As always, if you have any comments or just want to follow up on something in more detail, let me know at drobertson@areteam.com.

Market observations

Bob Elliott ($) rightly highlights the underappreciated importance of small business in the US economy:

Small businesses remain one of the most important areas of the US economy which are vastly undercovered by mainstream macro because there isn’t a lot of timely data (like earnings releases, etc). But with these companies covering 50% of all US employment and nearly two thirds of all private employment, how they are going is a critical driver of the overall economy.

He also points out that the recent NFIB (National Federation of Independent Business) survey indicates small businesses are “running at its weakest levels in nearly a decade (other than covid of course)”. They are getting squeezed most notably by a shortage of quality labor and by labor costs. As a result, “capex intentions are the lowest in the 40 year recorded history”.

While things are always harder for small private companies than large public companies, the degree to which these challenges also creep into public companies earnings reports will be a key item to monitor over the next few weeks.

Geopolitics I

Since the US naval blockade on the Strait of Hormuz was effected on Monday, markets seemed to let out a deep sigh of relief and get back to the regularly scheduled programming of a rising stock market.

That reflex overlooks a couple of important factors, however. One is that the blockade is intended to impose unbearable economic costs on Iran. That assumption misses the fact that Iran has been able to operate its economy for decades under the burden of severe sanctions; adversity is its baseline condition. Probably even more important is the fact that Iran’s national identity is not predicated on economic growth. Westerners just cannot seem to understand that some people believe there are things more important than money.

Further, there is every bit of evidence that the economic harm caused by the blockade will actually be greater for the Gulf states and oil importing countries than for Iran. For states without export access other than the Strait, the blockade extends the absence of oil revenues. According to Zerohedge, even Saudi Arabia is requesting an end to the blockade for fear of reprisal in the form of Houthi attacks on the Bab El-Mandeb Strait in the Red Sea.

Indeed, the US could have implemented the blockade weeks ago, but allowed Iranian oil to flow freely in order to keep oil prices from rising too much. From the start, the US revealed it has very little capacity to absorb economic pain.

In addition to the shortcomings of the blockade strategy in general, there are also questions as to what the blockade itself even entails. The terms leave a lot of room for interpretation. As Claude summarized the passage of the Rich Starry tanker on Tuesday morning:

The Rich Starry episode is a near-perfect illustration of the blockade’s ambiguity in practice. A U.S.-sanctioned Chinese-linked vessel, flying a fraudulent Malawi flag, transited without apparent interference — because it wasn’t technically headed to an Iranian port. The U.S. appears to be enforcing a narrower legal definition (destination-based) rather than flagging or ownership-based interdiction, which leaves a significant shadow fleet loophole intact. Whether that’s intentional restraint to avoid a direct confrontation with China, or an operational limitation, is the real question worth watching.

Indeed, the potential for direct confrontation with China was also addressed by China. Zerohedge reports:

According to unconfirmed reports earlier on Monday, China’s Defense Minister Dong Jun reportedly sent a message to the Trump administration and the U.S. Navy emphasizing Beijing’s intent to continue operating in the Strait of Hormuz and uphold its agreements with Iran. “Our ships are moving in and out of the waters of the Strait of Hormuz. We have trade and energy agreements with Iran. We will respect and honor those agreements and expect others not to interfere in our affairs” adding that “Iran controls the Strait of Hormuz and it is open for us.”

So, while the narrative of the blockade imposing an unbearable economic cost on Iran is prominent right now, it significantly misrepresents the actual situation. There is good reason to believe Iran can bear the costs at least as well as its counterparts because several other countries are also bearing the costs, the blockade has already revealed itself as leaky, and China is now expressing its interests. In short, the blockade looks more like a feint to buy time until the next major strategic move than any kind of solution in itself.

China

While China has not been front and center in the news lately, Shannon Brandao ($) shows it has nonetheless been methodically improving its defenses. From expanding its reach in the South China Sea to extending airspace controls to hardening nuclear infrastructure inland, China is improving capabilities with intent:

China is not only making its forces harder to destroy. It is making them more scalable, more modern, and more resilient under stress.

Keeping these background developments in mind, China is now also becoming a variable in the conflict in Iran. With the exact scope of the US blockade unclear, the question arises as to how forceful China might be in regard to Iranian vessels carrying oil to China. Would the US interdict them? If so, would China push back or acquiesce?

