Background
2023 was a year in which the world observed intensifying geopolitical complexity and volatility – Russia’s continued prosecution of its war against Ukraine, Hamas’s devastating raid on Israel ignited tensions and diffused diplomatic gains in the Middle East, a military coup in Niger that brought to light the extent to which the West must compete for influence in the global south, and most recently Venezuela’s referendum to claim sovereignty over a large swath of oil rich Guyana. The only regions around the globe not looking at immediate conflict are North America and Asia, the latter hotly contested at the flashpoint of Taiwan, which is heading into an important presential election as of the publishing of this note.
Markets, for the most part, shrugged off geopolitics instead largely favoring movement on any drop of economic news, primarily from the Fed – S&P500 up ~18.5% YTD midday as of writing this note, December 6th, 2023.s We view the November rally like most do, as investors pricing in hefty 2024 rate cuts. But what happens if the Fed doesn’t cut as much as expected? Or when these cuts don’t come as quickly as anticipated? We observe the 2023 rally as an overly sanguine view that solely banks on action from the Fed and does not account for unchanged fundamentals. We see the non-ZIRP (zero interest rate policy) environment as here to stay for longer than most investors want to admit, 3.5-4%+ likely prevailing during 2024. After a mostly dour outlook for valuations in 2023 the November rally has pushed the pendulum too far toward euphoria. Additionally, the world is still undergoing a profound sea change of de-globalization upending ingrained economic suppositions, and in the case of the U.S., is also de-coupling from China at the same time as geopolitical volatility is increasing. We are not settling into a new global mood of détente. All of which investors and markets fall short of appropriately pricing. For a quick summation we share a similar 2024 outlook as JPMorgan.
[Prefatory Modification] Putting together these annual notes takes time—so much time, in fact, that we’re now well underway into 2024 since beginning writing in December 2023. We realize the timing of publication makes the introduction less punchy, as we’re now in March. Some of these views have been tritely vindicated, some not so much. However, better late than never.
In our second capstone note to close out the year, we look forward to 2024 and posit four themes and events (scaling back from ten) that we believe will be the most impactful in guiding the trajectory in evolution of geopolitics and markets. We’ll track our calls and check in this time next year to gauge the efficacy of our assertions. We’ll be kicking off with the accuracy scoring of our calls last year predicated on the scale below.
2023 Re-Cap
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.
Accuracy Response: A slew of cyber-attacks in the U.S. & around the globe continued to plague both critical and non-critical consumer industries in 2023 – Twitter (Jan. 2023), MGM Resorts, Clorox, T-Mobile, AT&T, Oregon & Louisiana DMVs, and most recently ransomware attacks hitting emergency rooms across the country. Additionally, in line with our calls of inflation depressing performance, and in a non ZIRP (zero interest rate policy) environment, the sector is up on the year (Nasdaq CEA index ~+25% for 2023).
2. 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.
Accuracy Response: For most of 2023 AI certainly became the fad, if not the defacto religion, of investors (primarily Growth investors) seeking outsized returns in a rising rate environment crushing typical avenues for “easy” growth generated returns. However, when celebrity VCs begin announcing AI mandated funds and cyclical consumer services start SEC filings with the buzzword, it’s time to call the peak on the excitement in markets. When investors get swept up in hype – for any new thing – we can easily forget an important mantra of investing: Invest in what you know, strong leadership, and strong balance sheets. No doubt AI will continue to capture headlines and play an important role in company implementation for growth and valuation premiums but the flurry of excitement will inevitably die down to more pragmatic levels. Further, nearly all of the news around AI in 2023 was centered on commercial application. Potential government integration use was, unsurprisingly, dedicated to military application (U.S. & China specifically). We are a long long way away from the sort of AI application and use in private company, government, or any other use that doomsdayers compare to dystopian futures from science fiction.
3. 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.
Accuracy Response: While there were exciting developments around space travel & exploration throughout 2023, most news was centered on progress toward national programs, to a lesser extent commercial application. Most notably India became the first nation to land a craft on the Moon’s south polar region – while in near cinematic fashion Russia’s same attempt ended in a crash the very next month. All within the context of national power exertion, national security, and strategic resource acquisition. Permanent establishments on the moon will be here in our lifetime and driving these efforts are not private enterprise – It is a fact: we’re in a space race “And it is true that we better watch out that they (Beijing) don’t get to a place on the moon under the guise of scientific research. And it is not beyond the realm of possibility that they say, ‘Keep out, we’re here, this is our territory.’” And to Mr. Nelson’s point look at the South China Sea, where the Chinese military has established bases on contested islands. “If you doubt that, look at what they did with the Spratly Islands.” On markets, the space industry was generally an underperformer with Procure Space ETF down ~14% YTD for 2023, Barrons had a good article recapping goo avenues for growth in the industry.
