As we enter year 3 of a 15-year private sector confidence cycle, the public sector has cast a cloud over private markets via dysfunctional politics, the unwinding of post-WW2 multilateral alliances and norms, and increased suspicion of the monopoly power of Big Technology platforms.

Against this backdrop, stocks are again in a state of non-equilibrium. In such states, sudden shocks and unexpected events are common. Often, markets move in ways that traditional fundamental or technical models can’t comprehend. I am expecting both a dramatic near-term drop in stocks, perhaps over the first 1-2 months of the year as well as a sustained longer-term downturn. Many market observers are calling for a traditional 20% bear market drop in total (the S&P 500 is already down 15% peak-to-valley). The alignment and strength of our signals suggest a much larger drop is in store, between 20 and 40% from current levels.

Over the next 1-2 years, three not widely discussed geopolitical themes are likely to emerge that may shock markets and society:

  • Tangible Government Regulation of Big Tech Platforms
  • Dramatic and Rapid Breakdown Of Post-WW2 Multilateral Structures
  • Military Conflict Between India and Pakistan and Between Israel and Arab States

Market Outlook for 2019

Equities across the globe are in a bear market. The carnage is widespread, and it seems US stocks are just catching up to the rest of the world.
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Relative resilience in the US is not a surprise, as capital has been flowing into the private-sector dominated US economy since 2016. However, geopolitical events are overriding general economic health. The list is long and includes:
  • An expected rate increase program by the US Federal Reserve
  • Political dysfunction in Washington including the specter of a Presidential impeachment
  • An intensifying trade war with China
  • The hangover from the sugar-high of the tax-cut
Against this backdrop, stocks are again in a state of non-equilibrium. In such states, sudden shocks and unexpected events are common. Often, markets move in ways that traditional fundamental or technical models can’t comprehend. I am expecting both a dramatic near-term drop in stocks, perhaps over the first 1-2 months of the year as well as a sustained longer-term downturn. Many market observers are calling for a traditional 20% bear market drop in total (the S&P 500 is already down 15% peak-to-valley). The alignment and strength of our signals suggest a much larger drop is in store. Two scenarios seem relevant:
  • Scenario 1: Given the public-sector/geopolitical backdrop, a complete retracement of the “Trump bounce”, a 15%-20% drop from current levels to prices around S&P 500 2100-2150
  • Scenario 2: Given the tech backdrop, a peak-to-valley 45-50% drop, similar to the post-dotcom drop (from Mar ‘00 to Oct ‘02, the S&P 500 dropped as much as 51%)
It is important to keep in mind that despite the 50% drop in prices from 2000-2002, the US recession of that time was tied with three others for 3rd shortest on record at eight months. The unemployment rate ticked up, for sure, but from 4% in 2000 to 6% in 2003, not to 9 or 10% as we experienced in 2008. GDP growth fell from a robust 4.1% in 2000 to 1.0% in 2001 and 1.8% in 2002. But it did not dip to 2008 full-year negative growth levels. A 50% market drop, were it to materialize, would be painful. But we will persevere through it, and I expect a stronger economy to emerge on the other side.

Unexpected Theme 1: Tangible Government Regulation of Big Tech Platforms

US technology stocks led the downward move in Q4 and I expect them to continue to maintain this perverse mantle. Somewhere along the way, the incredible convenience provided by Big Tech led us down a path of embracing a most un-American ideal, that competition was bad. Legions of entrepreneurs and students embraced the notion that competition is for losers and monopolies are good for society. And the result? Essentially, a minuscule percentage of technology executives who represent a minuscule percentage even of the investor class control the world’s information and connection and have captured most of the economic gains of the last decade.

Despite the supposed wondrous innovations of the last decade by FAANG, couched in world-changing corporate mission statements, take a step back and ask yourself how much better off you are. Are you generally happier, are you more economically stable, are you closer with their friends and family, is the world around us healthier and more sustainable?

A growing number of people are beginning to see the deleterious impacts of our monopolist tech platforms. Facebook is currently on the receiving end of this concern. The US government has taken notice, and I expect a heavier emphasis on regulation of Big Tech. A dramatic drop in tech stock prices, a repricing of private tech company valuations (which have gotten silly), and falling venture capital returns will all contribute to a relative loss of influence by the tech sector. This will make regulation easier and more palatable to implement.

While regulation may weigh on FAANG share prices, it has the potential to do long-term good. I’ve talked about the rhythmic pattern of 72-year cycles. 72 years ago, in 1947, the world saw some amazing technological breakthroughs.

