Confusion Reigns
2025 is playing out much like we anticipated. The US economy keeps slowly weakening even as the equity markets remain elevated. Meanwhile, the Chinese economy is rapidly deteriorating, less so Europe and non-China Asia.
Equity markets don’t reflect the degree of economic malaise that exists across the globe because global central banks have learned that equity markets are key indicators for inspiring economic confidence. It’s why China and Europe are experiencing strong equity performance. It won’t last.
Equity markets are typically a leading indicator of the economy but no longer because government intervention is happening everywhere. It’s why equity markets are going to lag economic fundamentals in this cycle. Stocks around the world won’t drop until the global economic downturn becomes so obvious that no amount of intervention can maintain this artificial elevation.
It's not going to start with the US. The Big Beautiful Bill represents some substance wrapped in many layers of pork but that pork should soften the economic impact of global weakness. Europe’s new-found belligerence manifesting into aggressive defense spending should halt their slide somewhat which means we need to look to China to start off the global downturn.
China’s economy is a dumpster fire full of week-old eggs and seafood. If not for the CCP’s iron grip on news and economic data, the world would know the truth. Things are so bad that it appears that Xi Jinping has been effectively deposed, with a committee of party elders curtailing the power of the Party Secretary.
Yet none of this information is reflected in global equity markets where the party continues unabated. Too many hedge fund managers took the bait and shorted the markets in March and April believing that tariffs would crush the global economy. They were right about the impact of tariffs but wrong about the timing. As they say, timing is everything.
As I’ve written before, the US is addicted to low interest rates and debt in general. We’re also addicted to outsized government spending. As much disdain as I have for the Big Beautiful Bill, I grudgingly admit it’s the right course for today. It represents less of a corporate restructuring and more of soft transition from a government-led economy to a market-based economy.
In conjunction with trade tariffs, it represents an aid package for re-establishing high-end manufacturing operations in the US while conditioning our trade partners away from the post-WWII system that allowed them an unequal manufacturing playing field. In short, we gave our trade partners unfettered access to our domestic markets in addition to keeping the seas safe for shipping while allowing them to set tariffs on our exports. In return, they would use the US dollar for international transactions and support the US against the USSR on geopolitical questions.
The USSR has been gone since 1992 yet we still maintain the system designed to counter the Soviet Union. I sometimes wonder if we elevated China to the level of superpower to justify our security apparatus? The answer doesn’t matter because China IS a geopolitical competitor today and that necessitates our outsized defense spending.
We kept the system in place for 30 years beyond its expiration date and hollowed-out our economy in the process. The chart below is the price that we paid to keep the unsustainable system in place for 30 years beyond its useful life. This growth is unsustainable.
For the past 15 years, I’ve been estimating that organic growth ended around 2006 although we can make an argument that the real end-date was 1999. The chart above supports my thesis.
The US no longer needs to “buy” friends which is why we no longer need to offer our trade partners preferential terms; we can return to competing on equal terms. While returning to equitable relationships is justifiable in conversation, US producers need time to ramp up production to generate the scale sufficient to be competitive. Furthermore, the timing is bad for the rest of the world; they desperately need to sell to the US as global consumption is weakening.
The transition is going to be rough on the US economy but it’s going to be brutal on the rest of the world. The Big Beautiful Bill has incentives to ease the transition and enough pork to season the gravy train such that the US should outperform the rest of the world by a wide margin.
Interest Rates
Interest rates are much too high for the US economy. Alan Greenspan, Ben Bernanke, and Janet Yellen got us hooked on the morphine-drip of low interest rates such that our economy is suffering from withdrawal like an addict in a detox center. Even the federal government is getting the shivers as it deals with the extra $600 billion we are paying on interest each year.
Jay Powell, the current Fed Chair, seems to have fashioned himself as an intrepid inflation fighter in the style of the great Paul Volcker. It’s the wrong fight at the wrong time. Where Volker is considered a hero among central bankers, Powell’s name is destined for scorn in the history books yet to be written.
The European Central Bank’s overnight lending rate is 2.40%. The Swiss National Bank’s overnight lending rate is 0%. The Bank of Japan’s overnight call rate is 0.1%. The Shanghai Interbank Offered Rate is 1.6%. Meanwhile the US federal funds rate is 4.33%.