4. 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 broad geopolitically driven volatility will continue to be a theme next year.
Accuracy Response: Both in our assessment that the war is likely not to reach a formalized peace process until 2024 and geopolitical volatility increasing, we were correct. However, while headlines like secret meetings held in December 2023 to rally support for Ukraine’s conditions for holding peace talks come across as progress, the reality is mired in much more obfuscation. The two sides remain steadfastly at odds in what they view as acceptable tables takes to begin an end to hostilities. Russia demands Ukraine’s recognition of Russian-occupied Crimea, independence for separatist-controlled Luhansk and Donetsk, and intentionally vague “de-militarisation” and “de-Nazification” of the country as well as securing Ukraine’s neutral status. Putin infamously stating “There’ll be peace when we achieve our goals” rhetorically leaving little room for negotiation. While the withdrawal of Russian troops from its territory is a core pillar of Ukraine’s peace formula. Other points include returning deported children and prisoners of war as well as ensuring food and energy security. On the surface, the two sides remain entrenched on coming to the negotiating table. While behind the scenes there is clearly some motivation to bring the fighting to an end, as evidenced by December’s Riyadh meeting, it will be almost impossible to reach amicable terms if one side believes it’s winning.
5. 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).
Accuracy Response: 1,709 is the number of incursions made by Chinese warplanes into Taiwanese airspace. The Indo-Pacific in 2023 was marred with a number of near China-U.S. near misses by sea and air in 2023, these encounters also played a large factor in the resumption of high level military communication at the end of 2023. The Straight continues to be one of the most hotly contested regions in the world, and will be even more so with the Presidential Taiwan election in 2024. Taiwan quite literally sits at the intersection of geopolitics (U.S.-China competition) and markets (semiconductor companies themselves and all of the modern industries which they power). Additionally, Biden’s visit to Vietnam ignited a surge of interest from U.S. capital in the country.
6. 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’ onwheat, 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).
Accuracy Response: This topic was more heavily in focus during the first two years of Russia’s invasion of Ukraine, with the sparking of conflict in the Middle East via Hamas’ raid on Israel, food scarcity resulting from global conflict has fallen out of vogue. While food scarcity has remained out of vogue of societal concerns it hasn’t fallen out of relevance, in 2023, record levels of acute food insecurity persisted due to protracted food crises and new shocks. In 48 countries, 238 million people are facing high levels of acute food insecurity – 10% more than in 2022. However, while we believe this is an important issue, it did not play heavily into geopolitics or market trends.
7. 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.”
Accuracy Response: From ourreader statistics, we have consumers of the newsletter in a number of countries around the world touching nearly all continents. While we’re proud of this fact, this is relevant because as is/was likely felt by all of our readers,inflation globally, played a large part of geopolitical and market maneuvering in 2023. What failed to materialize, however, was a large scale resurgence in populism. For the most part more moderate incumbents across the globe retained their offices largely won in 2022. In the U.S. “Trump” inspired populist candidates lost state elections in swaths, Sweden, Italy, Hungary, Israel, India, Brazil, and Colombia all held onto more moderate candidates each with their distinctive flair of left or right populist tendencies but a far cry from the round of 2017-2021 leaders of the populism fueled Trump era.
8. 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.
Accuracy Response: Althoughour call for Q3 2023 for Sweden and Finland ascension into the alliance was slightly over, they did both join as full members. Moreover, the depletion of ammunition and lack of Western industry to quickly fill the gap have been overhanging problems that the West is still trying to find solutions for. Although dogged by questions of continued funding for Ukraine, cohesion amongst the alliance remains strong. As geopolitical analyst Peter Zeihan puts it alliance members are “reading from the same book, but not on the same page” which, given geopolitical volatility and number of countries in the alliance, is a good outcome over a long period of time.
9. 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.
