Background
The world we live in today is nearly unrecognizable from a short two years ago. While disruption is always in play, the global pandemic both enabled and exacerbated the rate and impact of sea change level events on a global scale. While much of the world (though not everyone) has since moved on from the worst effects of covid, ripple effects from this catalyst are still being felt in 2022. This year has been, as both 2020 and 2021 were, part of a larger mosaic of an evolving and uniquely challenged geopolitical landscape. Inevitably, we believe these conditions are fundamentally upstream of capital markets.
In our inaugural capstone note to close out the year, we look forward to 2023 and posit ten themes and events that we believe will be the most impactful in guiding the trajectory of this evolution in geopolitics and markets. We’ll track our calls and check back this time next year to benchmark the efficacy of our assertions.
Analysis & Themes
1. Cybersecurity: One of the most impactful themes for geopolitics and markets is the continued rise in prominence of cybersecurity both as a pre-eminent issue area for nations to tackle and for private operators to benefit from. Prominently, the cyberattack on the Colonial pipeline in 2021 and the Russian hacks in 2020 laid bare the fragility of key critical U.S. infrastructure and government networks. Since then, the SEC has mulled over requiring cybersecurity disclosure for public issuers, and federally, there is an evolution in how the U.S. treats cyberattacks (from passive to being treated as an attack on the homeland). Cybersecurity is the base upon which economic and societal growth is built in an ever-increasingly technology-driven world that’s quickly encompassing every facet of modern-day life. Over the short-medium-and long term, we believe cybersecurity will be so ubiquitous that its function will be akin to breathing air for countries, companies, and individuals globally. As such, even with short-term inflation driven headwinds facing the industry, we believe small to mid-cap names with strong leadership and aggressive R&D spend in the space are poised to outperform over the long run.
AI Sophistication: In the vein of technology, rapid advancements in AI sophistication have massive implications for the economy, military, culture, and society. While we’ve observed plenty of hype around new uses for AI this year, we believe practical integration is still in its nascency. However, trends in AI have the potential to revolutionize national security, advancements in medicine, global travel supply chains, etc. the promise of sophisticated AI integration is to speed up and broaden the pace of human advancement. By problem-solving and arriving at solutions that, on our own, would take years, decades, or even centuries, we condense the amount of time it takes to advance as a nation. Strategically, a good metaphor would be being told the best possible move in chess that you weren’t considering. For countries thinking geopolitically, AI could offer the best placement and amount of military hardware and personnel to achieve a desired outcome. Economically, it could inform lawmakers on drafting the most efficient policies. For investors, there are limited options for pure-play single equities focused on the broad type of strategic AI detailed above. This reinforces our view that this space still has a long way to go before it becomes broadly investable. Currently, many companies employ AI, but it’s highly specialized to perform a specific business function, not an all-encompassing ‘fix-all’ solution. Indeed, many companies offering AI/machine learning services don’t derive the majority of their revenue from these business segments. However, some companies like Google, Microsoft, and Palantir all represent avenues for retail investors to take advantage of what is likely the most advanced AI currently in 2023. Outside of public issuers, companies similar to Cambridge Analytica should be noted in how they implement AI to effect material change in 2023 and beyond.
Nationalization of Space: On November 29th, China launched its Shenzhou-15 spacecraft, taking three astronauts to its newly completed Tiangong space station. We believe the completion of the Tiangong represents the starting shot of a new race in space. Currently, five participating space agencies: NASA (United States), Roscosmos (Russia, though recently removed), JAXA (Japan), ESA (Europe), and CSA (Canada) operate the International Space Station (ISS); however, the mission of the ISS is inherently diplomatic, and science focused. While the stated purpose of the Chinese space station is research and science-driven, it is also uniquely positioned to carry out clandestine operations being fully built, owned, and operated by the CCP. While only 1/5th the size of the ISS, the realization of a Chinese presence in low earth orbit is likely to spur Washington into action. Additionally, competing plans for a permanent base on the moon between Washington and a joint Sino-Russian agreement are in development, with no set timelines. Both have an open invitation for other nations to join; however, with the Russian war in Ukraine, many Western European countries like Sweden, France, and the European Space Agency have canceled cooperation with Roscosmos and are likely to back Washington’s efforts representing the collective West. These vying plans for a permanent base on the moon tell us that focus, attention, and, importantly, capital isn’t being drawn away from this new geopolitical arena any time soon. These developments will also likely impact the emerging private space industry, with ventures focused on shipping and travel at the fore. Most notably, established names like SpaceX and Blue Origin focus on commercial travel, government contracting, and satellite services. Smaller names like Astra Space focus exclusively on integrating space (low earth orbit) into supply chains and commercial transportation. The long arc trends toward a negative impact on the budding industry as Washington and Beijing aren’t likely to give up ambitions for dominance of this new theatre any time soon. However, in our note on Taiwan, we detail that we’re likely seeing the precipice of Chinese power this decade degrading their ability to maintain a permanent presence in space. Over the next 40 years, we believe supply chain and logistics-focused space companies are poised to be an established investment area. However, the next ‘Apple’ or true winner that will revolutionize the space (forgive the play on words) has yet to materialize.