The Atlantic Daily ($) summarizes the situation:

How China might continue to respond over the coming days (and whether it might be more inclined to pressure Iran to reach an agreement with the U.S. and Israel) is an open question. “It’s what everyone’s watching,” Kavanagh said.

Investment landscape I

While Wall Street is generally optimistic about the outcome of the war in Iran, I have yet to read a single paper by a geopolitical expert that suggests the US is dominating this conflict. One of those experts, Robert Pape, has provided some of the most accurate analysis of the conflict and some of the most helpful insights for long-term investors.

In a piece from Monday, Pape ($) explains:

The language of this crisis is still wrong. Most commentary continues to describe rising oil prices as the central problem, as if this were another cyclical disruption that markets will absorb. That framing is now obsolete. What is unfolding is not primarily a price event but a structural supply shock operating on a system that lacks the capacity to adjust in the time that matters.

He summarizes the sequence we are likely to experience:

The system is now entering a predictable chain reaction: price spike, then physical shortage, then economic contraction.

I think this is an excellent point. Price spikes are easy to look past. Sure, they hurt for a little bit, but they almost never cause lasting damage. That is the assumption being made right now about oil.

In addition, big price changes also create trading opportunities. While the start of the war pushed prices up, traders are already looking forward to the next big move. With a ceasefire in place and the prospect of millions and millions of barrels of oil hitting the market all at once, they may have their opportunity.

I also suspect traders and investors learned the wrong lesson from the Russian invasion of Ukraine. Expectations at the time were for significant disruption to oil markets. I asked Claude why these expectations failed to materialize:

The Russia lesson is: don't overestimate commercial/sanctions-based oil disruption. The Hormuz lesson is: don't underestimate physical chokepoint disruption, because it operates through entirely different mechanisms. Most current analysis is making both errors simultaneously — being complacent about Hormuz physical risk while overstating the bite of financial pressure on Tehran.

In other words, investors overestimated the likely impact of economic sanction on Russia, but Russia found a way around them and as a result the oil flowed. Investors seem be assuming the same ultimate workaround in Iran, even though the constraint is physical rather than commercial.

Unless some magical resolution emerges, there isn’t going to be a 100 percent reopening of Hormuz. And as Pape foreshadows, “When this flow tightens, the effect is not confined to energy markets. It propagates across production systems.” Economic slowdown ahead.

Observations is free to read but it is not free to produce. I do so in order to help investors have a fair chance at getting ahead with their investments and to promote financial literacy.

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Investment landscape II

There continues to be a big disconnect between the fundamental assessments of risk from the Iran war and the market assessments. As Bob Elliott ($) highlights, the Polymarket odds of Hormuz traffic returning to normal by the end of May are only slightly better than a coin toss.

One observation is how cartoonishly naive media coverage has been. Talks in Islamabad last weekend concluded when JD Vance proclaimed that Iran wouldn’t concede its nuclear program. This despite the fact that both parties knew before departing for Islamabad this would never happen.

Another observation is how cartoonishly uninquisitive media coverage has been. One headline on Tuesday in Zerohedge (and attributed to the WSJ) read, “More than 20 commercial ships have passed through the Strait of Hormuz in the past 24 hours”. Of course that sounds like the Strait is opening back up.

A quick inquiry into Claude revealed a much more nuanced reality. The total number of ships transiting sounds plausible. However, they are also taking the Larak Island route which is the route prescribed by the IRGC. In other words, they appear to be complying with Iran’s tollbooth. In addition, two Chinese linked vessels transited without being interdicted which raises the question of how comprehensive the blockade is.

Despite the obvious biases in reporting and the inherent uncertainties of information in war situations, market observers seem to be extremely confident in their assessment of the war’s status. In my judgment this confidence is misplaced and if that’s the case, there will be some big “surprises” ahead.

Asset allocation

Even though the standard 60/40 (stock/bond) portfolio or some close relative is by far the most common allocation strategy, it is also far from being a persistent money maker. As The Daily Shot shows, “the 60/40 portfolio has experienced ‘lost decades’ after strong market rallies”.

This historical perspective is especially timely right now because as a recent AQR paper shows, bonds have become positively correlated with stocks over the last few years:

The positive correlation highlights the diminished utility of bonds in a portfolio, but as AQR points out, investors are often reacting in counterproductive ways.