  • Polaroid camera first demonstrated
  • The sound barrier is broken
  • Bell Labs invents the transistor
  • Alan Turing lays out his vision for Artificial Intelligence
I would hope that the breaking down of the monopoly power of Big Tech platforms allows idealistic entrepreneurs, working once again in their garages (be they in Boise, Bonn, Beirut, or Beijing), as opposed to the futuristic, slightly dystopian campuses of FAANG or BAT (Baidu, Alibaba, Tencent) to build real humanity-changing technology. It happened in 1947 and it can happen again.

Unexpected Theme 2: Dramatic and Rapid Breakdown Of Post-WW2 Multilateral Structures

The American people, via the 2016 US Presidential Election, have taken significant steps toward ushering in a rethink of the multilateral system that underpinned the post-WW2 global order. The British people have done the same with their Brexit votes. While it has become easy to blame the figureheads of these movements, President Trump and Prime Minister May, we would be well served to recall that most dramatic political and societal shifts come with little more than 50% support – go read up on the American Civil War. As discussed in my December 9th post here, 1947 saw the emergence of the backbone of the current post-WW2 global system. That system is coming to an end; what replaces it will define the rest of this century. Some areas to explore further:
  • Rapid Decline of the UN: The United States no longer views the United Nations as a credible tool to support its current worldview. The UN serves to cement existing norms and institutions, as opposed to supporting new nationalist and populist agendas that have taken hold in the US and elsewhere. Under the heading of watch what they do, not what they say, look no further than the Trump administration nominating a television personality and political novice (no offense intended to Ms. Nauert) to be our voice at the UN. Expect real diplomacy and action to come from the West Wing, not the east side of Manhattan.
  • Sudden Shift to a Multipolar World: The investor class, which has benefited greatly from globalism, must come to terms with the development of a bi-polar world, underpinned not simply by a choice between the US and China, but by a more fundamental choice between freedom versus autocracy. The relatively poor economies of the world cannot be blamed for being enamored by the dramatic rise of prosperity in China, and the ability of the CCP to thread the needle between accumulating vast gains for itself while raising the living standards of the masses and maintaining societal order. I would expect that model to gain favor in more countries of the world, especially those that China bends to its will, through economic and military means. On the other side, our investor and political classes would be well served to reframe the debate around nationalism and populism into one about freedom. What is right for the people of the world has clearly not worked for the American heartland. As long as the have a vote, they will vote in their own self-interest.
  • Western Europe Gets the Brexit Bug: Nationalist movements across Europe will further take hold, as Europeans face the specter of being overrun by three forces from the East and Southeast: China, Russia, Middle Eastern immigration. Voters remain ascendant in Western Europe and will finally wake up to the relative threats of these forces. Expect Brexit-like events in one country after the next as the US, Great Britain, and Western Europe form a firewall against autocratic regimes of the East.

Unexpected Theme 3: Rising Tension Between India-Pakistan and Between Israel-Arab States

The two great free democracies closest to the Middle East, India and Israel, stand to lose the most from a likely dramatic drop in the price of Crude Oil and continued destabilization of the region as the U.S. (now the world’s leading fossil fuel power) withdraws its boys (and girls) and its bucks($).

Again, the rhythm of 72 years casts a shadow. In 1947, India secured independence from Great Britain, and the United Nations voted to create an independent state of Israel. In both cases, the areas were split to accommodate religious fault lines, as Pakistan and Palestine were also born.

72 years later, India and Israel are nuclear powers and at the peak of their post-independence power, both having grown GDP at a compounded rate of 7-8% since 1990. They each (more so Israel) enjoy strong ties with the United States. However, few countries are surrounded by so many enemies and hostile states, notably, in India’s case, including China. A large drop in the price of oil is likely to occur faster than any restructuring MBS can muster. At the same time, major regional powers are pursuing military buildups and even harbor nuclear ambitions. Pakistan continues to remain a huge wild card in the region, and it would be no surprise if it were to look more and more like a Middle Eastern country in terms of political dysfunction, corruption, and instability while possessing no Crude Oil to paper over these weaknesses. Unsurprisingly, the new administration of Prime Minister Imran Khan has forged stronger ties with the Middle East. As Pakistan’s economy continues to suffer, expect greater tension and even conflict.

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Any opinions or forecasts contained herein reflect the personal and subjective judgments and assumptions of the author only. There can be no assurance that developments will transpire as forecasted and actual results will be different. The accuracy of data is not guaranteed but represents the author’s best judgment and can be derived from a variety of sources. The information is subject to change at any time without notice.