Investing in a Changing World Order: Part 2
Weekly Investment Update | By Brian Schreiner
This week I want to discuss in more detail how we are thinking about the changing world order. For an introduction, please read Part 1 here.
In their 1997 book, The Fourth Turning, William Strauss and Neil Howe proposed that history unfolds in four primary and recurring cycles that together span roughly 80 to 100 years. The last cycle, “The Fourth Turning,” which Howe believes we are entering now (Strauss passed away in 2007), the world will enter a period of major upheaval, possibly involving war and/or revolution and a transformation of society.
Ray Dalio, the legendary investor and founder of Bridgewater Associates, has provided a helpful framework for understanding the forces at play. In September of 2023, TIME published one of Dalio’s articles, Why the World Is on the Brink of Great Disorder, which summarizes his book, Principles for Dealing with the Changing World Order. Like Strauss and Howe, Dalio’s work is focused on cycles. He explains that the current cycle will be driven by major forces that will affect economies, markets and our daily lives, including our investments and personal finances.
In today’s piece, I want to discuss the Financial / Economic Force and the Domestic Order Force. Next week, I will address the International World Order Force, the Acts of Nature Force, and the Technology Force.
The Financial / Economic Force
We are now in the late stages of a global debt super cycle. Government, corporate and household debt have been on a steady upward trajectory for decades reaching new all-time highs year after year. Even on an inflation-adjusted basis, debt across the global economy is massive.
Debt is a useful financial tool, however, we should never forget that debt is a form of leverage and leverage is risky. Debt must either be repaid, defaulted on or serviced endlessly, all of which are costly. In addition to this long-term debt cycle, the short-term debt cycle, also known as the business cycle, is in its late stages. If Dalio is right, that means the global debt super cycle and the short-term debt cycle could come to an end at the same time. In this video, Ray explains long- and short-term debt cycles and how they interact.
Since debt is easier to produce than savings and investment, it has become the backbone of our economy. But today there’s too much debt. The Fed’s zero interest rate policies (ZIRP) has allowed the economy and the stock market to binge on easy money for decades. ZIRP has supported the addiction to easy money and the Fed has doubled down by bailing out the failed companies in every crisis.
Legendary investor Seth Klarman, who recently edited the 7th edition of the famous investment book Security Analysis by Benjamin Graham and David Dodd, explains how “the Fed has precipitated an everything bubble.” Klarman isn’t the only one pointing the finger at the Fed.
At this point, the Fed has lost a lot of credibility and its toolkit is weakened. They say they are targeting 2% inflation, but even when inflation is above their target and the economy is strong, they’re still cutting rates. The easy money is starting to go away and we’re going to have to deal with the withdrawal symptoms. If you’re interested in learning more about how we got here, check out the FRONTLINE documentary: The Age of Easy Money.
I agree with Dalio’s conclusion: “Because of unsustainable debt growth, we are likely approaching a major inflection point that will change the financial order. It appears to me likely that we are approaching a debt / financial / economic restructuring that will lead to big changes to the financial order. It appears likely to me that because of large deficits the U.S. Treasury will have to sell a lot of debt and it appears there will not be adequate demand for it. If that happens, it will lead to either much higher interest rates or the Fed printing a lot of money and buying bonds which will devalue money.”
Besides mountains of debt (leverage), high stock market valuations and sticky inflation, rising interest rates are likely to play an important role.
In an effort to defend against less than desirable potential outcomes, we are avoiding long-term bonds in favor of private credit, natural resources, commodities and precious metals. Historically, during periods of high inflation, stock prices tend to rise along with the price of everything else, however, at this point, the U.S. stock market is extremely overvalued. We prefer modest allocations to emerging market stocks and markets with more favorable demographic trends. For more details on our current allocations, please download our Quarterly Outlook.
The Domestic Order Force
The domestic order refers to the internal workings and stability of the U.S., particularly as it relates to economic and political health, including its politics, social cohesion, and economic policies.
Political polarization and populism have been trending for years and are beginning to cause conflict in society. Wealth disparity is also growing as the gap between the rich and poor is beginning to cause tension across economic classes. The government is the primary cause of wealth disparity through ill-advised monetary and fiscal policies.
In my personal opinion, I believe the declining domestic order is reflected in observable declines in areas such as morality, decency, work ethic. I sense an increase in entitlement and immorality. I believe overall declines in our society are objectively obvious in the arts, literature and architecture.
Someone recently asked the great Jordan Peterson, “Did you ever wonder why cathedrals and other old buildings were built using such spectacular architecture and design?” Peterson responded, “If you're going to house the ultimate ideal you build something beautiful to represent its dwelling place. This is something most people do not take seriously. Think about the hundreds of millions of dollars that were invested into beauty in Europe. These massive investments in beauty have been paid back… god only knows, many multiples of times. People make pilgrimages to Europe constantly because it's so beautiful. The beauty just staggers you. Its beauty is so valuable - and we're afraid of it. And I think we're afraid of it because it's a pathway to the divine.”
I often hear people say that they are “spiritual.” But if you ask them, “Do you believe in the supernatural?” they become uncomfortable. Many of people today who say they believe in “a higher power,” have never read a book about philosophy or attend regular church services.
As investors, understanding the domestic order is important because it provides a piece of context for the work we are doing with fundamental and technical analysis. Observation and study of the changing domestic order help us understand the economic and social landscape which do influence the financial markets indirectly. α
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Interesting things I came across this week…
A Modest Stagflation Shock But Not a Recession (Torsten Slok, Apollo)
GMO's Jeremy Grantham Warns US Stocks Are About to Be Crushed (YouTube)
Gold Rush: Central banks have increased purchases by 11.5% annually since 2019 (@dailychartbook on Twitter)
Pico de Gallo: Authentic Mexican Salsa Recipe (YouTube)
Thanks for reading!
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