One of those ways is by substituting investments like private credit, buffer funds, and crypto for bonds. Each of these alternatives, however, entail even more equity market risk than bonds. Equity market neutral and trend following funds are be better substitutes.

Another mistake is to overweight the importance of bond risk when by far the greatest risk in a 60/40 portfolio is equity risk. This issue is especially relevant when stocks are at all-time high valuations.

The final point I would make is that with stocks being the big honking risk factor in most portfolios, that is the key risk to manage. Gold also serves as an excellent diversifier over long time horizons. In addition, another way to reduce equity risk is simply to reduce equity exposure.

Gold

There seem to be alternate realities for a number of subjects during times of war and for good reason: every party involved has an incentive to shape the narrative in ways that show their position as the strongest and that puts their cause in the most favorable possible light. Alyosha ($) highlights the fact that the US government is no stranger to this playbook:

In every war that I can remember going back to Desert Storm, the US treasury sold gold, bought stocks and dollars or otherwise as needed to deny the adversaries any weaponized panic or financial damage to our capital markets. This has happened before and during every war, every time; never a public announcement but always severe losses for the errant spec who went against the Fed and US Treasury. I have no doubt our leaders in Washington and on Wall Street will be on the financial front lines until this mess is tallied up and booked.

Whether financial market pundits are unaware of this historical pattern or simply unwilling to get in its way is unclear, but either way they have crawled out of the woodwork to pronounce the end of gold as a safe haven asset. It is true that strong retail buying probably caused gold to overshoot earlier this year, but that is a long way from losing safe haven status.

Another consideration is that if the US Treasury is worried that adversaries could weaponize “panic or financial damage to our capital markets”, exactly how resilient are they to begin with? If the weakness in gold and relative strength in stocks is the result of protective policy, it would indicate genuine cause for concern. Something to think about.

Implications I

So much attention is being placed on the short-term market ups and downs even though investors are getting a sense of how fruitless it is to keep betting on these. Fortunately, there is a separate phenomenon that is more predictable and therefore more “investable”. Ben Hunt ($) calls it Crashing the Car of Pax Americana.

According to Hunt, the global system of Pax Americana brought serious problems that need to be fixed but also brought great benefits to the US and the rest of the world. For example, some conflicting ideas include:

the American socioeconomic system desperately needs fixing after decades of venal corruption from (mostly) Democratic but (also) Republican Administrations AND
there is an underlying global system worth preserving that gives the United States enormous privilege, wealth and freedom of action in the world. Or, for example, that there’s no reason to doubt the authentic intentions of Donald Trump and his Administration to improve the position of the United States AND their economic policies can have the unintended consequence of blasting the underlying global system to smithereens, making it impossible to achieve their goals.

The problem with the Trump administration is not its economic goals, which are generally laudable, but its economic policies, which are counterproductive. As Hunt summarizes, “We are on a road to a permanently lower ‘sticking point’ for growth, productivity, wealth, standard of living ... because that’s what the America First competition game brings.”

So, a key implication for investors over the longer-term is to mitigate the risk of what Hunt calls a “slow-motion denouement”. More specifically that involves underweighting US financial assets and looking elsewhere for opportunities for improvement in global status.

Implications II

Through the lens of Trump tweets, American exceptionalism, and a healthy helping of hopium, the S&P 500 is breached a new all-time high this week. Through the lens of fundamental evidence, however, the skies are much darker.

As Robert Pape describes, the longer the Strait of Hormuz remains closed, the more fundamental the damage to the global economy. This starts with countries in closest proximity to the Middle East and ripples outward. In the absence of an open Strait, and we still aren’t there, the lack of energy and intermediate materials causes factories to shut down. Needless to say, this causes earnings to fall and economies to slow down. The US is fairly well insulated but not totally immune.

Another factor that will work against stocks is buybacks. For one, AI capital expenditures are now competing with buybacks for uses of cash at the big tech companies. For another, a revved up IPO machine is also significantly increasing the supply of stock to the market. For yet another, higher prices from oil and its derivatives are likely to pressure margins — which will reduce free cash flow for buybacks. In sum, there are a lot of headwinds to even maintain the pace of buybacks.

