For many people, nothing feels better than being given something without having to make an effort. No matter whether the government is sending you free money in the form of a cheque or “the system” allows you to borrow what you don’t have, it feels good. At least for the moment.
For the government and the commercial system it’s a deeply gratifying process too. By handing out money, politicians secure re-election, while financial and commercial enterprises boost their profits, as indebted consumers become even more indebted. The question, of course, is how long our society can live it up today at tomorrow’s expense.
For many, a time of great hardship has already arrived; the number of people who describe their existence as a monumental struggle is increasing rapidly. Yet, the addiction to debt is by now so entrenched that a gradual adjustment is unimaginable. A far more likely scenario, and one monetary history offers many examples of, is a sudden breakdown of financial systems. Sometimes that takes the form of a deflationary collapse; at other times, as in the Weimar Republic or more recently in places like Zimbabwe or Venezuela, hyper-inflation sorts things out. In both scenarios, living standards collapse.
Federal Reserve Economic Data: Total U.S. Public Debt
No one knows when exactly America’s, Japan’s or Europe’s debt spiral will be forced into reverse gear or what the catalyst for a turnaround will be. But one thing we can know with certainty is that the current borrowing and spending habits of governments, corporations and consumers are unsustainable.
Will the great reckoning unfold in 2024 or in three years’ time? It’s unknowable, but again, within even the vaguest projections there resides an element that is indisputable: the longer the binge continues, the more painful and drawn-out the adjustment process will be.
I talked about the economy in some detail in the last issue, so let me keep today’s comments short. In a nutshell, global growth was lukewarm during the past year. Most nations were on the recovery path from Covid, but other factors intervened. In China the property crisis kept growth sub-par; in much of Europe, sheer mismanagement caused havoc. Good examples of entrenched disfunction are Germany and the U.K. In North American, on the other hand, output was much stronger than generally expected, mainly thanks to robust consumer spending, much of which was debt-driven.
The feedback loop is clearly visible: government keeps the debt-spiral fed, the central banks try to counteract the inflationary consequences but can’t risk an all-out economic calamity, and so the party continues. Until it doesn’t.
One thing that makes for an interesting study is how different “expert groups” see the U.S. economy evolve. The consensus of economists and financial professionals is that the probability of a soft landing is over 60%. Yet roughly the same number of chief executives feel a recession is imminent. Given the track record of the two groups, I’m inclined to trust the latter, whose prediction also jives with my sentiments.
Socio-politically, A Pivotal Year
People in most of Africa, the Middle East, Latin American and Asia have been disillusioned with the concept of government for a long time. Civil servants and agents of enforcement are tolerated, but never trusted. Everyone knows that things like war or tax collection serve the very few who form the elite. And because the elite holds the levers of power, you don’t argue. If you need something done, you accept the status quo and bribe the policeman, tax collector or city councillor and move on.
In Europe, there is a wide gap between North and South, East and West. In countries like Greece, Italy or Spain, compliance with government decrees is generally low, and the same can be said of most of the former Soviet Union. In contrast, the continent’s Northerners have historically been more comfortable with their country’s systems, but that is rapidly changing. Whenever I talk to my European friends about the political class, their verdict is unanimous: not only are politicians incompetent, but they’re also far more interested in serving their corporate masters than the electorate. In other words, they’re untrustworthy, a label that’s increasingly attached to those in power and in opposition. That makes for a level of cynicism I have never seen in my lifetime.
Yet another dynamic seems to be underway in nations where, at least in recent history, there have only been two major parties. Most Anglo-Saxon countries fall into this category, but the U.S. and Britain stand out in that independent politicians are not only rare, but are inevitably vilified by the two main parties and their facilitators in the mainstream media. That results in enormous polarization, with both supporters of the left and the right convinced that things would be perfect if only their party reigned supremely.
In the U.S. it gets even more peculiar: according to most surveys, American Democrats and Republicans stand united in their belief that their country is uniquely qualified to lead the world. Yet to any foreigner, the corruption of U.S. politics is as visible as the ineptitude of the two leading presidential contenders. Given the entertainment value of this sad dynamic, it’s easy to dismiss what’s going on as a temporary aberration and lose track of America’s ongoing breakdown and the threat that poses to the domestic social order and the world.
Geo-politically, A New Game
Finally, a brief comment on geo-politics, which is currently the least predictable piece of the pie. Last year, three key developments occurred. First, as we predicted right after the Russian invasion of Ukraine, European support for U.S.-led actions unravelled. The appetite for both military aid and new sanctions weakened by the month, as the heavily pushed media narrative of a Russian defeat collapsed.
The second consequential event was the expansion of the BRICS block. The very fact that previously U.S.-aligned nations such as Argentina, Brazil, Saudi Arabia and the United Arab Emirates have joined a group that actively seeks to restrain American dominance, is a game-changer.
