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Fully invested bears, anyone?


Fully invested bears, anyone?

Letter # 58

It’s easy to miss the events that occur in far-off lands, but a few offer an interesting perspective. Yesterday, Algeria closed its airspace to Morocco, a month after it broke off all diplomatic ties with its neighbour. While it is difficult to spot the two small North African nations on a map, their story is fascinating. One that leaves you gasping with… “but, why?”

On paper, the African nations appear promising. Oil reserves (Algeria), vast natural resources (including a large coastline) and new-found independence. Circa 1960s, they held the potential to usher North Africa into prosperity in the post-independence era. Well, they did not.

It started when the French conquered Algeria in 1830s. Like a good neighbour, Morocco catalysed a rebellion against the occupation. But a decade later, France responded by attacking the Moroccan army and annexed parts of its territory to France.

By the 1950s, however, precious metals were discovered in the annexed parts and France transferred the area to Algeria. Years later, France offered to return it to Morocco, if the latter was willing to jointly develop the minerals with France. Morocco rejected this advance as by then Algeria was in final swing of its independence movement. Provisional government of Algeria offered a better deal.

But, on gaining independence, Algeria was in no mood to comply. The trust was broken, relationships were soiled and “Sand Wars” broke out. The final nail came in 1975 when Spain conceded its territorial occupation of Western Sahara to Morocco (a region to its South). Western Sahara had a large coastline and offered access to the Atlantic Ocean by bypassing the Gibraltar Strait. For Algeria, that was the key to its aspiration of regional dominance. A proxy conflict ensued which lasted for two decades. A cease fire was announced in 1991, but the score was far from settled.

Over the past decade, the two countries combined have spent over USD110bn on defence (combined GDP is cUSD300bn). Morocco runs amongst the most sophisticated military with arsenal of F16 jets, M1 Abrams battle tanks, M109 howitzers and observation satellites. Algeria matches it with its own fleet of SU 34 jets, Navy frigates and kilo-class submarines. A close observation would reveal the country of origin of this equipment (for respective countries).

The two countries do not face a national threat, apart from each other. Yet, they spend all that money on defence, year after year, just trying to out manoeuvre each other; precious money that could have been spent on education, infrastructure building and general economic development. All this, while Algeria’s GDP is contracting, and austerity measures are in place for more than the past five years (1).

In his book, The Wisdom of Crowds, James Surowiecki argues that under the right circumstances, groups are remarkably intelligent and are often smarter than the smartest people in them. He begins by telling the story of Francis Galton, the English Victorian-era polymath. In one of the poultry contests in 1907, some 787 people paid six pence for the opportunity to guess the weight of a rather large ox. A few guessers were farmers and butchers (maybe classified as experts), but a far greater number had no specialized knowledge of farm animals. Based on that, he anticipated his 787 participants would come up with a dumb answer.

The ox weighed 1,198 pounds. Galton took all guesses and plotted a distribution curve. He found that the median guess was within 0.8% of the correct weight and mean guess was within 0.1% (average guess was 1,197 pounds). The crowd, as a collective, just knew! They knew it better than the “so-called” experts could guess. How?

Surowiecki writes that two critical variables are necessary for a collective to make superior decisions–diversity and independence. One, if a collective can tabulate decisions from a diverse group of individuals who have different ideas or opinions on how to solve a problem, the results will be superior. Two, independence does not mean participants remain in isolation, but each member is free from influence of other members.

A geopolitical history of the two African nations reveals how the collective wisdom of crowds has always been missing. The politics of Morocco takes place in the framework of parliamentary constitutional monarchy. It hold elections, but the King makes strategic decisions. In July 2020, Morocco’s King Mohammed VI celebrated 21 years on the throne. Prior to him, late King Hassan II ruled from 1961 to 1999 and the list of dynasts date back to 788 AD.

Algeria, on the other hand, is a constitutional semi-presidential republic. However, many political observers call Algeria a “controlled democracy”— a state where the military and “a select group” of unelected civilians make major decisions, such as who should be president (2). When talking of countries, one cannot distil the failure point to one (or even a few) variables. Nevertheless, it is fair to say that the wisdom of crowds has been long missing, and the lack of accountability does explain the situation in part.

Now let us consider Galton’s idea for stock markets–a system that is incentive-based and one that can aggregate investor decisions. If the “smart collective” always comes to the right conclusion, how come we end up with booms and busts? Why does the “diverse group” not come to the right prediction for the market as it did in Galton’s country fair?

Surowiecki argues that with markets, condition No. 2 (independence) is often not met and more so in modern times. Decisions of market participants are not always independent, but often coalesced into one opinion. People make decisions based on actions of others rather than their own private information. The age of social media accentuates this process.

And, it adds up. Prior to March 2020, the market had never fallen 35% in one month and never before had it recovered in one straight line; and yet it did. Earlier, two cohorts existed: (a) “Trend followers” (momentum strategies) who bought more when prices rose (and vice-versa); and
(b) “Fundamentalists” who bought based on underlying value. They used to balance each other out and historical market corrections (or recovery) were not as pronounced.

Increasingly, that difference has blurred. Whereas momentum strategies continue, fundamental investors have devised ways of valuing businesses that did not exist before. Thought process moves to relative–B is cheaper compared to A, hence one must buy B. Regardless of whether B deserves to be valued at current absolute valuations. PE multiples are just a state of mind, they say, right?

When everyone starts operating looking at others, it eventually results in market rallies (and corrections) assuming extreme proportions. The last straw is when fundamentalists throw in the proverbial towel and convert into what one finds regularly now… “a fully invested bear”. Now that this is out of the way and as US and Indian markets hit their all-time highs, do you think it is a good time to start getting invested in equities for the next decade?

ALGERIA: Shift Towards Austerity (

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