Game Theorist Pins Stock Market Fortunes on Spain, Not Brexit

Updated on
  • IBEX 35 Index is cheap and political fears are too high
  • Brexit doesn't provide enough outcomes to apply game theory

If you’re looking to make money betting on political turmoil, the market to watch right now is Spain, not the U.K., says William Blair Investment Management LLC’s Brian Singer.

Singer and his team of 12 analysts and fund managers in Chicago are focusing on the general election scheduled for June 26, three days after Britons choose whether to leave the European Union. They’re scrutinizing Spain’s political leaders for a sign that the pro-market Ciudadanos and incumbent People’s Party are willing to form a coalition.

Singer, who sold out of Spain after December’s inconclusive vote, is now looking to get back in. As others withdraw, he sees a political landscape with so many moving parts that applying his specialty, game theory analysis, is likely to bear fruit.

“There’s lots of opportunities there,” said Singer, the manager of the $1.8 billion William Blair Macro Allocation Fund, which beat most of its peers in the last three years. “Spain made tremendous strides to reform its banking sector and made a lot of progress throughout these years. The political risk is the only barrier to investment.”

The team manages a total of $2.7 billion for William Blair through several funds and looks for cheap markets where investor anxiety is on the rise. When political tensions are high, it uses game theory to assess the probability of an event and compare it with its associated risk. If the model indicates exaggerated fear, it’s time to buy.

In explaining the use of game theory in such settings, the firm cites “rock/paper/scissors,” where the outcome is determined by the secret choices of independent players. Politicians are faced with those kinds of challenges all the time, trying to predict the reactions of allies and foes when they take actions such as leaving a coalition.

Another set of problems tries to assess the likelihood of cooperation among players, the most famous example being the “prisoner’s dilemma,” in which a pair of separated crime suspects face hidden incentives to act in each other’s interest. A multi-party election bears a passing resemblance to that model, where the rewards of forming a coalition may surpass those of staying independent.

In the case of Spain, where the benchmark IBEX 35 Index trades near a three-year low relative to peers, Singer says the market is too pessimistic about the chances of Ciudadanos giving in and forming an agreement with the PP.

“Spain never had to develop a coalition since Franco, so we’re now in the middle of the most interesting game theory theaters,” Singer said. The most likely party to concede in negotiations is Ciudadanos, a chance the market doesn’t fully reflect, according to him. “Ciudadanos has been slowly migrating towards the center, where it tries to establish itself as a viable center-right option.”

Game theory has been used in a wide range of areas from politics to biology, but not as much in investing, said Singer, who was also the chief investment officer for UBS Group AG’s wealth-management unit in the Americas until 2007 and has been fascinated by the subject for decades. He became interested in game theory during his undergraduate studies at Northwestern University and learned more about it during his Master of Business Administration at the University of Chicago in the 1980s.

He’s now reading about the Ottoman Empire, seeking to understand the reasons behind Islamic State and Turkish President Recep Tayyip Erdogan’s actions, and how the refugee crisis and Greece’s negotiations could impact the euro zone.

Spain, where there are more potential outcomes and the IBEX 35 has tumbled 27 percent since its high last year, provides more opportunities than the U.K. if investors are fast, Singer said. His fund, started at the end of 2011, returned more than 13 percent in 2012 and 2013 as the euro-area crisis unraveled, beating 94 percent of its peers, data compiled by Bloomberg show. Spain was central to his success then, too.

While Greece’s anti-austerity Syriza was emerging as a threat to establishment parties, European stock markets were falling. Singer bought what investors feared most at the time, periphery shares. The game theory model was showing him Germany and the European Central Bank held the most power in negotiations and other leaders would need to give in.

Singer doesn’t pick individual stocks, but instead invests in markets through exchange-traded funds and derivatives. His team keeps a fifth of its money in U.S. equities, for which it’s developing a new game-theory model ahead of the Republican and Democratic national conventions scheduled for July.

But that’s for later -- now the focus is on Spain. While traders have pulled money out of the biggest exchange-traded fund tracking the market for a record seven months, Singer is slowly coming back in. His exposure is almost back at 1 percent, and he’s ready to add more if investors continue to fear that a coalition won’t take place.

Game theory allows “to cut through all the noise and figure out if it’s worth worrying,” Singer said. “We like panicky markets, that’s what we are looking for. Spain is a great opportunity.”

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(Updates with Singer's other areas of focus.)
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