U.S. Financials/Consumer Staples: Stick With It

Our U.S equity team continues to recommend a long financials/short consumer staples equity pair trade.

SP Financials

There are high odds of further gains in coming months as business confidence picks up, and hiring and capital spending gain traction leading to a narrowing output gap.

Importantly, the relative share price ratio has been positively correlated with the output and unemployment gaps. Financials profits benefit from reviving animal spirits, rising loan activity and increased capital formation. In contrast, consumer staples demand underwhelms at the margin as the economic recovery gains enough thrust to become self-sustaining. This message is corroborated by our relative sale-per-share models that are pointing to a brighter demand backdrop for the financials sector compared with consumer staples businesses.

In the absence of a relapse into a deflationary environment, financials will maintain the upper hand over consumer staples.

We Read (And Liked)… War! What Is It Good For?

War is not only inevitable, but it is also very good for humankind.

This is the message that Stanford historian and archaeologist Ian Morris argues in his provocative War! What Is It Good For?* Apparently it is good for a lot! Morris contends that violent contests between human societies foster in-group cooperation, technological innovation, and eventually human progress itself.

In a sweeping survey of history – surprisingly readable considering the scope – Morris shows that war, and eventually conquest, led to the decline in violent deaths from 20% to just around 3-4% by the first century AD – to even lower levels today. Although war is perhaps negative in the short term, in the long term it forces societies to organize on an ever larger scale that ultimately suppresses violence in the broader human population.

Underpinning Morris’ argument is a thoroughly Darwinian mechanism. Just as with biological evolution, human societies get bigger and more sophisticated, or they become extinct. The lesson from history for humans is therefore to get bigger, meaner, better organized, and thus more proficient at killing other societies on a mass scale. In the process, societies eliminate internal conflict and discord, replacing countless micro-conflicts with the ability to wage a few macro ones. In this way, Morris can claim that the 20th century, which produced some of the most extraordinary organized killing campaigns known to man, was actually far more peaceful than any major time period that preceded it.

Morris is not the first to make the argument that war makes states. Charles Tilly, one of the most famous sociologists and political scientists of the 20th century, famously compared the state to an organized crime syndicate. The state organizes itself and collects taxes in order to fund what is essentially a protection racket. States that do not to perform this function efficiently ultimately fail.

What can investors take from these pro-war arguments? Morris’ book is a great read for the late-summer, full of fascinating anecdotes from history; but is all this emphasis on the evolutionary quality of war in any way applicable to today’s world?

I would say yes. As the world enters a multipolar era where no one state is in charge, it is likely that geopolitical tensions and wars will increase in frequency. If as Morris and Tilly argue, war has an organizing quality, perhaps then internal discord will dissipate in the face of increasing geopolitical conflict. Take American political polarization. It was at its nadir during the early days of the Cold War (Chart 1). Perhaps what American policymakers need to overcome their ideological differences is a clear external threat. Similarly, perhaps what Chinese policymakers need to pursue painful structural reforms, or Europeans to strengthen their integration, is the clarity of purpose that comes with geopolitical competition.

Chart 1: Could Cold War Lite Assuage Polarization?

GPS Cold War Chart

The problem with this view is that we have no evidence that economic and financial globalization is sustainable between geopolitical rivals. The late 19th century saw a considerable increase in globalization, and it was multipolar, but European countries also coordinated their relations via the Concert System established by the Congress of Vienna following the Napoleonic Wars. If today’s multipolar system goes down the path of competition and tension, it is likely that it will erode globalization along with it.

*Morris, Ian (2014). War! What Is It Good For?: Conflict And The Progress Of Civilization From Primates To Robots. London: Profile Books.