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Long-term matters: Of herds and bubbles

There is much talk in the investment community of the long term and of fundamentals. Yet behaviour remains rather short term in practice. It’s easy to fall into the trap of diagnosing personality flaws but that is a fundamental attribution error. Rather, we should look at the underlying mind-sets.

We have been working on some scenarios that describe where, on current trends, the investment industry might end up. Looking at endgame scenarios is a way to understand better what we are doing and the trade offs we are making. The scenarios don’t need to be accurate predictions to shed light on dynamics.

It is a tautology to say that prices reflect fundamentals in a well-functioning, rational market. In the sort of markets we enjoy there are both major irrationalities like bubbles and major side effects, which economics calls externalities. Externalities such climate change become intrinsic fundamentals in a global market. The work of the CarbonTracker group on unburnable carbon will merely help the market to catch up with something that has become intrinsic and highlights the need for an orderly transition, not the popping of a bubble with the economic destruction that entails.

Markets are herd-like in the way they behave in practice. Everybody knows one thing. And when things change they know its opposite equally fervently. It is because of this herd-like behaviour that the scenarios presented here are important. Here is our (rather obvious) prediction: the investment industry will continue to make lots of money but how it will do so will necessarily change.

What connects the scenarios is that in each the investment industry comes up against limits that affect the ways it can make money. There is still very much a game to play but it is a markedly different game in each case.

• Scenario 1: Limits due to the environment, to stagnation in the real economy and to rapid shifts in industrial patterns. Here, whilst the vast majority of investors continue to invest in some fossil fuel companies, they are also aware that hard global limits to growth are disrupting those investments. In this scenario investors have to get savvy about ecological and social constraints and how they are going to disrupt market valuations.

• Scenario 2: Limits due to the politicisation of the investment environment and its increasing use in economic warfare. This means second guessing the effect of the growing sanctions war with Russia or the competition with the Chinese for investing in African resources, for example. This sort of constraint is about geopolitical forces and its biggest prize is understanding what happens if the world trade moves away from the dollar.

• Scenario 3: Limits due to its disconnect from the real economy, the financial industry becomes a free-floating sphere of its own. Here, clients really learn to love trading and investors focus more and more on competing to make money from each other. Already, major corporates are sitting on huge piles of cash and are in some way insulated from the decisions of the investment community. In this scenario the investment community feeds on itself and the real economy finds other routes forward, just as regulation of the banks has led to a hugely swollen shadow banking sector. Disruptive financial technical innovation could be a big factor.

To repeat, these scenarios do not have to be accurate predictions. They merely describe types of endgame. These scenarios could certainly be useful in strategic planning. But they could also help concerned parties find ways of discussing future states that various players may want to avoid, for very different reasons. We look forward to hearing what you think.  

Raj Thamotheram is CEO of Preventable Surprises and a visiting fellow at the Smith School, Oxford University, and Aidan Ward is an organisational systems consultant. For further details see www.preventablesurprises.com/scenarios

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