in the middle east to more downgrades in peripheral Euro zone sovereign debt, it is challenging to figure out where or in what form one can find shelter from the damaging effect of a sudden "fat tail" event. This challenge stems from the fact that the last couple of years have shown us that what used to be considered "safe" may no longer be. If you cannot differentiate between high risk and low risk, you are in trouble.
The Euro zone debt debacle is a case in point with the onetime almost "risk free" sovereign debt of a number of member states suddenly finding themselves in "junk bond status" territory. Another example would be the infamous money market funds that at one time was considered as safe as cash but in fact carried an disproportionate amount of risk as managers, under pressure to enhance returns, stuffed the funds with significantly higher risk instruments.
What about commodities such as gold which has experienced a nice run since the beginning of February? Sure, when visibility is low and the threat of systemic risk rears its ugly head, gold seems to be a safe bet. It is in a way the collective expression of distrust towards monetary authorities across the globe. At the same time, gold, just like other commodities, exhibit a tremendous amount of volatility as it is very much guided by sentiment which tends to be fickle when tensions run high.
At the end of the day, the only effective method in facing these challenges is to diversify. Not just any sort of diversification mind you, but one that involves a well thought out approach where the underlying risks are clearly identified.
The Euro zone debt debacle is a case in point with the onetime almost "risk free" sovereign debt of a number of member states suddenly finding themselves in "junk bond status" territory. Another example would be the infamous money market funds that at one time was considered as safe as cash but in fact carried an disproportionate amount of risk as managers, under pressure to enhance returns, stuffed the funds with significantly higher risk instruments.
What about commodities such as gold which has experienced a nice run since the beginning of February? Sure, when visibility is low and the threat of systemic risk rears its ugly head, gold seems to be a safe bet. It is in a way the collective expression of distrust towards monetary authorities across the globe. At the same time, gold, just like other commodities, exhibit a tremendous amount of volatility as it is very much guided by sentiment which tends to be fickle when tensions run high.
At the end of the day, the only effective method in facing these challenges is to diversify. Not just any sort of diversification mind you, but one that involves a well thought out approach where the underlying risks are clearly identified.
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