By Rahul Keshap
At the 64th CFA Institute Annual Conference yesterday, Dr. Pippa Malmgren outlined the crucial interplay between global economics and geopolitics. In her talk, “Managing Unquantifiable Portfolio Risks: Politics, Policy, and Geopolitics,” Dr. Malmgren, president and founder of Canonbury Group and Principalis Asset Management, demonstrated how investors can draw correlations between inflation and global political instability, noting that “geopolitics is not a black swan phenomenon.”
Because of an influx of new workers and a period of relative stability after the fall of the Berlin Wall, “most people managing money today have not experienced inflation during their careers,” Malmgren asserted. As a result, she added, the investment industry is not currently well equipped to understand the impact of global political instability.
Malmgren said it is important to distinguish between actual inflation rates and official government figures, because volatile commodities such as food and energy may be excluded from calculations, as is the case in the United States. Official figures thus may underestimate the reality of price increases.
“The actual inflation rate in China is probably a lot closer to 10% than it is to 5%,” Mamgren said. “In India, it is officially around 16% for food, but in parts of the country the real inflation rate is closer to 100% for core staple foods.”
Important indicators of inflation might be as humble as the candy bar, where rising prices of sugar, milk, and cocoa will have an impact and encourage producers to resort to smaller packaging, causing squares of chocolate to disappear from the wrapper. Good investments in this environment include companies with strong brands that know how to manage margins effectively and pass rising prices along to consumers.
When analyzing countries under pressure, paying close attention to the actual inflation rates may reveal clues about where civil unrest could happen next. The “Arab Spring” did not begin by chance earlier this year, Malmgren said, and it is not limited to the Middle East. In response to the unrest, governments have provided wage hikes, but that may not be enough in emerging markets, where Malmgren said workers are demanding immediate hikes because of uncertainty about the future. Although China may be able to handle such pressures, “the Chinese are exceptionally worried about inflation, because in their history, it has always been the catalyst for dramatic unrest.” Elsewhere in Asia, there are indications that Vietnam could be the next Tunisia, she contended.
With record debt burdens comparable only to the interwar period, “I think we’re going to have defaults, and this will give us interesting investment opportunities,” Malmgren said. Sovereign defaults will come in various forms, and under clever guises, such as debt rescheduling, devaluation, inflation, and austerity measures, which she argued are a form of default — one that impacts a country’s own citizens as essential services are cut.
Following the stability of the last two decades, volatility and politics have again taken center stage. “[Investors] can no longer say that if you can’t quantify it, it doesn’t matter,” Malmgren said. Still, out of regulatory changes and pressures “new financial instruments and whole financial sectors will be invented.”