On Course
Volatility is coming to global markets this summer. We know it’s close because we’re starting to witness panic amongst global leaders and bankers. The Swiss have cut interest rates to 0% to keep the Swiss franc from spiking in currency markets. Let that sink in for a bit because it’s a window into the future.
Gerhard Merz, the new Chancellor of Germany, just betrayed the electorate that elevated him by forcing a massive spending package through the outgoing German parliament that he explicitly vowed NOT to do if elected. Now, he wants to arm Ukraine in their fight with Russia despite the pacifist inclinations of the German people since the end of WWII.
Great Britain no longer has much of an army or navy yet it too wants to back Ukraine versus Russia. And don’t forget Emmanuele Macron, the lame duck President of France, who has offered to put French troops on the ground in Ukraine to free up Ukrainian manpower for the front lines. Sacré bleu! Did he learn nothing from Napoleon?
Things are so bad in China that we no longer know who is in charge. Did anyone notice that two of the three lead negotiators sent to Geneva to talk trade with US Treasury Secretary Scott Bessent were acolytes of former Premier Hu Jintao? Has Xi already been dethroned? How about President Trump’s comment that if he kept the onerous tariffs in place, it’s quite possible that China would split apart?
Why have India and Pakistan broken their truce? Could it be that China is getting desperate to slow the shift of industrial production from China to India? Pakistan is effectively bankrupt and China represents its economic lifeline.
Unemployment is spiking around the world. German unemployment is higher than Covid levels at 6.3%. French unemployment has spiked to 7.3% and the UK climbed to 4.5%. No wonder they’re looking to put young men in military uniforms.
China may be the worst of all. Despite changing the methodology of counting youth unemployment when it was over 20%, it now stands at 16.5%. Perhaps worse, newly minted college graduates have only a 50% chance of getting a job. As such, there are a LOT of angry young people in China with few prospects and nothing to lose.
The global economy is moving towards an economic depression at a glacial pace but I expect the decline to start speeding up this summer. Contrary to history, I expect global equity markets to lag the global economy, not lead. I covered this in the two “Slow Ride” pieces linked here. https://geovestadvisors.com/slow-ride-take-it-easy/
https://geovestadvisors.com/slow-ride-ii-michael-porter-returns/
Sometimes it seems as if there are more solutions than problems. On closer scrutiny, it turns out that many of today’s problems are a result of yesterday’s solutions – Thomas Sowell
People and institutions are self-immolating everywhere as they attempt to hold onto the old cycle – and power. The Federal Reserve is one of those institutions that is destroying itself. Later this year when the global economic downturn hits in full force, we’re going to see that the specially constructed façade of omniscience at the Fed is merely a Potemkin village behind which hides a politically motivated Wizard of Oz.
By temporarily negating the business cycle, they have created the conditions for a much bigger retrenchment in the US economy. The average American doesn’t understand the situation in the context above but he/she senses that the current direction isn’t right.
The problem is credit and the misallocation of capital; it’s also an opportunity for investors. The artificial stability created by the Fed gave rise to excessive levels of credit, particularly in private equity and commercial real estate. But unlike 2008, the bad credit isn’t limited to bank balance sheets and structured notes in insurance portfolios, it’s everywhere like a Covid outbreak. This includes retirement portfolios.
Credit is a problem because the Fed got the US economy addicted to 0% interest rates. The graph of the 3-month Treasury Bill clearly shows that for much of the past 15 years, short-term interest rates have hovered around 0%. What happens when you make drug addicts go cold turkey?
You don’t need a Phd. in Economics to know that going from 0% to 5% rates in a short time has consequences. These consequences have been hidden by the extraordinary expansion of US government debt during the Biden years. Now that the debt machine is idling, we’re going to see the ugly truth about the Fed’s misguided policies. It’s happening slowly because the debt machine was running full-out through early January this year.
The Fed can’t see past their own models. Relationships between variables in models change all the time – correlation is not causation – yet the Fed can’t see this because they’ve become a myopic institution. They’re like a driver who becomes so dependent on computer navigation that he forgets how to read a map!
Once the effects of extraordinary US government debt spending run out, the US economy is going to hit a low hanging branch at high speed. It’s happening slowly exactly as we’ve expected. Mortgage and auto loan delinquencies have been quietly building for two years. Companies like Microsoft, Meta, Amazon, and Google have been cutting headcount for the past year.
The Fed was behind the curve on inflation – their models didn’t see it coming. Once their models caught up, they overcompensated to the upside, raising rates by far too much in too short of a time. Pretty soon, they’re going to slash interest rates back to 0% and probably into negative territory. I can guarantee that the Trump Administration is going to blame Jay Powell when this happens and rightfully so. The Fed is going to be castigated by the public.
Interest rates have been too high for 3.5 years, causing a ton of pain in the real economy.
Thoughts On Strategy
Wealth is not static; it must be continuously created. It arises from human action, innovation, investment, hard-work, risk-taking, efficient organization, combining resources in ways that produce goods and services people value – Thomas Sowell
Thomas Sowell has been my favorite economist for 30 years because he has the unusual ability to combine academic rigor with common sense. The other thing I admire about him is that he doesn’t care what his detractors say about him. To thine own self be true – Sowell embodies this wisdom.
People don’t stay atop the mountain in the US for very long because we’re a nation born to compete. This is why Sowell’s quote above is so important for professional investors and why future changes in our portfolio will require fresh thinking about the way value is created in the future.
