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As investors scramble for yield in markets awash with central bank liquidity, their eyes continue to be drawn toward the glitter of emerging markets, including those in the Middle East and South Asia, where I’ve been trolling for the past few weeks to probe the links between portfolio strategy and tail risk. Few countries offer as much fertile ground for such ruminations as Pakistan.

The Islamic Republic has its own special charm for diplomats, soldiers and spies, who worry about different risks emerging from the country and its growing stockpile of nuclear weapons. But below the Bloomberg radar, Pakistan may also have the potential to perturbate global financial markets. My time in Islamabad was brightened by winter sunshine and darkened by conspiracy theories.

“Assassinations, mayhem and lack of rule of law in some emerging-market locations often make them a marginal sideshow to global macro markets,” says Thomas McGlade, portfolio manager at London-based hedge fund Prologue Capital. “Even Syria can hardly get the attention of the markets, so the low boil that is constant in Pakistan rarely registers. But it’s the security and nuclear dynamic which could push Pakistan to the forefront.”

My diplomat friends aren’t eager to see a crisis in Pakistan, but some traders take a different view. Global macro hedge funds are starving from a lack of volatility, which is their lifeblood. Europe’s financial markets have healed dramatically since Mario Draghi promised last year to do whatever it takes to save the euro. The decision by Washington lawmakers to avoid any fiscal cliff–diving has provided a similar tonic on the other side of the Atlantic. China’s policymakers have engineered a soft landing for their economy. The civil war in Syria hasn’t spilled over into instability in the Gulf or posed a threat to global oil supplies. And on top of it all, central banks in Europe, Japan, the U.K. and the U.S. continue to pump liquidity willy-nilly into global financial markets, forcing everybody into higher-risk, higher-return assets.

All in all, it’s a pretty benign environment for the global economy but one that makes macro traders squirm. Returns at many hedge funds lagged their benchmarks in 2012, and a lot of investors are still smarting about the 2 percent fees. “We could really use some volatility right now,” one London-based trader complained to me over a curbside lager at a Mount Street pub in Mayfair. “It’s hard to make money when things are this quiet.”

And so macro traders have their ears to the ground for the first rumblings of turmoil. “There is still a desire to find, or anticipate, the next ‘tail event,’ and there certainly will be others going forward,” says Adam Crisafulli, head of market intelligence at J.P. Morgan in New York.

A couple of traders in New York and London told me that Pakistan was on their list of prime candidates for tail risk. I found this intriguing since I was headed there anyway. How much of this perception is real and how much is the cinematic reflection of Zero Dark Thirty, the gripping Kathryn Bigelow movie about the search for Osama bin Laden?

(Not that I’m immune to cinematic reflection nor to what I thought was Bigelow’s sympathetic portrayal of my former CIA colleagues. The film’s bombing scene at the Islamabad Marriott prompted me to stroll over and have tea at the hotel’s lounge, for old time’s sake. Navigating the Hesco barrier gauntlet and double-thick blast walls that were erected after the actual 2008 attack was a minor hassle, but no more so than trying to enter any U.S. embassy in this part of the world.)

On my way to Pakistan, I heard plenty more risk scenarios on a stopover in Dubai. The iPhone told me it was freezing in New York and snowing in London as I smoked shisha, or flavored tobacco, by the pool of a luxury hotel with a random scrum of traders, investors, entrepreneurs, retired diplomats, soldiers and people who describe their work simply as “export and import.” We bathed in the reflected light of the Burj Khalifa tower on a balmy 20 degree Celsius evening. I confess that I haven’t enjoyed a hookah so much since 1973. And yes, I inhaled.

According to portfolio managers, an emerging market like Pakistan could trigger one or more of four possible convulsions that would jolt markets.