The End Of All Empires: Strategic Overreach
The third and most important event was unleashed by the Hamas terrorist attack, the Israeli Defence Forces’ massive assault on Gaza, and America’s determination to back it. The consequences to Middle East stability and Washington’s foreign policy architecture are immense. To begin with, efforts to bring Saudi Arabia, the Emirates and Egypt closer to Israel and thus create a counterweight to U.S.-hostile states such as Iran, Iraq, Syria, Yemen and an increasingly obstinate Turkey, are effectively ruined.
Then there are the consequences to America’s NATO allies. Within the UN, the United States has been completely unsupported with its persistent veto of a Gaza ceasefire, a display that must have sent shockwaves through the Pentagon and the State Department. Then there was Washington’s push to draw its allies into “Operation Prosperity Guardian”, the naval push to secure shipping lanes through the Red Sea. The response from France, Italy, Spain and others was revealing: “if we intervene it will not be as part of a U.S.-led campaign.”
For now, the greatest risk is a serious escalation of Middle East hostilities. But even if that doesn’t happen, the current conflict has comprehensively changed strategic realities. Going forward, America’s model of finding support for its imperial ambitions looks extremely vulnerable. The consequences of that will reverberate globally.
Portfolio Strategy: How To Approach 2024
Most strategists approach the new year with a high degree of certainty. It’s what their clientele wants—projections they can rely on. “Another favourable year for stocks, as the Fed will continue to lower rates,” says one commentary, while another points out that presidential election years are typically great for investors. A smaller number of analysts are becoming more cautious, some of them referring to the possibility of a “Black Swan” incident. The term refers to a highly disruptive event that comes out of nowhere, but in hindsight was quite predictable. With everything that’s going on, 2024 may indeed be the year of one or multiple Black Swans, but my point is that with so many issues unresolved, detailed scenario construction makes no sense.
That doesn’t necessarily mean that we can’t have a strategy. Mine is to be prepared for multiple outcomes and to continuously make tactical adjustments as new developments unfold. That means our approach is cautious and our style favours capital preservation. A significant position in cash or near-cash assets and gold are both imperative. Yet despite their defensive characteristics, both have produced decent returns and, throughout a volatile past year, helped stabilize the overall investment portfolio.
To be sure, interest rates on treasury bills and short-term CD’s (or in Canada GIC’s) have come down recently, to the 4.5% – 5.0% level. They may even decline a bit further. Yet even that seems attractive to me, given the current unstable environment.
Gold has acted well too, gaining roughly 10% in 2023 and, close to year-end, making a new all-time high before settling back into the US$2,020/US$2,040 range. Where is the yellow metal headed next? My own belief is that we’ll see continued strength, although the interplay of interest rates, inflation and the dollar will all affect the timing of gold’s next “great leap forward.” In short, as I’ve summed up my feelings for the past several years, I see no reason to part with our gold position. On the contrary, as popular trust in governments, their fiat currencies and an impaired banking system further erodes, gold may become the best-positioned asset.
One of gold’s critical attributes is that it is no one else’s liability—at least in its physical form. The same, of course, is true of equity investments. That is one reason why we’ve hugely preferred stocks to bonds during the past few years. But even within the equity sector, we exercise caution, focusing on balance sheet strength, strong cash-flow generation and, ideally, an attractive dividend or a determination to invest back into the business.
One more comment on equities: natural resource related stocks seriously lagged for most of 2024, only to rally in December. Much of that has to do with the performance of the underlying commodities, which suffered along with the all-important economy and the restoration of the supply chains for most critical materials. Again, gold stood out as the winner, while lithium lost 81% of its value as numerous governments drastically cut back on their EV targets. (Lesson: never base your investment decisions on government promises!)
We also believe the Chinese economy will do much better this year, which is why we feel there are opportunities in the commodities sector.
2024 may change some key dynamics in the stock market. Perhaps most important of all, sales growth may recede as the post-Covid rebound in consumer spending comes to a halt. Instead of continuous surprises on the upside, I believe the coming year is likely to bring us downward revisions, both in economic data and corporate earnings. If I’m right, value stocks and select small-cap stocks will provide more safety than the large-capitalization/growth segment. If I had to make one bet for 2024, it would be that volatility, currently at lows not seen in years, will significantly increase.
Finally, a word on bonds. Despite the recent rally from epic lows, we remain cautious. The corporate sector and most developed economy governments are hopelessly indebted, so that covering financing needs is not as easy as it was anytime during the past decades. Meanwhile, uncertainty over the timing of central bank actions also weighs on fixed-income markets. We re-entered the bond market at the right time, but our allocation is still low.
One final look at the rear-view mirror. Despite our highly defensive posture throughout the year, we managed a portfolio appreciation of around 11.5%. Higher returns on our cash hoard helped, while bonds perked up and gold did its part. But the largest contribution came from a stronger-than-expected stock market.
We enter 2024 with the same concerns we had a year ago, and a few new ones. As one of my early bosses used to say under far more benign circumstances, “Let’s be prepared for the worst, but hope for the best.”
As always, best wishes!
Peter C. Cavelti