Accuracy Response: Global shifts in countries’ energy mix continue to evolve as a result of Russia’s war in Ukraine and Middle East conflict via the Hamas/Israel hostilities. While many countries pledged net zero by 2050 through the Paris Agreement, many of those same countries have brought coal plants back online and American natural gas has become nearly ubiquitous in the EU and Asia. And in fact, we are already seeing trend take place. In contradiction to global forums such as COP28 where governments pledge to transition away from and eventually phase out fossil fuels, governments are in fact spending money in a much different way. This dichotomy of rhetoric vs action is driven in large part by a growing geopolitical volatility facilitating energy scarcity and driving up national anxieties around energy security in multiple economic regions around the world. Tangibly feeling the effects of a less secure energy landscape, countries understandably trade progress on the global energy transition for national energy security.
10. 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.
Accuracy Response: The first sentence says it all – extremely unlikely. And in fact, there was no new global pandemic that roused the world into a state of lockdown. On our last item of 2023, we were factually wrong.
2024 Outlook Analysis & Themes
1. Resource Security: Thenecessity of state access to strategic resources – critical minerals (copper, cobalt, lithium, nickel, uranium etc.), oil, natural gas, and water – is imperative for modern economies to strategically maneuver on the geopolitical stage. In recent years access to these resources has become intrinsically linked with geopolitics and the ability to, not only enhance, but maintain a strategic policy leg to stand on. Put simply, if you’re beholden to your adversary’s goodwill for access to these resources you’re strategically disadvantaged.
An example of this dynamic, the onset of Russia’s war in Ukraine. Overnight, the Russian invasion flipped the table on what had been a politically tenable environment for the EU’s reliance on Russian gas into one where the EU could not politically accept total reliance on Russian gas for energy security. This was for two reasons. 1. Continued unabated EU purchases of Russian gas would provide the Kremlin with an easy means of funding a protracted conflict and 2. The Kremlin heavily bet that the EU would diplomatically capitulate given their stranglehold on a large part of the EU’s energy supply.
Similarly, the Venezuela-Guyana crisis unfolded in late 2023 over Exxon’s discovery of massive offshore oil & gas reserves in the latter’s territory. Venezuela’s Maduro administration, under the heavy U.S. sanctions and intensifying political pressure to expand democratic elections, was/is seeking leverage for strategic autonomy to maintain a stranglehold on power in Caracas. The discovery, anticipated to ramp to 1.2 MMboed by 2027, in neighboring Guyana was the impetus for the referendum held by the Maduro administration to claim sovereignty over the region of Guyana in which the offshore discovery sits. Access to enhanced oil reserves in Guyana would give Maduro the ability to sell the resource into historically high prices giving Caracas strategic maneuverability via a degree of economic relief to everyday Venezuelan’s and subsequently room to rebuff pressure for expanded elections at home.
Ultimately, the global dynamic of resource security will continue to feature heavily in both geopolitical exchanges and markets throughout 2024. For investors, domestic producers in Western countries away from kinetic conflicts are poised for stable valuation growth and continued dividend issuance. Names to watch include those gaining access to additional oil and natural gas reserves and transport infrastructure through M&A, recent noteworthy activity includes:
- In October 2023, Exxon Mobil Corp. (XOM) reached a $60 billion deal to buy Pioneer Natural Resources Co. (PXD)
- Chevron Corp. (CVX) followed up with a $53 billion agreement for Hess Corp. (HES)
- And in December 2023, Occidental Petroleum Corp. (OXY) agreed to acquire CrownRock LP (privately owned) for $10.8 billion.
- In January 2024, Chesapeake Energy Corp. (CHK) agreed to acquire rival Southwestern Energy Co. (SWX) for about $7.4 billion in an all-stock deal to create the largest natural gas producer in the US.
- Talos Energy (TALO) to acquire QuarterNorth (privately held) for $1.29 Billion in January 2024
Additionally, Russia’s invasion of Ukraine forced liquified natural gas’s (LNG’s) prolific rise in relevance within geopolitics (below). The U.S. is currently the world’s largest exporter of the resource.
Quantitatively, that enhanced U.S LNG supply is largely going to Europe (below) thus supplanting Russia as the EU’s de-facto guarantor of energy security.
In response to quickly growing demand, the U.S. is in the process of building multiple export facilities that, by 2030, will account for more than 300 million tons for new LNG capacity.
This is to say, small to mid cap U.S. natural gas producers not a part of the current M&A spree are well positioned for valuation growth over the next decade or so. This is both a practical function of energy security as well as a play on the energy transition as both the EU and Asia view natural gas as a ‘transition fuel’ as it emits less greenhouse gas emissions when consumed for energy. Somewhere in the back critics argue LNG’s methane content is worse than oil, but the overwhelming consensus among countries trying to secure cheap and reliable energy in Europe as well as developing nations in Asia is that it’s either LNG or coal…or de-industrialization which no economy will willingly accept. This secures relevancy for the coming decade.
