FWIW # 54 - Geopolitical Issues

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Foreign policy is coming fast and furious. What do the president’s actions appear to be? Think in terms of a decision tree. While a decision tree has many branches, the one I think about in relation to the markets is the one that implies the president is rapidly rebuilding the United States’ economic and security strength. World psychology is leaning toward WWIII. As an example, before WWII, Germans tested their war-making ability by supplying the Franco side in the Spanish civil war.

Today, Russia is engaged in a war with Ukraine, and both sides are developing and using the latest equipment. The war has stalemated. The Russians are receiving help from Iran, China, and North Korea. The Ukrainians are supported by the EU and formerly by the US. European leadership is the issue. They give support to resist but not support to win. Amid the turmoil, the president has positioned the US around the world to benefit from a continued war or peace.

The Middle East

In the Middle East, Iran will not stop seeking a nuclear weapon and missile system until and unless the hardline Islamists are removed from power. It will also continue to supply proxy militias to other countries. Only Israel and President Trump seem to understand this fact. If Iran is willing to give the extremists money and guns, the battle lines in the Middle East will draw sharper as time goes on. President Trump is using his unorthodox methods to disarm this constant threat.

The protests in the streets of Iran could have and may still topple the government even despite the brutality it is using against the protestors. The United States government has said it will stand by the protestors; however, at this point, there has not been any overt assistance. If Venezuela is any indication, covert action is likely being taken. Will the Iranian government fall? No one knows for sure, but this situation is the best opportunity to get rid of the extremists in the last 50 years.

China

As Iran has been a key oil supplier to China, will the Chinese step in to protect the Iranian government? Without constant friction, the Middle East could be a major spur to global growth, including more energy for China.

            In Asia, China is selling US goods and using the proceeds to build up its military. The fear is China will take over Taiwan. One strong restraint keeping China from moving against Taiwan is the potential blowback in terms of exports. Remember, China’s economy relies on exports. As we found out with COVID, the US is dependent on China for critical supplies to maintain national security. President Trump is moving as fast as possible to reduce that dependency. Ask yourself, how did our political leadership over 50 years allow the country to become so dependent on a communist country?

            The Chinese are also spending the money they make from exports to build influence on, and establish Chinese economic dominance throughout, the underdeveloped countries of Latin America and Africa. For example, how could the US political leadership over the last 45 years allow a Chinese company to control the ports at both ends of the Panama Canal? The US actions in Venezuela, including the capture of Maduro, sent a signal to everyone south of the US border.

Greenland

The Greenland episode is an example of applying pressure to protect the country. The process likely would have been smoother without the bullying demands and threats by the president; however, without his bombastic style, nothing would have gotten done. Could his urgency be due to his understanding that the oft-declared partnership between the Russians and Chinese may embolden Russia to take military steps in the Arctic? He obviously believes in pleasing results, not pleasing methods.

Europe

President Trump is trying to put the US in a strong economic and security posture. Every step he has taken is a move in this direction. Think I’m wrong? Consider each of his actions over the last year and ask yourself, Does this strengthen our country? Some will say no because he has acted against our “allies.” But Europeans have used the US since WWII to move their own countries toward socialism while the US spent our resources defending them. Collectively, they have erected barriers against our goods and services while shipping goods and services into our economy.

Why did our political leadership believe in allowing our wealth to erode in the interest of globalization? Remember, globalization was going to eliminate war since everyone would be trading with each other—a prediction that was illogical at best and plain stupid when thought about. Some analysts say we’re the strongest country on earth. Really? We now have national debt greater than our GDP. How strong would we have been if our political leadership hadn’t allowed our country to be taken advantage of in the name of globalization?

Effects on the Markets

Even though it sounds like it, this is not a fan letter about President Trump. It’s becoming clearer that his policies, including tariffs, are driving economic growth. This year will prove the validity of those policies. GDP appears to be on an upward trajectory. If it continues, the valuations of assets will be vindicated.

            So, what does all this geopolitical craziness have to do with the markets? Over time, stock prices move toward the earning ability of the individual company. In the short term, stock prices are volatile as the market’s speculative elements react to news. These are the events that are important to the investment markets:

1. Trump vs. the Fed

The Fed and President Trump both profess to want the same thing: lower interest rates. The Fed, however, is allowing its ego to get in the way. The president’s personal attacks on the Fed chair are part of the problem, and so is the falsehood of Fed “independence.” Some US economists are touting a productivity boost that will make lower rates inevitable, but the fixed-income market seems to doubt this. Japanese rates have been hitting highs recently. US overnight rates have also had a series of spikes recently, and long-term Treasury rates jumped up last week and appear to be staying higher. Whenever a sure thing appears in the investment markets, be wary. A series of fixed-income maturities works best.

2. The Fourth Industrial Revolution

The tech stocks are undergoing a significant change. Many of the favorite names have gone from cash accumulators to indebted borrowers. The number of data centers and their costs are as staggering as the railroad infrastructure and debt incurred at the end of the 19^th century. It’s hard to imagine these costs will be recouped in a reasonable period of years. It makes sense to look at the companies in this frantic data-center-building race and see which ones are becoming overleveraged.

3. Fed Money Printing

Tech company borrowing may be part of the reason the overnight borrowing rates experience upward pressure from time to time. The Fed’s decision to digitally print more money to keep the market rate suppressed does not appear to be the right one in the long term. Just as the Fed action to accommodate aggressive Congressional spending during and after Covid led to the inflation spike from 2022 to 2026, the new money printing will likely have an inflationary cost in the future.

4. The Failure of Alternative Energy

Government subsidies and mandates for alternative energy sources seem to have failed in most parts of the country. Sooner or later, and it appears later, governments will find out that real adoption of new energy sources happens when the public perceives the cost of utilizing those new technologies as lower than that of using fossil fuels. One day that may happen, but it is not today.

Fossil fuels will be the dominant energy source for the foreseeable future. To reinforce that point, just look at the crisis of astronomical electric bills facing many communities now. Higher costs from alternative energy usage will put additional upward pressure on electric bills. What is interesting is that the large oil and gas companies are working directly with some data center companies to help them build their own power sources. This concept is putting these companies into a new end-use for some of their production—think past transportation’s use of oil and gas. The use of natural gas for turbines is increasing around the world. Further, the use of crude oil for chemicals is expanding. The oil and gas energy economic sector is important to a portfolio and will remain so.

5. Inflation

One of the supposed truisms in the current stock market is that stocks always go up over time. There are two reasons for that belief: companies’ earnings increase over time and, more importantly, even at 2% or 3% annually, inflation erodes the value of the dollar.

Think for a minute: Between the 2008 recession and 2019, the Fed told us that inflation was below 2%, and in some years, less than 1%. Yet the cost of living for the average American went up 21.74%. Stated differently, the value of the dollar (a fiat currency) declined by at least one-fifth.

Since common stocks represent businesses with tangible and intangible assets, the value of those assets will normally reflect an approximate currency value. The share price will have upward pressure unless the company had specific negative issues unique to them or to their economic sector. Only in a deflationary period will the value of fiat money increase. Since the stock market reflects the underlying value of a company and the viewpoint of speculators about the future of that value, the price of a stock will be volatile as the speculators’ belief in the currency value changes. Assuming a steady erosion of the dollar’s value is appropriate.

6. Market Sector Rotation

Market sector rotation appears to be underway. There are still sectors lagging behind the overall market valuation. Seek them out, invest in the ones that fit your portfolio, and be patient, collecting the dividend. Precious metals are the brightest spot in the speculative world. How long it will continue is not knowable. Surprisingly, crypto is showing signs of a problem. There will be major changes in the crypto markets as we get close to the implementation of the crypto legislation.

The increased volatility in stocks and fixed-income securities is a signal that market psychology is changing. Be prepared. Check your liquidity. Know what companies you own and the services they provide. Make a list of the companies you want to add to your portfolio. An accelerating economy can cause increased market volatility. Be neutral, always looking for opportunities to invest.