Russia-Ukraine War Outcome: Perhaps, a rather obvious event we expect to play heavily in 2023 is the outcome of Russia’s war in Ukraine. First, we gauge that the war won’t end until 2H 2023, specifically, Q4 at the earliest. Fighting may ebb and flow, but we don’t expect a truly formalized peace process until then, and more likely will settle in 2024. Now, detaching from the heartbreak of war, the geopolitical results of Putin’s miscalculation have been overwhelmingly positive for the United States. The West has coalesced under common values of freedom, democracy, and the rule of law, exemplified its resolve in fighting for those values (none more than the Ukrainians doing the literal fighting), the EU is in deeper lockstep with the U.S. and trepidatious of cooperation with China, the world has been shown the effectiveness of our system of beliefs (against the backdrop of U.S.-China soft power competition), the Chinese are having to go back to the drawing board on potential plans to invade Taiwan, and Russia is quickly diminishing its capacity both to wage war and to function as a ‘Great Power’ in the long term. On the flip side of this coin, markets will continue to be burdened by the weight of continued uncertainty. Specific commodities and sectors will continue to outperform in 2023, but broadly geopolitically driven volatility will continue to be a theme next year.
Taiwan: As we’ve mentioned in our note on Taiwan, we believe China’s window of opportunity to invade and annex Taiwan is open for a maximum of 30 years, after which we believe their ability to accomplish a military victory over the country is severely compromised. Although China is rethinking the fundamentals on which they’ve predicated a potential invasion of Taiwan thanks to Russia’s blunder in Ukraine, the possibility remains a continual overhang until that window closes. To that end, and to clearly state, we do not believe a Chinese invasion of Taiwan is imminent in 2023. Resulting, semiconductors, defense, and TMT are primed to outperform in the long run. The rub of what investors and companies need to consider is a quickly changing supply chain. Global supply chain shifts out of China are already underway, and CCP planners have taken notice, part in parcel of why they are easing some covid restrictions. Out of this shift, countries such as Vietnam, India, and African nations are the beneficiaries of foreign capital and interest. Each is vying to be the ‘next China’ as a hub for global supply chains. We believe India and Vietnam are likely to be the winners of this race (both have increasing populations), and the deciding factor will be who can provide the most stable governance. To that end, Indian and Vietnamese manufacturers are primed to deliver outsized returns long-term. For broad exposure, we like emerging market indices focused primarily on Southeast Asia ex. China and Taiwan).
Food Scarcity: As a consequence of Russia’s war in Ukraine, swaths of North Africa and the Middle East will have (and are currently experiencing) shocks to wheat supplies, de-stabilizing caloric intake for these populations as Ukraine supplies a rough 80% of both region’s imports. Broadly, “15% of the world’s calories come from wheat, about 1/3 of that wheat comes from Russia/Ukraine.” As fighting continues in Ukraine, farmers are unable to plant and harvest wheat yields throughout the year. In the absence of, or better put, ‘Russian sanctions’ on wheat, we anticipate the possibility of migration from both North Africa and the Middle East to spike in 2023. Additionally, for investors, continued disruption to much of the world’s fertilizer production makes names in stable countries attractive. Even in a scenario that includes a near-term close to the war in Ukraine, food instability is likely to play to the long-term importance of agricultural development (potash in particular).
Global Inflation – Resurgence of Populism: Recent headlines have lauded menial decreases in the U.S. inflation rate. However, we believe that, both in the U.S. and globally, inflationary pressures will persist for most of 2023. In the developed world, persistent inflation has an outsized potential to destabilize current political environments. Lack of economic momentum, cheap energy (as much of the West works to replace Russian barrels), and the potential for food scarcity-based migration (above) converge to create potential shifts away from moderate political regimes. Additionally, for market-based economies outside the U.S., demographics over the long term create a challenging environment for monetary and fiscal policies. At a high level, “we’re converging on mass retirement more or less at the same time, with the developed world leading the way, the majority of the baby boomers of the world aging to mass retirement at the end of this year. So we’re there; it’s not an issue of having too few children it’s now an issue of having too few tax-paying and working-age adults…we now have to get by with a world with less market and fewer working adults and fewer taxpayers, and less capital, and that means less trade because you can’t have trade without consumption, and consumption requires adults.”