As the global economy weakens through the end of the year, the Fed will be forced to cut rates aggressively. Ultimately, I expect rates to hit 0% or lower before the end of this deflationary cycle.
0% represents full-blown financial repression and I expect it to happen because it takes organic growth to service our excess debt, something we haven’t had in at least 20 years. It’s why I like the idea of owning long-dated, zero-coupon US Treasury bonds. Lock in close to 5% and let time work for you!
Meanwhile, 0% interest rates will make it easier for industrial concerns to return operations to the US. Ride the long end of the curve down to 2022 levels, or lower, and capital gains will follow even if the rest of the market is weak.
Artificial Intelligence
Unless something dramatic comes out of the AI space soon, I’m starting to fear that investments in AI by major companies such as Microsoft, Google, Tesla, and Meta are going to yield future losses. They have all spent billions on developing AI models that promise to replace high-cost engineering, science, programming, and financial talent but they may be destroying their own business models in the process. Along with efficiency gains, are they also empowering enemies of civilization? Criminal enterprises, rogue states, and geopolitical competitors can all use these models and hardware to make the internet untenable for all but the most securely protected.
Will the result be a need for more physical security of financial assets? Will bank branches return to being the center of the financial industry? It’s a reasonable question because criminal elements are already forcing financial organizations to demand physical proof for many kinds of transactions that had been previously automated.
The future doesn’t move in a straight line. Sometimes the law of unintended consequences changes the trajectory of industries that are seemingly unstoppable. A great example of this law is in Climate Change and “Green Energy” in particular. The need for extraordinary increases in electric generation to feed AI has resulted in many abandoning the green energy initiative because it isn’t compatible with the needs of AI. Furthermore, we have learned that China has installed surreptitious coding into the inverters that change the DC power generated by Chinese solar panels to the AC current we use in our electric grid. This coding has security experts concerned over China’s ability to “shut down” electric grids that use its solar panels.
It’s still too early to identify the long-term beneficiaries of AI, beyond equipment suppliers, because it takes time and capital to integrate technology into business models. This is made worse by concerns over weakness in the global economy that has corporate boards uneasy.
The problem for the stock market is that AI has been the driving force behind gains in the indexes, led by Nvidia, Tesla, Google, and other tech giants. The market is paying for success in AI before getting proof that it will be successful for these firms, apart from Nvidia. Unlike the internet revolution which drove extraordinary levels of investment and public acceptance, AI is being “pushed” on us without the public’s enthusiasm.
I haven’t yet seen an AI application worth paying for outside of defense applications. As such, I suspect we are getting closer to a Y2K moment for these stocks and beyond that, I’m concerned that empowering criminals will make many on-line financial apps unusable for the masses. This could prove negative for the stock market later this year.
The GeoVest Approach
The US is moving away from being the “nice guy” in global trade , no longer allowing our trade partners to take advantage of us even as the Chinese economy moves closer to a cliff-dive. These two factors are putting extraordinary levels of stress on the global economy which is why I believe that it is prudent to discount these risks in our client portfolios while the stock market is at an all-time high.
The long-term opportunities for the US economy are piling up even as the rest of the world is facing an economic crisis due to war, growing Chinese weakness, and the prospect of losing market share to US companies in trade. The global economic pie is getting smaller and the US is demanding a bigger slice of what’s left.
Paul Hurley continues to expand our presence on Linked-In and X(Twitter) where he is posting updates regularly. I’ve been adding to our analyses on our website www.geovestadvisors.com under the 2nd Derivative section of Insights. I post two insightful pieces a month. These represent a deeper dive than what I can cram into this newsletter. You’ll see that we are viewing the present climate opportunistically and without trepidation.
The US economy has the potential to completely dominate the rest of the world in trade. We have competitive advantages in most critical industries and the potential to develop those advantages where we are lax today such as rare earth metals.
While the global economy is facing a 100-car pile-up on the expressway, the US has access to a service road that lets us avoid this trap in most industries. I am truly excited for the prospects of the US economy as Americans have proven for 250 years that we are up to any challenge! Thank you and it is our continued pleasure to serve you.
Philip M. Byrne, CFA