From the original piece:
“We live in a dangerous world where instabilities are proliferating and the forces outside the control of the global corporate machine are large and intimidating…
Why would an investor expect sustainable growth from their investments when the policies that have created the current environment are completely non-sustainable?”
We mentioned the following six major risks and we will provide an update to these risks and discuss new risks that have emerged:
"Almost across the globe, developed countries have embraced a fiscal posture to create money and spend on an unsustainable basis, which has a short-term and long-term effect. On the short-term basis, the economy becomes dependent on the steady flow of capital throughout the economy. On a longer-term basis, the public debt load overwhelms the economy and cannot be repaid."
- October 2022 — As our policy makers finally acknowledged that their actions had in fact created structural (not transitory) inflation, they have tapped the brakes on easy money and begun an aggressive interest rate hiking program that has yet to tame inflation. We obviously maintain a mountain of public debt, but we haven’t reached the scary point where we struggle to find buyers for it and are forced to raise interest rates further. Aside from inflation, another outcome of this policy has been general labor unrest and a lack of an adequate work force, which continues to leave economic uncertainty and will make inflation control difficult.
- Risk Profile — It’s hard to call this a high probability or likely outcome given this issue has persisted since the 1960s and has yet to show signs that today is different. But, items remain on a tilting table until they all fall off at once when the angle becomes too steep. If this issue did manifest itself, inflation would spiral as the central banks would have to print money at an ever-increasing rate.
"The Middle East has just become exponentially more dangerous as we have a U.S.-armed Taliban that can move freely across Afghanistan and quickly into adjoining countries, most assuredly making the entire Middle East a more dangerous place."
- October 2022 — The Middle East has remained relatively quiet since our disastrous exit from Afghanistan. It’s difficult to identify every impact of this phase shift in foreign policy, but downstream problems will likely rear their head at some point. Iran and the US have never been great friends, but our precipitous fleeing from Afghanistan encourages the kind of stark defiance that Iran has shown with their decision to supply Russia with missiles and drones against Ukraine.
- Risk Profile — The disaster outcome here is pretty simple: Tensions between U.S. and Middle Eastern countries mount as American leadership makes tactless decisions; conflict ensues.
"The Delta variant is proving to be too contagious to contain in the short run. While it will likely hasten our move to herd immunity, it will also certainly put a short-term muzzle on growth around the globe."
- October 2022 — The Delta variant and Covid more generally has become almost a non-issue for most developed countries. It has proved to be much more difficult in China as they have been in continuous lockdowns for the last 12 months, which has slowed their economy beyond what any economist would have predicted. China has even temporarily decided to not report their most recent economic data. This may have reduced the risk of a Chinese invasion of Taiwan in the short run, but it has added to the risks of a major global slowdown. It is also likely we are not quite done with Covid as there are new variants in Singapore, Hong Kong and Europe. According to the Daily Beast, there is a new variant, XBB. “XBB is in many ways the worst form of the virus so far. It’s more contagious than any previous variant or subvariant. It also evades the antibodies from monoclonal therapies, potentially rendering a whole category of drugs ineffective as COVID treatments.”
- Risk Profile — Covid is likely a permanent fixture of our lives; this seems to be fairly certain. Whether it settles into influenza’s partner in crime, or continues mutating into something deadlier remains to be seen. In the former case, financial markets and global economies will be unimpacted. In the latter, flash crashes may be on the horizon if countries refuse to learn that lockdowns are a bad policy
"As the U.S. has made responsible economics and our foreign security a secondary concern to the coronavirus and social equity concerns, the country's financial dominance, strength and security is being threatened and opening the door for our potential foreign competitors to gain ground. China may be emboldened to expand its control in Asia with a move against Taiwan while Russia may feel equally emboldened to move on Ukraine. Why not make your big moves when the U.S. is distracted and has non-unified leadership?"
- October 2022 — Russia did make a move on Ukraine, but has had much more limited success than anyone would have guessed. Western arms, Ukrainian resolve and Russian incompetence have collectively allowed Ukraine to very successfully defend their homeland. The Biden administration has been happy to fund the war in Ukraine but domestically still appears more focused on social equity concerns than the economy.
- Risk Profile — The outcome of the war hangs in the balance, but it's clear to me no outcome is a good one. Russia’s pariah status and isolation in the world could lead to many bad outcomes ranging from the use of nuclear weapons to an economic collapse creating great economic instability in Europe.
"We now have most of the developed countries around the globe with non-sustainably high debt-to-GDP ratios that leave little room for maintaining their current policies. There will likely be a large economic vacuum when these countries are all forced to change policy."
- October 2022 — This is taking place aggressively as we are seeing a global rise in interest rates led by the US. It’s unclear if central banks will have the resolve to keep rates high long enough to squelch inflation. Even if central banks are successful in this endeavor, the higher rates actually make their debt a greater burden and harder to pay back.
- Risk Profile — The risks of this change in policy having a strong impact on global growth are increasing substantially. Higher interest rates are increasing the likelihood of a global recession.
"Emerging markets with debt-issuing capabilities have also followed the lead of developed economies and have taken on large debt loads. There will likely be some serious defaults that will cascade to affect much more than some small economies."
- October 2022 — We have yet to see an emerging market collapse under their debt load but there are many candidates waiting to be first.
- Risk Profile — The risks of contagion from an emerging economy collapsing are not high. However, if it becomes structural with many emerging economies defaulting, this could be severe risk.
Unfortunately, the left tails of most of these issues are very closely linked to each other. If one shoe falls, the likelihood of another one falling increases dramatically. There are also new threats that have arisen from the fiscal stimulus of the last three years:
- The UK government is facing a major crisis with significant “MissTrussT” in their leaders and their economic policy.
- China appears to be focused on increasing its military budget as Chairman Xi begins his third term. He has made it very clear that he fully intends to reunite China and Taiwan.
- The Biden administration has decided to take on / make enemies on many fronts at the same time (China, Russia, Iran and Saudi Arabia). This seems like a very risky strategy with lots of downside.
We concluded with the following:
“Risk is always a non-linear problem but rarely are there so many forces at work that could make the current market environment mean nothing one week later. This is a time for caution in your portfolios.”
We can only reiterate the same message today. We would be remiss to ignore that markets generally go higher as corporate earnings continue to expand. One should also never underestimate the human spirit to adapt, grow and solve the problems of the day.