In addition, there is a good chance liquidity will be a headwind as well. The underlying growth in commercial and industrial bank loans has improved from a trickle but is still dominated by growth in loans to non-depository financial institutions. Liquidity has been goosed by the Fed through its reserve management program but with the express purpose of paving the way through tax day which arrived this week. Finally, the Treasury significantly cut down the Treasury General Account in March which also gooses liquidity. That will be refilled once tax revenues roll in though.

In sum, there are a lot of things that can start working against stocks — and fairly soon. If policymakers were maneuvering for the least bad time to allow stocks to crash, the next couple of months would be right in that sweet spot. Plus, Iran and China are both top of mind potential bad guys if someone is needed to blame. Investors wanting to bet against all of this had better have some pretty good reasons for doing so.

Note

Sources marked with ($) are restricted by a paywall or in some other way. Sources not marked are not restricted and therefore widely accessible.

Disclosures

This commentary is designed to provide information which may be useful to investors in general and should not be taken as investment advice. It has been prepared without regard to any individual’s or organization's particular financial circumstances. As a result, any action you may take as a result of information contained on this commentary is ultimately your own responsibility. Areté will not accept liability for any loss or damage, including without limitation to any loss of profit, which may arise directly or indirectly from use of or reliance on such information. 

Some statements may be forward-looking. Forward-looking statements and other views expressed herein are as of the date such information was originally posted. Actual future results or occurrences may differ significantly from those anticipated in any forward-looking statements, and there is no guarantee that any predictions will come to pass. The views expressed herein are subject to change at any time, due to numerous market and other factors. Areté disclaims any obligation to update publicly or revise any forward-looking statements or views expressed herein.

This information is neither an offer to sell nor a solicitation of any offer to buy any securities. Past performance is not a guarantee of future results. Areté is not responsible for any third-party content that may be accessed through this commentary.

This material may not be reproduced in whole or in part without the express written permission of Areté Asset Management.

As always, if you have any comments or just want to follow up on something in more detail, let me know at drobertson@areteam.com.

Market observations

Markets started off the week fairly calm but that was more a non-reaction than any meaningful indication. After Trump’s expletive-laden Easter ultimatum to Iran, everyone was just waiting for the Tuesday deadline to show up to see what would happen.

What happened was a last minute framework of a ceasefire agreement that contained just enough to allow investors to believe what they wanted to believe. And believe they did — the S&P 500 shot up 2.5% and 10-year Treasury yields dropped about 10 basis points. Formal talks and actual agreement to follow — maybe.

The chart below from The Daily Shot shows retail investors have recently changed their playbook. As long-timer buyers of the dip, they became progressively less enthusiastic about buying the dip — and also started selling rallies in March. This change in behavior combined with the daily volatility of the Iran war probably explains a lot of the frustration that emerged from investors during the month.

Politics

As midterm elections creep ever-closer, a couple of interesting phenomena are emerging. For one, while Democrats have clearly gained ground due to various stumbles by the Trump administration, they aren’t doing as well as Trump’s disapproval rating would suggest. For another, it’s becoming increasingly clear that economic challenges are front and center for most Americans, not ideological issues.

G. Elliott Morris ($) provides some striking insights:

The focus groups reveal a level of economic desperation that polls can’t fully capture. BlueLabs’ detailed interviews surfaced gut-wrenching stories from voters. Some described working two jobs, skipping meals so their kids could eat, and spending hours managing coupon apps just to afford groceries. One participant in a Republican-leaning focus group, a woman in her mid-50s, put it simply: “We shouldn’t have to work so hard to survive.”

The divide in the focus groups wasn’t left vs. right, it was working class vs. political elites. Voters don’t want policy platforms — they want someone who’s actually struggled. As one woman put it: “I would want somebody that’s for us and understands what it’s like to struggle.”

In another piece, Morris ($) identifies where the real opportunities are:

Among swing voters, the two largest non-ideological blocs are Anti-System and Affordability. Among non-voters, the same is true. A big part of the electorate Democrats most need is reacting less to ideological distance than to whether politics seems responsive to everyday material problems and institutional decay.

Once again, this reorganization of political affiliations along non-ideological lines sounds a lot like the concept of regeneracy described in the Fourth Turning by William Strauss and Neil Howe. The incumbent political platforms are no longer resonating with voters because they don’t address their core concerns. The situation screams for some political entrepreneurship to either reconfigure one or both of the main party platforms or to start a new one.

