Long-time readers may remember that last year I sang the praises of Antifragile: Things That Gain From Disorder, a book by Nassim Nicolas Taleb. He was also the author of The Black Swan, the book that made him famous.
As the title suggests, Antifragile is about standing the test of time and becoming stronger from withstanding those tests. The version I bought came wrapped with a loose band of paper around it, with the words, ‘tough times don’t last, tough people do’.
Given the global turmoil that seems to have come out of nowhere lately (but has been brewing for a while) I thought it might be worth revisiting Taleb’s thesis.
Earlier this year he co-wrote an essay that was published in Foreign Affairs, called ‘The Calm Before the Storm, Why Volatility Signals Stability and Vice-Versa’.
We had the calm in the first half of the year. Are we now entering the storm?
It certainly feels that way today. Global markets had a shocker on Friday. The S&P500 lost 3.2%, while the Dow lost 3.1%. It’s one of the largest one-day falls in US markets in years. It followed on from Shanghai’s 4.2% drop, which is pretty much run-of-the mill these days. European bourses fell around 3% too, while oil declined over 2%.
The excuse for the sell-off was weak manufacturing data out of China and the US. But markets have absorbed weak data plenty of times over the past few years. It’s investor psychology that has changed.
Apart from bonds, only gold put in a decent performance, rising 0.5% to around US$1,160 an ounce. But keep in mind that this is merely a rebound from a bout of very heavy selling. In US dollar terms, gold is still in a strong downtrend. So there will be a tendency for the short sellers to move back in after this rally and put pressure back on gold again.
But as I keep pointing out, in Aussie dollar terms the gold price is in much better shape. After looking pretty fragile a few weeks ago, gold in Aussie dollars has rallied over $100 an ounce to $1,585. That maintains the upward trend and ensures ongoing healthy margins for Aussie gold producers.
The test for gold will come in the next few weeks. Will it turn back down sharply again, or find buying support during the next correction?
The outlook for oil, on the other hand, is much worse. Both Brent and West Texas oil just broke down to multi-year lows. This tells you the downward trend is still very strong. It’s what led me to recommend two major Aussie energy plays as short selling candidates last week in the inaugural Crisis & Opportunity report.
Energy stocks are already well off their highs. But with oil prices where they are, and many of the large players with huge capital expenditure budgets, there’s nothing but pain on the horizon for these companies.
Some are in real trouble so bargain hunters beware…there are no bargains here…not with oil prices around US$40 a barrel. Oil IS oversold though so a punt on a short term bounce might pay off. But the bigger picture trend is down. Which means serious investors should stay away.
But I’m getting off track here. I meant to talk Taleb’s ‘Antifragile’ thesis. More to the point, I want to apply it to Australia and see how we stack up.
As Taleb writes in the Foreign Affairs essay:
‘Although one cannot predict what events will befall a country, one can predict how events will affect a country. Some political systems can sustain an extraordinary amount of stress, while others fall apart at the onset of the slightest trouble. The good news is that it’s possible to tell which are which by relying on the theory of fragility.
‘Simply put, fragility is aversion to disorder. Things that are fragile do not like variability, volatility, stress, chaos, and random events, which cause them to either gain little or suffer. A teacup, for example, will not benefit from any form of shock. It wants peace and predictability, something that is not possible in the long run, which is why time is an enemy to the fragile.’
Hmmm. Is Australia a teacup? Is time our enemy? Some would argue that we sailed through the disorder and volatility of the GFC, and came through it with flying colours.
I agree with that in part. We had a floating currency that absorbed some of the hit, along with falling interest rates and a strong fiscal response that pumped billions of dollars into the economy right when we needed it.
And we had a big dose of luck. We benefited enormously from China’s response to the crisis. But over the past few years that support has ended. And now we’re relaying on leverage and low interest rates to survive the fallout. How much longer can we do it? Is time now the enemy?
Back to Taleb:
‘For countries, fragility has five principal sources: a centralized governing system, an undiversified economy, excessive debt and leverage, a lack of political variability, and no history of surviving past shocks. Applying these criteria, the world map looks a lot different. Disorderly regimes come out as safer bets than commonly thought—and seemingly placid states turn out to be ticking time bombs.’
Australia gets a pass mark on the first point. Our system is: government is not highly centralised. The States and the Federal government share power.
But on the next three points we score poorly. Australia has an undiversified economy, relying heavily on commodities for income and house price speculation to drive the services economy.
In the June quarter, our trade deficit came in at nearly $10 billion thanks to falling commodity prices and a lack of anything else to take its place. The current account deficit for the quarter, due out in a few weeks’ time, will be a shocker. We have very little economic diversity, a sign of fragility.
Australian households have excessive debt and leverage, which adds to the fragility of a narrow economy. The resources boom sustained the debt boom, but it cannot continue to do so now.
Australia also has little political variability. If we boot one bunch of clowns out a new circus just rolls into town. We get the same economic policies, adjusted slightly for political ideologies.
The economic policy of both parties is this: pander to the rent seekers and special interest groups, avoid meaningful reform because it’s too hard and too risky, and hope low interest rates do the job. In short, fragile.
On the last point, we get a pass. Australia has now enjoyed 24 years of uninterrupted economic group. We have survived past shocks. That’s largely because we’ve had the capacity to deal with them.
But now, as time rolls on, we’re running out of ammo. Interest rates are at historic lows, household debt at historic highs, and we don’t have much room to move on fiscal policy.
The conclusion I come to is that Australia is fragile to the next shock. What I don’t know is whether that shock is now underway. This could be the end of Australia as we know it.
Editor, Markets and Money