Sunday, October 7, 2007

Sports, sentiment, and cycles....

I can't sit here, as a native-born Kiwi (New Zealander) and not make a comment on the shocking result in the Rugby World Cup in the early hours of the morning, HK time. Completely against expectations, the world's top rugby team, and the most successful in the history of the sport, lost to France in the quarter-finals. There are many things I'd like discuss (like the refereeing), but I'll leave that to the experts. The fact is, based on current form, the All Blacks (as the NZ team are called) should have won by a large margin.

Let me first address the apparent contradiction of the top team failing to win the World Cup, and then get on to the macroeconomic implications of sports, and implications for China.

Rugby teams have different styles of play. Some are flamboyant, occasionally producing amazing results, but in the long run are likely to disappoint (like hedge funds); others play excellent, exciting rugby, win more often than not, but sometimes suffer major lapses (like equities); and others are dead boring, able to grind out a modest return under most circumstances, but fail to inspire in the long run (like bonds).

Of these three types, I'd characterise the All Blacks as the top equities fund of world rugby. For over 100 years, they have out-performed all other funds across all asset classes on average, but they've had significant set-backs along the way, in particular failing to win some crucial games at world cups! But maybe that's just a result of the structure of the world cup. To win, a team must beat three competitors on three consecuative weekends in sudden-death matches. Winning two by a large margin is irrelevant if you lose the remainder.

Consider the analogy of investing. Suppose your objective was to have the highest return in three consecuative pairwise comparisons with randomly selected alternative funds. Would the top equities fund win? There's a good chance of that if all the competitors were also equity funds. But the probability drops as the investment strategies of the opposition diverge from equities. For example, equities may have out-performed bonds consistently for as long we we've had data (and have now started out-performing hedge funds as well), but I'd expect equities to beat bonds in three consecuative periods (months, say) with a probability of less than 50%, since bonds consistently outperform equities in a falling market.

Of course that doesn't completely explain the Rugby World Cup: with one victory in 5 world cups, the most dominant team is running at a lowly 20% success rate! But at least it's a start.

The semi-finals of the cup include England (bonds) versus France (hedge fund) and the winner of South Africa (equities)/Fiji (hedge fund) versus the winner of Scotland (underperforming bonds)/Argentina (inexperienced hedge fund). As with investments, it's impossible to be sure what the outcome will be.

But lets get on to the macroeconomics of sport, since this is supposed to be a macroeconomics blog! New Zealand has a small population that is completely rugby obsessed. This obsession starts at birth, and aflicts nearly all members of the population, whether they've ever picked up an oval ball or not. Perhaps more so than in any other country, the performance of the national rugby team affects the mindset, optimism, and outlook of the population.

So what happens when the national team losses unexpectedly? National mourning and stunned disbelief. But maybe more. How about a recession?

Remember that expectations and optimism play a major role in the consumption and savings decisions of consumers. In the case of New Zealand, the current phase of the business cycle would suggest that this is particularly so. As with the United States until recently, the economy has been booming, largely on the basis of the "feel good" factor. This has fueled increases in house prices to historically unprecedented levels, which has in turn fueled large increases in consumption spending and investment (in new houses), driving the economy to new heights. The end result is unsustainable, with the current account deficit at worse than 8% of GDP, and record household debt levels.

This ponzi scheme of inflated real estate prices driving excessive consumption must at some point come tumbling down. Could a shock to expectations, in the form of the worst ever performance of the All Blacks at a world cup trigger such a correction? Time will tell.

Coming closer to home, the Chinese market is a "bubble of bubbles" according to some commentators. Hype about the coming olympics may be helping to drive up asset prices above fundamental levels. What happens when the olympics is over, especially if China fails to impress with a record medals haul? It's the final straw that breaks the camel's back, and the smallest pin that bursts the largest bubble....

No comments: