Poker bets

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  By Guest Blogger Doug Rowat

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The following alert hit my phone on October 1st:

Source: BBC

I knew immediately that this would lead to two possible outcomes: 1) the literal end of the world (extremely low likelihood) or 2) a few clients asking to move their portfolio entirely to cash (high likelihood).

Indeed, outcome 2) proved correct and it became necessary to remind these clients of the parallels between poker and investing.

First, investing, like poker, is about probabilities. The Middle East, as we’re all aware, is a volatile region prone to more consistent turmoil over past 75 years than any other region of the world. Clients seeking to move entirely to cash after the October 1st attack might have forgotten that this isn’t even the first Iranian strike against Israel this year. It’s actually the second. In mid-April, Iran also launched a large-scale drone and missile attack against Israel; however, the S&P 500 has traded higher by more than 13% since. As we now know, both attacks were largely contained by Israeli and US air defenses.

Somehow, The Middle East finds a way to limp its way through each and every crisis, and investors have learned to live with the region’s almost never-ending cycle of threats, escalation, and—eventually—tense calm.

CNBC proved as much by examining Middle East crisis events over the past 30 years, which included the attacks on Saudi Arabian oil fields in 2019 by Iran-backed militants (I bet you’ve already forgotten about this crisis, but it was major headline news at the time). While these Middle East crises can impact oil prices, as the chart below shows, they have no lasting negative impact on equity markets:

Market reactions to 20 Middle East crisis events over the past three decades (to 2020)

Source: CNBC

Second, investing, like poker, is about dealing with incomplete information and uncertain outcomes. Just as your opponents’ cards and dealer community cards are unknown in poker, so too are the outcomes of geopolitical conflicts. This is not to say that you shouldn’t, perhaps, slightly pivot your portfolio based on changing information, but dramatic, absolute wagers (e.g., moving entirely to cash) implies a decision based on ALL the information. Outcomes are always unknown, especially in a region a volatile as The Middle East, so why make a wager as if they are known? Concentrated portfolio bets are usually driven by emotion, not certain forecasting. Investors NEVER see all the cards, and portfolios should be positioned accordingly.

Finally, let’s consider the totality of the poker room, or put another way, the totality of global financial markets. According to SIFMA Research Capital, global equity markets presently have a combined market cap of roughly US$115 trillion (with a ‘t’) while global fixed income markets have a combined market cap of roughly US$141 trillion. Collectively, then, more than US$255 trillion. To put this in perspective, global financial markets are more than 100x the size of the entire Canadian economy.

This is the magnitude of the market that one of our (usually skittish) clients is trying to outwit. Bluffing a market of this size is obviously pointless and, again, moving a portfolio to 100% cash implies a flawless forecast and the assumption that trillions and trillions of dollars of capital deployed globally (across billions of other market participants) will be outmaneuvered. Would US$255 trillion in global assets move suddenly and entirely to cash because Iran sent missiles into Israel? Of course not.

So, invest like a poker player. The size of your bet should reflect the probability of winning. And it should also be a reflection of the massive amount of information that remains hidden. Wagers should never imply that you have flawless insight into the future.

Skilled poker players always leave themselves the flexibility to be wrong. So should you.

Doug Rowat, FCSI® is Portfolio Manager with Turner Investments and Senior Investment Advisor, Private Client Group, Raymond James Ltd.

Source: https://www.greaterfool.ca/2024/10/12/poker-bets/