Geopolitical Pessimism And Investing

Date: 7/8/2022
Author: Mr. X

According to a Reuters poll of analysts, the American dollar is expected to remain strong for at least the next few months. As this is written, the stock market has strong together a winning streak of four days and there is increasing confidence in the Fed’s ability to control inflation without pushing the country into a recession. The White House is claiming that the United States is stronger than “we have been in history [sic].” And while many might scoff, there are reasons to think the proclamations of doom are premature.

Unemployment is low, though it is rising. Bank of America notes that consumer spending remains higher than it was last year. Spending increased compared to last year at this time. Gas prices are, in fact, declining. While President Biden is caught in a scandal because oil was exported to foreign countries even at a time when the Strategic Petroleum Reserve was trapped, he’ll probably survive. Besides, his political nemesis, Senate Minority Leader Mitch McConnell, says the real problem is that Americans still have too much money from the stimulus.

In short, there’s not really evidence of a true crisis. Why then does the country feel like it is on the brink of financial disaster?

Don’t chalk this up to just my gut feelings. A recent poll found 52% of Americans said they were worse off than they were a year ago. In June, the index of consumer sentiment hit its lowest level in its entire history. A poll of 70% of economists said the country was heading into a recession and more than half of Americans a month ago said that we were already in a recession.

Things do seem to be improving lately, with the stock market recovering and prices falling. However, earlier this week, the 2-Year Treasury yield once again inverted above the 10-Year yield, traditionally a warning sign of recession. Michael Burry of “The Big Short” fame is predicting “long-term inflation,” because of global supply chain disruptions and continuing geopolitical tensions. On that front, there’s an indication the Chinese government is about to engage in a stimulus program, issuing about $220 billion in government bonds – this year. That’s a flashing sign that the Chinese government is probably not going to meet its 5.5% economic growth target… and even if it does, we should question the legitimacy of that report.

In Ukraine, Russia has now secured one of the two “People’s Republics” that supposedly served as casus belli. Meanwhile, Europe is already blinking, as energy prices hit a six- month high. The “Green Agenda” is in full retreat, with the Netherlands, Germany, and Austria all returning to coal. This is drawing protests from some climate activists. However, there are far bigger protests against new climate regulations in the Netherlands that were designed to reduce nitrate emissions. Dutch farmers are blocking roads and ports with their tractors. They’ve also rejected negotiations with the government, suggesting that this will continue for some time.

In Ukraine, the war has hit a critical point. Following the “liberation” of the Luhansk People’s Republic, Russia is now concentrating its forces on the Donetsk People’s Republic. Ukrainian forces are reportedly reaping a heavy toll with their new Western artillery pieces and they have successfully established a new defensive line. Ukraine is also rejecting any negotiations and refusing to trade land for peace, even Crimea.

However, Russia does not seem like it is in retreat. President Vladimir Putin enjoys widespread popularity and sounds confident. “Everyone should know that we have not started in earnest yet,” he said. “At the same time we are not refusing to hold peace negotiations, but those who are refusing should know that it will be harder to come to an agreement with us [at a later stage].

There’s some truth to this. Russia has not declared war or fully mobilized, defying some predictions (including mine) that it would make a move towards doing this on Victory Day. While Russia is desperately trying to recruit new soldiers, it can still count on reserves. It has even threatened the West. “Today we hear that they want to defeat us on the battlefield, let them try,” he said. “We have heard many times that the West wants to fight us to the last Ukrainian. This is a tragedy for the Ukrainian people, but it seems that everything is heading towards this.”

Russia also is enjoying a symbolic triumph with the fall of British Prime Minister Boris Johnson, perhaps the single biggest backer of the Ukraine in the entire West. It’s unclear whether whoever succeeds him will continue his policies, especially as the economic situation worsens in the UK.

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Perhaps the most interesting news is coming out of China on the geopolitical front. Foreign Policy reports that “Beijing is confident in the United States’ decline and unwilling to rock the boat.” While China did not enthusiastically back Russia, it did not condemn it either. “In this context, China’s strategic priority is to avoid doing anything that would interrupt the process of U.S. decline,” the magazine wrote. China does not want Russia to drag it into a conflict prematurely… but China does see the conflict itself as inevitable.

The key is that China is putting its short-term economic interests over its long-term strategic interest. The Chinese government is boosting aid for EVs, which is obviously going a long way towards helping Tesla [TSLA] from its recent decline. Chinese EV companies are also increasing.

There are two major areas investors should be focused on. The first is Holland. The big trend in investing was supposed to be Environmental, Social, and Governance (ESG) stocks. However, as we’re seeing in the Netherlands, this represents a major threat to farmers. The protests are also spreading quickly to other countries. Countries like Canada were able to crush protests like this, but that was mostly focused on vaccines. This is something more primal, and the Dutch protesters seem to have more support from among the people. If protests spread in Germany and other European countries, we could see the Atlantic order start to tremble.

The second area to watch is Turkey. Turkey is a NATO member, but often doesn’t act like it. Turkey’s been suffering from crushing inflation, has protested the entry of Sweden and Finland into NATO, and is accused of letting a “stolen” ship filled with Ukrainian grain leave port. President Recep Tayyip Erdoğan is operating as an independent pole between NATO and Russia. He does not see his interests as aligned with those of Brussels or Washington… and there’s always the chance he could align more closely with Russia if NATO doesn’t give him what he wants.

Western Europe and Turkey are the two elements investors need to keep their eyes on. Short-term, it does look like the Fed may be able to thread the needle. However, as Michael Burry seems to suggest, there are geopolitical factors that are going to continue. Investors counting on a best case scenario are kidding themselves. We could see a populist uprising in Western Europe that would dramatically increase food prices and destabilize government. It would also reduce the pressure on Russia, which, at this point, seems to be winning the war and ready to operate over the long term. If Turkey itself pulls out of NATO, that could be a tipping point that would cause the end of the entire Atlantic order.

Never underestimate the possibility of chance, choice, and individual decisions to shape global markets. Even as this is written, it has been announced that former Prime Minister Shinzo Abe has died of his wounds after being shot yesterday. Japan is a pillar of the American geopolitical order and absolutely essential in any long-term plan to contain China.

This alone will change the Asian security environment.

Volatile markets can deliver major gains… but never operate on the assumptions that just because something is happening now it will continue indefinitely. The world can change with a single action.

Mr. X is an investment analyst working in the Washington DC area who specializes in the intersection of business and public policy. After fifteen years working in politics, he writes on a classified basis for to bring you news on what those with power are debating, planning, and doing.

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