NATO Expansion & Cohesion: Another positive outcome of Russia’s war in Ukraine has been the addition of Sweden and Finland to NATO. However, their full ratification into the alliance is still being hamstrung by Turkey and Hungary. Formal inclusion of the two Nordic countries would drastically shift the defense environment in Europe. As Hungary is expected to ratify both Sweden and Finland’s entry in Q1 2023, the last remaining hurdle (and it’s a big one) will be Turkey. We predict that both countries will be full-fledged NATO members in 2H 2023, specifically in Q3. Additionally, though not a 2023 consideration, NATO cooperation with allies in the Pacific should be carefully watched as formalized ties or expansion in strategic synchronization here would dramatically alter the defense landscape in Asia. Moreover, as an outgrowth of potential inflation/migration-driven political shifts, internal pressures will be put on European NATO countries threatening continued cohesion. A unified NATO will be hugely impactful in 2023 as it will impact the outcome of the war in Ukraine and serves as a deterrence against a Chinese invasion of Taiwan. Though facing potential political turbulence, we believe European NATO countries will ultimately be in lockstep regarding financial and military aid to Ukraine. For investors – as Western arsenals deplete from the mass moving of hardware to eastern Europe, expect traditional U.S. defense names to benefit from restocking orders to provide U.S. and Western European NATO members with the latest equipment – a process that will be years in the making. This space is doubly relevant with a potential conflict in the Taiwan Strait.
Climate Change & Energy Transition: The West’s collective efforts to detach from Russian energy are inherently leading more capital to ‘green’ solutions. 2023 is likely to be the year of the material confluence of results between climate change, the war in Ukraine, and the energy transition. To lay out the chain of events:
- The majority of countries the world over acknowledge climate change poses an existential threat (though the Paris Agreement was signed, many countries are projected to blow past the 2050 emissions threshold)
- Russia’s war in Ukraine forced the collective West to replace Russian barrels in favor of ‘trustworthy’ oil & gas producers (though no single source meets this requirement.) This has accelerated the pace of capital investment in ‘green’ solutions, more in Europe and less in the U.S.
- Across the U.S., EU, and China, the material effects of climate change were truly felt in 2022 as historic heatwaves and droughts impacted energy generation, access to potable water, industry disruption, and food production. While enforcement of the Paris agreement is voluntary, governments are much more likely to act when food, water, and energy security is threatened. This will lead to tangible momentum in the energy transition.
Immediate impacts in 2023 will likely be more felt on the climate change front and less on the energy transition. We believe we will see an increased volume of volatile weather events (earthquakes, storms, tornadoes, etc.) as well as drought, flooding, and heat waves. While we believe the energy transition will inevitably take place, it will be over the next 100+ years, not measured in decades, and certainly won’t impact 2023. Additionally, the transition will include traditional energy (oil & gas) and other sources like nuclear as we’ve seen new plants come back into vogue, while commercially available and cheap renewable sources are still developing as an industry globally. Investors should consider U.S. energy producers as they will likely benefit from increased global demand and expanding domestic production capacity. Additionally, we like rare earth mineral miners and cheap broad-based renewable technology index funds as, over the long-term, renewable energy trends favorably.
Global Pandemic: While we believe it is extremely unlikely in 2023, the possibility of another global pandemic that disrupts the global economy is not 0%. An Increased pace of glacial melting poses the threat that centuries-old viruses preserved in ice could spread to local populations and eventually internationally. Again, for 2023 we believe this will not play a role as the possibility remains incredibly low, but it should be considered as we’ve seen how quickly events like these take a toll on global economies and industries.
Sources:
[1] https://www.bloomberg.com/news/articles/2022-12-28/us-to-require-negative-covid-tests-for-travelers-from-china
[2] https://www.bloomberg.com/news/articles/2021-06-04/hackers-breached-colonial-pipeline-using-compromised-password
[3] https://www.nytimes.com/2020/12/14/us/politics/russia-hack-nsa-homeland-security-pentagon.html
[4] https://www.sec.gov/news/press-release/2022-39
[5] https://www.bloomberg.com/news/articles/2022-11-29/cybersecurity-stocks-drop-as-crowdstrike-warns-headwinds-growing
[6] https://www.bloomberg.com/news/articles/2022-11-29/space-race-heats-up-with-shenzhou-15-launch-of-astronauts-to-china-space-station
[7] https://theconversation.com/chinas-new-space-station-opens-for-business-in-an-increasingly-competitive-era-of-space-activity-195882
[8] https://acrosstatlantic.com/island-fever-taiwans-midterms/
[9] https://acrosstatlantic.com/the-solomon-islands-a-microcosm-of-soft-power/
[10] https://acrosstatlantic.com/bretton-woods-iii-global-trade/
[11] https://www.npr.org/2022/08/31/1120223535/ukrainian-grain-is-arriving-in-east-africa-for-the-first-time-since-russia-invad#:~:text=Ukraine%20is%20one%20of%20the,80%25%20of%20what%20they%20have.
[12] https://www.youtube.com/watch?v=_U3pVW4u_vw
[13] https://www.youtube.com/watch?v=oARuhc4TwYY
[14] https://www.defensenews.com/global/europe/2022/12/29/sweden-finland-try-future-ally-path-with-turkey-in-bid-to-join-nato/
[15] https://www.japantimes.co.jp/news/2022/07/11/asia-pacific/politics-diplomacy-asia-pacific/china-asian-nato/
[16] https://www.downing.co.uk/news/the-nordics-a-renewable-energy-powerhouse
[17] https://www.bbc.com/news/62751110
[18] https://beta.nsf.gov/news/15000-year-old-viruses-discovered-tibetan-glacier
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