2. Multipolar & Election Driven Volatility: Only a few weeks ago Taiwan held its presidential election, in which pro-Taiwanese independence candidate Lai Ching-te came out the victor. Starting 2024 off with an election with the gravity as heavy as the Taiwanese presidency may make the rest of the year feel like a slog…or incredibly exciting depending on your point of view. In this sentiment we take the latter.
The democratic world is heading into an extensive election year with the potential to re-shape and upend historically established ties between traditional friends and allies (below). As we discuss in our piece on a multi polar world driving geopolitical volatility, the past 5 years or so have been a slow and evolving watershed period in which historically accepted norms in geopolitical relationships have been changing; driven largely by a division in poles of global power (i.e. ‘Great Powers’ that the U.S. DoD often refers to which are the – U.S., China, Russia) or put even more plainly liberal democracies and illiberal authoritarians. A quote from our piece “Tying our concepts together, loss of asymmetry begets multipolarity, which in turn makes rules based multilateralism harder, greatly increasing geopolitical volatility and, in tandem, expands the proverbial surface area in which the probability of black cygnets can occur.” This dynamic will be exacerbated as we head into this very active election year.
3. Higher rates, Higher prices: Briefly touched on in the intro to this piece – the Q4’23 rally in equities was almost entirely driven by investor expectations that the Fed would generously cut rates at the start of 2024. To quote “what happens if the Fed doesn’t cut as much as expected? Or when these cuts don’t come as quickly as anticipated? We observe the 2023 rally as an overly sanguine view that solely banks on action from the Fed and does not account for unchanged fundamentals”. [Prefatory Modification] This piece of our note was written on March 4, 2024.
After coming out the other side of a big Q4 earnings cycle, fundamentals seem to be only slightly more intact than we thought. However, instead of stellar reports to justify historically high P/E ratios, the market is “suffering” from a “rising tide lifts all boats” dynamic – not in the economic context by which John F. Kennedy popularized the term, but rather post magnificent 7 earnings (particularly Meta & Nvidia), it’s clear that most U.S. stock prices (market cap agnostic) are at artificial premiums led by a concentration of the largest companies. This makes finding value within the U.S. equity market more challenging. Additionally, now that we’re in March with no rate cuts – we’re firmly reassured in our supposition that that the Fed will be on conservative course for 2024. Cuts will no doubt come but there won’t be as many, and they won’t be as deep as many had thought only 3 months ago.
4. Russia-Ukraine War Outcome:
[Prefatory Modification] This piece of our note was written on March 4, 2024.
The addition of a re-conflagrated Middle East to the geopolitical stage has made for a very challenged global attention span. This failing lack of gravity ascribed to the outcome of Russia’s war in Europe is manifested in a fading will across the West to strategically support Ukraine via funding and military hardware – “as the U.S. begins gearing up for a presidential election and sorts through an ongoing banking crisis, the American political zeitgeist is experiencing headwinds against bi-partisan support of aid to Ukraine and, overall, against the long-termism required to find a decisive victory against Russia” . To their credit, the most recent push for funding Ukraine aid has come from the EU, followed by what almost feels like begrudgingly, Washington. Europeans know that a decisive Russian military victory in Ukraine fundamentally alters, first and foremost, the security landscape of Europe, and second seriously threatens and challenges the global rules based order on which EU economic and diplomatic efficacy depends on. A Russian victory and re-drawing of border via military force would be both a tangible and symbolic victory for revisionist authoritarian powers (Russia of course, but China as well). In our last inaugural note, we put forward the likelihood that the conflict would likely not end by “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.” While current positioning of the war looks to favor a Ukrainian defeat, which would make our forecast of peace in 2024 correct, we hope we are ultimately proven incorrect. For the war to end with a favorable outcome for Ukraine and the collective West, the conflict will likely have to drag on into 2025. However, this prospect comes with significant challenges as enthusiasm for aid (financial, ammunition, and other hardware) falters paired with reports that Ukraine lacks the sheer manpower to continue the fight for long term.
Markets would likely take any end to the conflict as a massive tailwind, however, a scenario in which the conflict ends in Russia’s favor and markets rally would be an illusory success as over the long term the degradation of the rule of law dramatically hurts stability and free markets on which capitalism thrives. This is particularly true for sectors that sell into illiberal markets, primarily China. In 2024, investors need to care not only if but how the war in Europe ends to capture opportunity in equity markets.
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