For starters, something really bad could happen in an emerging market that would derail GDP growth in one of the bigger BRICS. The obvious risk here is a Pakistani economic implosion with spillover effects on its Indian neighbor. The economy enjoyed several years of nearly 7 percent growth in the mid-2000s under the leadership of reformist prime minister Shaukat Aziz, but political instability and mismanagement have sapped its strength in recent years. The assassination of former prime minister Benazir Bhutto in December 2007 unleashed a wave of violence, including the 2008 Marriott bombing. Bhutto’s widower, Asif Ali Zardari, won election as president in 2008, but subsequent governments have failed to pursue reforms, crack down on corruption or get a grip on the deficit; foreign investment has slowed to a trickle. The result? Growth has averaged only about 3 percent a year since 2008 and is projected by the International Monetary Fund to be a sluggish 3.25 percent in the fiscal year ending June 30.

There’s also the possibility that a South Asian crisis could interrupt the smooth flow of petroleum from the Gulf. Unlike Iran, however, Pakistan isn’t in a position to choke the Strait of Hormuz. To the contrary, in January the Pakistan Navy engaged in joint naval exercises with the Royal Saudi Navy to help secure the Gulf passages and the Horn of Africa against Iranian interference and Somali piracy. Moreover, the Pakistanis are close to being choked themselves. Many of the offices and residences in Islamabad are unpleasantly cool in the evening chill; there isn’t enough natural gas to turn on the heaters because the national oil company is virtually bankrupt. There are quarter-mile-long queues at every gas station. So this aspect of Pakistani tail risk is vanishingly low, in my view.

Alternatively, a terrorist attack linked in some way with an emerging market’s domestic struggle could spook markets, particularly if the epicenter is Canary Wharf or Wall Street. Pakistan is still the center of gravity of the global Al Qaeda network, even after bin Laden’s removal. (As I walked back from the Marriott, it struck me that the CIA analyst played by Jessica Chastain in Zero Dark Thirty is a full generation younger than my former colleagues who supported the Afghan mujahedeen proxies against the Soviets and did so hand in glove with Pakistan’s Inter-Services Intelligence Directorate, the ISI.)

At the far end of the scale, and most ominously, a nuclear event would trigger raw market panic. Pakistan is on its way to becoming the world’s fifth- or sixth-largest nuclear power. The prospect that one of those weapons could fall into the wrong hands, intentionally or not, is one of the few things that actually keeps me awake at night.

After a three-hour hop across the Gulf, I arrived in Islamabad and found the capital cool and much less tense than on my prior trips. It’s quiet because occupancy is down, explained the manager at the Serena Hotel. The day before I landed, Imam Tahirul Qadri, a centrist cleric who advocates good governance, disbanded 100,000 protestors who had flooded the streets threatening to storm Parliament if the government of Prime Minister Raja Pervaiz Ashraf didn’t promise new elections and “throw out the corrupt politicians.”

It’s cool because the sun rises late over the steep, arid limestone Margalla Hills that frame the city to the North. Islamabad itself is a sprawling, dusty metropolis; its once-grand municipal fabric and splendid ministry buildings show the effects of poor maintenance, economic stagnation and the occasional suicide bombing.

There are checkpoints everywhere, staffed by police, and Pakistan Army Rangers in olive-drab, long-shirttailed shalwar kameez nervously fingering their AK’s as they huddle around burning logs in the evening chill. They stand up to shine a flashlight into the passing cars; then they usually smile back, lower their guns and return to their sandbagged fireside. I confess to ducking low in the front seat one evening as a diplomat friend blithely waved to an anxious pair of Rangers as she weaved her battered Toyota through a concrete block checkpoint without braking.

Such frissons aside, I am fond of the city and its attractive residents — resilient, clever, funny and hard working. They manage to enjoy life in the face of adversity and poor governance. During my visit, Islamabad’s buildings were draped with elaborate festive patterns of lights in the evening, celebrating Milad an-Nabi, the Prophet’s birthday. Miraculously, these nighttime filigrees defy the rolling brownouts and random power outages. The Ministry of the Interior looked like Manhattan’s Tavern on the Green at Christmas.

What is the probability that Pakistan will generate one of the four tail-risk events that would move global markets? What would be the timing and magnitude of such an event, and what might be the early warning indicators — against the backdrop of a falling or failed state?

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