Humans are pattern-recognition machines. It’s amazing to watch my toddlers have no idea how something works, say, touching a hot mug and realizing that most liquids in mugs are likely hot. In investing, most will steep themselves in the greats at the beginning (including me). The lessons are most often that one has to do something different than the crowd to get different results. But it is incredibly hard to truly think differently, as we train ourselves to see patterns and act on instinct. Being a pattern recognition machine often enables a blind spot to things happening that have no precedent.
Over the weekend, incredible events happened in China. During the closing ceremony for the Communist Congress in China, in which President Xi named a new set of leaders and was elected for an unprecedented third term, implying potential life appointment, former President Hu Jintao, who was seated next to him, was forcibly removed from his side. An unprecedented event given that the entire event is highly choreographed.
The supposed implication is that Xi is visibly showing his nation that his way is the only way. The market, made up of pattern recognizers, did not see this coming. Hong Kong’s stock index fell like a stone this morning, and is now down near 50% over the past five years, of which it is down 42% in the past 12 months alone:
Zooming out to investing globally, it is interesting to think of the 2000s when the term BRIC was used as the new frontier for investing (Brazil, Russia, India, and China). As of now, Russia is entirely un-investable and China has this weekend proven that it is likely heading in that direction. Brazil and India still appear investable, but one is undergoing an election between “Trump of the tropics” and a former criminal (which is in a run-off now).
What are the lessons here? I think one can make a nice list that would be fit for a Buzzfeed article, but in actuality, there is only one lesson. That is, protecting capital is most often more important than growing it. Greed pushes all investors out on the spectrum of risk, and investing in foreign markets that derive excess return from the idea that their internal politics will evolve towards something we can all pattern match against has proven riskier than previously perceived. In today’s markets, I personally believe that there is more than enough risk opportunity within markets we know well.