Simply avoiding the assets that were funded by bad credit, as well as the bad credit itself, is step one. This means avoiding levered loans, which are loans to entities that are heavily burdened by debt such as companies owned by private equity funds. It also includes a wide swathe of commercial real estate loans, particularly office and retail.
Step two will involve finding the companies and municipalities that are positioned for the next economic cycle. I don’t believe it will be multinationals because the Trump’s tariffs are designed to beggar the global economy so the US can grow at the expense of the world. It’s why we’re focused on domestic companies and why our trigger variables, copper and the dollar, should signal us when China and Europe are set to decline.
Yes, the courts have ruled against broad tariffs but that’s just a temporary speed bump. The US needs tariffs to re-build what was negligently discarded by the previous five Administrations - by both major political parties. The US is heading back to the future because the great global economic expansion is over.
We’ve traded the utility of a balanced economy for the luxury of importing virtually everything. In the process, our marginal ability to consume became dominated by the top 10% of the income strata as the lower 90% increasingly struggled with employment insecurity, consumer inflation, and excess debt. Those people voted to re-store balance to the US economy instead of the socialist approach of re-distribution. Future investment returns will reflect this shift.
The West created China and it has grown into a Frankenstein’s monster. The monster is experiencing an undeclared economic depression that is irreversible. Circa 2010, China faced a painful retrenchment from misallocation of capital. In 2025, thanks to the ruinous policies of Xi Jinping, China is experiencing an economic meltdown far worse than the Great Depression.
The reported numbers don’t indicate a depression but we know that Xi Jinping is very close to being deposed by party elders – for cause. We also know that the representatives sent to Geneva to negotiate with US Treasury Secretary Scott Bessent were supporters of China’s prior Premier, Hu Jintao and not Xi Jinping. Unexpectedly, President Trump gave China a 90-day reprieve citing fear that China would “break apart”. We could be weeks away from such a fracture and the global equity markets don’t reflect this risk.
Nobody understands the full implications of China’s economic demise and the impact it will have on the global supply chain because there are thousands of small companies that add to the value chains of a wide assortment of products. The Chinese government works hard to ensure that nobody has a clear picture of their internal struggles.
The last line is the reason why Trump will eventually get his tariffs and why the US will return to a more balanced economy. More than any other variable, China represents the low hanging branch that breaks our teeth, metaphorically speaking.
The Dollar And Copper
I’ve got two simple indicators that are a function of a heavy volume of research and consideration spanning two decades. I boiled it down to the dollar and copper because these two assets will move in opposite directions and because their movement will be a result of the broad changes we anticipate at GeoVest.
The dollar is going to spike despite the Fed’s balance sheet expansion over three decades. The dollar is going to spike because trillions of dollars in bad investment will be destroyed in the next crisis.
People keep talking about an imminent re-set. At some point, it will happen but it’s definitely not imminent. We need to go through crisis before the world will be ready to consider change to today’s currency arrangement. Furthermore, it will be because our global trade partners have no way to access dollars in trade except from positions of extreme negotiating weakness.
This is where crypto may finally find its place but I don’t see it as a dollar substitute. Instead, it may become a substitute for euros, real, pesos, rubles, lira, and yuan. Crypto is really nothing more than bank notes that are easily traded yet puts holders at risk of criminal elements.
A decline in copper will reflect the collapse of the Chinese economy and the realization that AI won’t be extensively utilized. That’s a piece for a later date.
China represents the marginal demand for copper in the world, putting AI aside for the moment. The Chinese government doesn’t have the money to keep building redundant infrastructure. They already have too many houses for the shrinking Chinese population. Furthermore, the world doesn’t want their electrical vehicles or green energy devices – with a few exceptions.
The Chinese population is growing poorer by the day and the export avenue is closing for the capital goods they produce. Copper is in everything they produced for themselves in the past and in the “green” products they hope to sell in the future.
I’ll write another piece about China in the future but for now, it’s decline is the central variable in my outlook for investments over the next five years.
Conclusion
The thing that hath been, it is that which shall be; and that which is done is that which shall be done: and there is no new thing under the sun – Ecclesiastes verse 1:9
My daughter ran the Buffalo Marathon on Sunday and I bounced around the course, which ran through downtown Buffalo, to supply water, nutrition supplements, and support. Buffalo has a beautiful downtown reflecting an icon of industry during the Gilded Age. As such, there are many examples of its former wealth and status.
As professional investors, it’s important to reflect on the changes that accompanied both the expansion and contraction of these locales that were instrumental in building our nation. They remind us of Sowell’s quote about how wealth must always be created because when conditions change, so too does the fortunes of people and places.
The current levels in the capital markets represent long-term speculations, not permanent plateaus of wealth and comfort. The US has been experiencing these periods since the 18th century through to the present. They represent a permanent variable in our investment landscape because there always seems to be a speculative bubble somewhere in the US at any given time.
Our investment plan is to avoid the pain and profit where possible from the coming retrenchment while creating the roadmap to take advantage of the necessary re-balancing of the US economy. It’s sounds simple enough but it is anything but simple. Timing is everything. Fortunately, we’re having a good year.
This retrenchment is playing out slowly which is exactly what we expected. Nobody likes to be patient but that’s what it’s going to take this time because the system is programmed to run on negative speculation.
It’s also going to take time for the US economy to get back on course after jettisoning so many industries and competitive advantages in prior decades. The Trump Administration has the right ideas about re-industrializing but it would take a miracle to succeed on his timetable.
If you’re interested in learning more, visit us at https://geovestadvisors.com/ and contact Paul Hurley.
Philip M. Byrne, CFA