Cashing in on a crisis is not as easy as just listening for cannons
• With tension mounting between the US and North Korea, it is difficult to know how to invest
The old trading adage “buy on the sound of cannons, sell on the sound of trumpets” is often attributed to London financier Nathan Rothschild, who supposedly made millions after the Battle of Waterloo by using his early knowledge of the English victory to deceive bond traders on the stock exchange.
As Frederic Morton tells it in his book The Rothschilds: A Family Portrait: “To the Rothschilds, [England’s] chief financial agents, Waterloo brought a many million-pound scoop.… A moment later, Nathan Rothschild … was on his way to London (beating Wellington’s envoy by many hours) to tell the government that Napoleon had been crushed: but his news was not believed, because the government had just heard of the English defeat at Quatre Bras.
“Then he proceeded to the stock exchange. Another man in his position would have sunk his work into consols [bank annuities], already weak because of Quatre Bras. But this was Nathan Rothschild. He leaned against ‘his’ pillar. He did not invest. He sold. He dumped consols…. Consols dropped still more. ‘Rothschild knows,’ the whisper rippled through the exchange; ‘Waterloo is lost’.
“Rothschild kept on selling … consols plummeted — until, a split second before it was too late, Nathan suddenly bought a giant parcel for a song. Moments afterwards, the great news broke, to send consols soaring.”
It’s a great story that illustrates that, in times of war, there is an uncertainty and panic in the markets that can be taken advantage of. But it may better illustrate another old trading adage, “buy the rumour, sell the news”, meaning that by the time something hits the headlines, those in the know are already cashing out.
The problem with both sayings is that they’re not nearly as useful as they might first appear. They require that all-important ingredient when it comes to trading — an edge — in this case, getting the news first. Nor is that always enough.
According to historian Niall Ferguson: “The Rothschilds’ couriers did get to London first … but since the family had been banking on a protracted military campaign, the losses arising from the disruption to their business more than offset any shortterm gains in bonds after Waterloo. Rothschild capital did soar, but over a much longer period: Nathan’s breakthrough had been prior to Waterloo, when he negotiated a deal to supply cash to Wellington’s army.
“The family made huge profits over a number of years from this governmental financing by adopting a high-risk strategy involving exchange rate transactions, bond-price speculations and commissions ....
“Knowing the structure of the market we can conclude that however much Nathan made out of Waterloo, it must have been very considerably less than a million pounds, let alone ‘millions’.”
More recently, Brian Cathcart has disputed the claim that Rothschild was the first man in London to know of the victory at Waterloo. He traces the earliest news to a dispatch the Duke of Wellington sent via his messenger to Lord Bathurst, the secretary of war. This suggests it wasn’t so much getting the news first that allowed Rothschild to make his money, as knowing what to do with it.
This brings us to the question of how to trade political events in the markets. How, for instance, should we take advantage of the North Korean crisis?
First-level thinking, as Howard Marks would say, will probably put forward the more obvious trades: buying the “fear” index – the VIX – or buying into the defence sector.
And, as usual, there will be those who will recommend buying gold. Unfortunately, when it comes to the markets, nothing is that easy.
Despite the apparent threat — given credence by a report from the UK’s Royal United Services Institute that a war between North Korea and the US is now a “real possibility” with a “growing risk of action being taken by Donald Trump to ‘resolve’ the issue” — the VIX remains at historic lows, closing below 10 again last Friday.
So, while some investors may be preparing for a violent end to one of the world’s most popular trades — shorting volatility — for now, it’s still more profitable than buying into it.
As for defence stocks, the opportunity may have already come and gone. Over the past year, the five biggest military stocks on US stock exchanges have experienced price jumps of between 33% and 93%, not counting dividends.
Boeing has almost doubled in price, from 131.27c at the end of September 2016, to a close of 252.21c on Friday. Raytheon set a new 52-week high during Friday’s trading session, when it reached 186.7c, a share price increase of nearly 56% over the year. Rockwell Collins has risen 55% in the past year, while Lockheed Martin has jumped from a low of 228.59c to close at 310.29c on Friday.
“Defence was one of the hottest sectors in the stock market in 2016, but might not turn out so hot for investors in future,” says The Motley Fool.
“There are any number of reasons to like military stocks — their ability to generate steady sales and profit in almost any market, their above-average dividend yields and, of course, their recent outperformance on the stock market.” But there’s one reason to distrust their ability to continue to outperform — they’re not cheap.
According to S&P Global Market Intelligence, the five largest US defence stocks have traditionally sold at an average debt-adjusted price-to-sales ratio of about 1.
“From 2000 to 2016, the average for the group as a whole has been 0.98 times sales. Rockwell’s [price-to-sales ratio] now stands at 3.4, the others at around 2,” says The Motley Fool.
It means that rather than “buying on the sound of the cannons” — in this case Trump and Kim Jong-un’s diatribe — it may be time to “sell on the news”.
Anyone who bought gold in the past few weeks will have seen it rise, but then fall in value. And when it comes to separating fake news from “real” news, things get even more difficult, so let’s not even go there.
That’s the problem with market axioms — they’re not as useful going forward as they are in hindsight.
It’s also the reason why doing nothing is almost always the best investment strategy during a geopolitical crisis. Which may be just as well, because if the US were to go to war with North Korea we’d have bigger things to worry about than our portfolios.
DEFENCE WAS ONE OF THE HOTTEST SECTORS … IN 2016, BUT MIGHT NOT TURN OUT SO HOT… IN FUTURE