The Daily Alpha: Real Talk with Chris McKee of The PRS Group

Jun 2 2017 | 12:31pm ET

Today, we speak with Chris McKee, the CEO and Owner of The PRS Group, a quant-driven political risk consultancy. McKee received his PhD in international political economy from Queen’s University and is a former faculty member at UBC in Vancouver.

The PRS Group maintains two proprietary methods to assess risk that are quant-driven and back-tested regularly by independent organizations. They are the product of more than 20 years of research with the State Department and the Central Intelligence Agency. The data series, affecting 140 countries, dates to the early 1980s. PRS generates close to 100,000 original data points annually.

In 2016, the company accurately forecasted the likelihood of Spain’s special elections. In April, The PRS Group accurately projected that Hong Kong’s September elections would shift in favor of pro-democracy and independence groups and exacerbate tensions between pro-Beijing and pro-independence camps. And at the start of the year, PRS offered a very accurate assessment of geopolitical risk in Europe, the United States and China in the months ahead. This included the market reactions to the recent French election.

FINalternatives: Given Angela Merkel’s recent statements that the world can no longer rely on the United States, are foreign leaders and investors looking to our nation with new eyes and having to make new plans for the future?

Chris McKee (CM): I think that sentiment – viz., looking at the U.S. with different eyes – is largely a product of media and elite opinion, although perhaps it might be true in relation to larger, foreign policy objectives (Syria) or those affecting multilateral agreements (Paris Accord).

As far as institutional investors go, I don’t think the opinions of politicians really matter all that much. I’ve made this distinction before in some of PRS’ client letters; that is, the distinction between politics and policy: the former being simply ‘noise.’  Most studies that have looked at the extent to which politics (at least in developed, Western nations) affects the behavior of assets or the economy have found that the real impact comes from the "fundamentals" or the policy: inflation, monetary and fiscal policy, currency volatility.  That’s what investors – and indeed business – consider. Not the latest inflammatory statement or report by a journalist.

Even in the case of France, even if Marine Le Pen prevailed, I suspect there would have been some rather significant drawdowns in the equity markets in France and elsewhere. But politicians are generally reactive and need to balance a range of competing vested interests.  The status quo usually prevails or at least – and we can see this in relation to the frustration Trump’s policy agenda has experienced – it corrals politicians that try to go outside. This is the case in developed markets. Most emerging markets and especially frontier markets would be the exception.

FIN: How much of the “problems” that we’re hearing about are the actions of Trump and how much is media hype?

CM: Most of this is media hype. I‘d estimate that 80% is driven by the media. In the end, investors look at more tangible factors when taking tactical and especially strategic positions in their portfolios.

FIN: Markets have been resilient despite the perception of geopolitical problems in North Korea and Iran. What is happening?

CM: Looking at Iran and North Korea, neither has the power to move the markets unless something really significant happens: a government is overthrown; a leading politician is assassinated; a war breaks out. And whether this has a real impact on the markets over time is largely the product of the kinds of linkages the country has with the world economy.  How important is Iran (now) to the world oil market? Not as much as it was 10 years ago.

North Korea is a different story. A prestigious hedge fund manager recently told me at the 2017 SALT Conference that dialogue with Kim Jong-un was essential and he welcomed Trump’s suggestion of a meeting. (It was more than tongue in cheek.)

Whether dialogue will do much is probably fanciful thinking. But I think the new administration did the right thing in taking a more constructive approach to our relations with China because that country would face some serious issues if hostilities between the North and South broke out; issues involving refugees and all of the unpleasant "political" issues that accompany migration of this sort.

Again, North Korea doesn’t occupy a significant role in the world economy, so hostilities from there – depending on how significant they would be – would immediately affect the typical ‘safe-haven’ assets (gold, U.S. Treasuries and so on.)

FIN: There is an idea that China is the economy and geopolitical force of the 21st century. But how seriously can we take China if they are unable to contain North Korea?

CM: I think the containment would be a multilateral effort, as it has always been. That China and the United States met recently and the summit between the leaders was generally seen as a success (with Trump backing off all the pre-election rhetoric, which, on the currency manipulation issue, never made any sense to me, by the way) is suggestive of how this would play out.  I don’t think the media would be a very good source of information on this issue, at any rate.

FIN: What did you make of Moody’s downgrading China’s sovereign debt? Are there any other big economies that could face a similar fate in the near term?

CM: I was not surprised. PRS had China’s risk scores – as they touch on this aspect – in the "high risk" category for years. Our clients were informed. Besides, in discussions with my clients, I’m not sure how much weight they put into the decisions by the rating agencies – at least in terms of their timeliness.

I think there are some countries in the Middle East and Sub-Saharan Africa, especially, that, given their fiscal situation and the downturn in their major FX earners (oil and other commodities) could be in a tenuous position. 

We were correct about Congo, incidentally. But what we also see is that the multilaterals tend to move in an offer balance of payments support prior to any potential default or debt moratorium. Remember: sovereign defaults are essentially political decisions as opposed to economic or financial ones.

FIN: What is the region of the world that is on your radar right now that offers the best investment potential? Where do you think there is too much hype and susceptibility to a downturn?

CM: On the currency side, we are bullish on the Mexican peso and the South African rand

It’s a tricky play but we think, overall, there is a good case to be made for long positions in these currencies against the USD.

PRS also likes emerging and frontier markets as an asset class given their valuations and given the weakness of the greenback lately. Haitian infrastructure is also a favorite of PRS given the relative stability that has come upon that country over the last couple of months, its proximity to the DR and better relations between the two countries, and the need for Haiti to rebuild after years of neglect and environmental damage.

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Garrett Baldwin is the voice of the The Daily Alpha, the features editor for Modern Trader magazine, and the author of The Man with The Big Red Balloon. 

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