In between enjoying the myriad of water sports our island has to offer through the summer months, such as sailing, surfing, paddle boarding and kayaking; we have also found time to read a number of thought-provoking books. The entire investment team enjoyed Algorithms To Live By – the computer science of human decisions by Brian Christian and Tom Griffiths; some have read one or the other, or both, of Homo Sapiens: A Brief History of Humankind and Homo Deus: A Brief History of Tomorrow by Yuval Noah Harari and another popular book has been Shoe Dog – A Memoir By The Creator of NIKE, authored by Phil Knight. ‘Algorithms’ was a compulsory read, having been selected and subsequently reviewed by the team as part of our 6 monthly ‘reading week’ schedule. We believe this type of self-learning is a very important component of our investment process and generating ideas through research as a collective, or creating them individually, helps us in our drive to think differently.
To bring some of this to life, how might this help as we seek to interpret the current investment environment? It is not our usual style to use VFTD to focus on near-term issues, but given financial markets are being buffeted by (1) the latest escalation in rhetoric over the North Korea nuclear tests, (2) some unexpectedly dovish Fedspeak, (3) ongoing concerns about the looming US debt ceiling, (4) Trump’s decision to end the ‘legal’ status of adults brought into the US illegally when children, and (5) the threat of Hurricane Irma. It would take too long to address each of these individually so we will focus solely on North Korea for the purposes of this blog. This brings us to Eric Ellis and Stanislav Petrov.
In 1994, the Australian journalist, Eric Ellis, applied for a visa to enter North Korea posing as a golf course developer. He used this ruse, thinking it sounded benign enough to get him into the country, and it worked. When he arrived, he was assigned two "minders" – a driver and a guide - who escorted him to Pyongyang Golf Club. Ellis was really in North Korea to investigate famines and the social unrest these were allegedly creating at the time. During the visit he found no evidence of this, but instead stumbled across a story that quickly went viral.
At the golf club, he met what he understood to be the country's only golf professional and asked him to name his favourite golfer. Jack Nicklaus? Arnold Palmer? Greg Norman? The individual had never heard of any of these, but when questioned if he had ever met the Dear Leader of the time, Kim Jong-il, he replied he had. Ellis later described how the golfer went on to say the “Dear Leader Comrade General Kim Jong-il, who I respect from the bottom of my heart, scored a 2 on the opening 374 yard par 4 first hole.” This was a great start to the round, but Ellis was told it got better from there and Kim went on to not only score five holes-in-one, but also the worst score he posted on any single hole was one under par. The resultant final score of 34, was a remarkable 38 under par; a round of golf made all the more legendary, as it was reported this was the first time Kim had ever played the game.
Outside of North Korea, of course, this feat is considered utterly outrageous. This is the same regime which has subsequently claimed Americans eat Korean babies and that Pyongyang won the space race, by landing a rocket on the moon years before Neil Armstrong made his lunar walk. Inside the country, however, these and many other stories are believed and shape the attitudes and behaviours of millions of people. A natural question for us is how can this population be brain washed to this extent? Moreover, history tells us the North Koreans are far from the first people to be coerced and deceived through coordinated state propaganda and persistent untruths. What makes us humans vulnerable to this?
In the book Sapiens, referred to earlier, we are told evidence suggests something happened in our brains circa 70,000 years ago causing a ‘cognitive revolution’, moving us from the middle of the food chain, to the very top in an evolutionary ‘blink of an eye’. The author’s account of this places particular emphasis on one unique capacity of our species: the ability to tell stories and create myths about ourselves. A group of humans existing only because of personal ties is typically limited to about 125 members; think hunter/gatherers. It is only after this revolution that “imagined communities” allowing thousands, or millions, to be part of the same enterprise — a kingdom, an empire, or a religion – became possible. “Much of history,” says Harari, “revolves around this question: How does one persuade millions of people to believe particular stories about gods, or leaders, or political doctrines? Yet when it succeeds, it gives homo sapiens immense power, because it enables millions of strangers to cooperate and work toward common goals.” This “mythic glue,” argues Harari, is the secret sauce of humanity. The ability to create unifying myths (used here as powerful, defining stories, not fictions) is our most powerful, distinguishing characteristic as a species. Few would want to condone the actions of the North Korean leadership, but adversaries would be wise not to underestimate the strength of the mythic glue binding the beliefs and sense of purpose for that population.
Turning to Stanislav Petrov
On 26 September 1983 – three weeks after the Soviet military had shot down Korean Air Lines Flight 007 - he was the duty officer at a Russian command centre, with a nuclear attack early-warning system. During his ‘watch’, this system reported a missile had been launched from the United States, followed by up to five more. Petrov declared this a false alarm and did not trigger a retaliatory nuclear attack. This proved to be the correct decision, and it was subsequently determined the alarm had been created by a rare alignment of sunlight on high-altitude clouds above North Dakota and the orbits of the Soviet monitoring satellites.
Just how close the world came to nuclear war is a much debated subject, but most analysts accept we should all be thankful Petrov made the decision he did. In Algorithms To Live By, the mathematical and economic concept of ‘game theory’ is explored. This underpinned the strategy of Mutually Assured Destruction employed by both sides during the Cold War. Viewed through the lens of game theory, the outcome of nuclear war is the same whether one initiates an attack or responds to it and, since this outcome is worse than “no nuclear war,” the optimal move is to not launch missiles. Of course, this depends on a number of assumptions; second-strike capabilities must be available and known to the enemy; both sides must have perfect detection equipment since a false positive - like the one recognised by Petrov – could lead to nuclear war; and rational leaders must be in place. By making it clear retaliation was more likely than not, both the US and Soviets managed to discourage each other from ever launching a single missile.
It would seem the principles behind game theory are at play in the current North Korea nuclear stand-off. The North Korean leadership do not believe the US will attack them, but have spent years creating a non nuclear response to such a scenario, demonstrating a capability which guarantees an overwhelming number of South Koreans would die should this take place. To further deter this type of action, the US is unsure whether the North Koreans can successfully fire a nuclear weapon at their citizens in Guam. Finally, the possibility China (or Russia) would rise to the defence of North Korea in the event of US aggression – an outcome the latter would wish to avoid – makes the case for action by Trump’s administration weaker and weaker. From a military viewpoint, North Korea’s capabilities are clearly inferior to those of the US, but the game it is playing arguably gives it the upper hand in any negotiations to follow.
Implications for portfolios
We are the first to admit having a deeper insight into geopolitical issues is not going to give us a significant edge in managing money. We have no idea how the North Korea situation will further unfold, but can be sure any further deterioration will – at least temporarily - unnerve markets. In our June 2016 edition of VFTD we wrote about the virtues of gold in this type of situation and we have seen both our dedicated gold bullion fund, and our more esoteric hybrid gold and silver bullion/mining equities fund, post strong returns in recent weeks.
Geopolitical risks are an ever present factor in our investing lives. However, as Deutsche Bank recently highlighted, the impact of such events on markets is often relatively short-lived (reference table that follows).
Equity market sell off and recovery around geopolitical events
Whilst these events make for dramatic headlines – across our imagined communities - they are not something to become too distracted by. Consequently they have not influenced our view that emerging markets equities – including Asia – remain relatively attractive. Indeed, despite their strong year-to-date performance, we are considering increasing our exposure further.
Julia Warrander and Russell Waite
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