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Hussman Weekly: Passed Pawns

October 15, 2012
“Patience is the most valuable trait of the endgame player. In the endgame, the most common errors, besides those resulting from ignorance of theory, are caused by either impatience, complacency, exhaustion, or all of the above.”

– Pal Benko

I’ve long been fascinated by the parallels between Chess and finance. Years ago, I asked Tsagaan Battsetseg, a highly ranked world chess champion, what runs through her mind most frequently during matches. She answered with two questions – “What is the opportunity?” and “What is threatened?” At present, I remain convinced that the key opportunity lies in closing down exposure to risk, because prices in both bonds and stocks have been driven to the point where the prospective additional compensation for risk is extraordinarily thin on a historical basis, and much of these gains are the result of monetary interventions in perpetual search of a greater fool.

The final minutes of a Chess game often go something like this – each side has exhausted most of its pieces, and many pieces that have great latitude for movement have been captured, leaving grand moves off the table. At that point, the game is often decided as a result of some seemingly small threat that was overlooked. Maybe a pawn, incorrectly dismissed as insignificant, has passed to the other side of the board, where it stands to become a Queen. Maybe one player has brought the King forward a bit earlier than seemed necessary, chipping away at the opponent’s strength and quietly shifting the balance of power. Within a few moves, one of the players discovers that one of those overlooked, easily dismissed threats creates a situation from which it is impossible to escape or recover.

My impression is that investors have been so entranced by the moves of their two Knights – Ben Bernanke and Mario Draghi – that they have allowed an entire army of pawns to pass across the board without opposition. In Chess, those overlooked, seemingly insignificant passed pawns can draw away the opponent's resources, or even be poetically transformed into the most powerful pieces in the game.

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