While it will be interesting to observe how this story continues to develop, it also suggests there are likely to be darker days ahead. Major political platforms don’t get overturned overnight. A lot more pain will need to be felt in order to produce a political force powerful enough to induce major change. That’s a long road ahead, but the foundations are firmly in place.

Relatedly, it will be interesting to see how events of the last couple of weeks hold up to posterity. Personally, I have a hard time seeing how Trump’s Easter profanities and threat of war crimes won’t make it into campaign videos for every candidate running against an incumbent Republican. By failing to stand up to such behavior, these Republicans have implicitly endorsed it. As midterm election campaigns heat up, they are going to have to make some tough decisions as to how much they want to hitch their political wagon to Trump’s record.

Geopolitics I

While US investors continue to frame the war in Iran as a negotiation that sooner or later will be concluded, the disruption is also having an important effect on regional political dynamics in the Middle East. As the US and Israel initiated the conflict and as Iran has gained relative power, Gulf states are adjusting to the new landscape.

As Robert Pape ($) describes, three distinct patterns are emerging:

First, Iraq is moving to distance itself from U.S. military operations while quietly ensuring its own economic lifelines. That means hedging—maintaining formal ties with Washington while exploring arrangements that reduce vulnerability to disruption in the Strait.

Second, states like Qatar and Oman are positioning themselves as neutral intermediaries. Their objective is not alignment, but insulation—preserving flexibility by avoiding full commitment to either side while keeping channels open.

Third, Saudi Arabia and the United Arab Emirates face the most acute dilemma. They are the most exposed to long-term instability in energy flows and the most threatened by the political implications of Iranian dominance over the Strait. For them, the risk is not just economic. It is internal: sustained vulnerability could translate into domestic pressure and questions about regime security.

Pape describes this as a “key shift now occurring in Iran’s favor”. The shift favors Iran because it challenges assumptions, the main one being the power of the US to effect strategic outcomes. Since that assumption has now been shaken, it affects other countries and their interrelationships.

This is the opening of a global Pandora’s box. For one, it introduces instability and uncertainty to a wide swath of countries. That instability then ripples outward even further. As a result, there is no going back; this is a new paradigm.

Geopolitics II

One of the points I made in the market review earlier this week is the conflict in Iran is already inducing lasting changes in geopolitics and public policy, regardless of whether it is resolved soon or not. Rory Johnston explains, “A world in which Iran manages the Strait would be a deeply unstable and politically-untenable order. The oil market simply isn’t prepared for a reality in which the Strait becomes an off-again-on-again risk.”

Badr Jafar, the UAE’s special envoy for business and philanthropy, corroborates Johnston’s analysis in the ($) FT, “However the current crisis is resolved, no government will return to a posture of strategic dependence on a narrow strait controlled by an unpredictable neighbour.”

Jafar goes on to describe, “This type of existential threat would, inevitably, kick off a colossal infrastructure building programme by the Gulf states to further buttress alternative paths around the Strait.” Further, “The conversation has already shifted — from managing the immediate crisis to redesigning the systems that created this vulnerability in the first place.”

The important point to realize here is that the effort is not just about rebuilding, but redesigning new systems. While there are certainly implications for domestic infrastructure, they are probably even greater for regional national relationships. As Jafar highlights, “States whose ties were strained only weeks ago are now finding common cause.” There is a whole new power structure coming to the Middle East.

Observations is free to read but it is not free to produce. I do so in order to help investors have a fair chance at getting ahead with their investments and to promote financial literacy.

If you find this kind of work valuable, please consider subscribing, sharing this post on social media, or even, heaven forbid, recommending it in person!

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Investment landscape I

The big news dominating the week was the threat by President Trump to destroy Iran followed by a ceasefire agreement shortly before the deadline on Tuesday evening.

John Authers ($) characterized the market reaction as “all-clear”:

The initial market reaction is treating the ceasefire as a moment like the start of Desert Storm, when the resolution suddenly became clear. If that comes to pass, it will have arrived quicker this time, without putting the world through the extremes of the Kuwait crisis.

While that assessment (as of Wednesday morning) was fair enough based on futures prices, a lot of niggling details came out that are going to be extremely difficult to overcome.

For example, Zerohedge reports:

Hamid Hosseini, a spokesperson for Iran’s Oil, Gas and Petrochemical Products Exporters’ Union, told the FT on Wednesday that Iran wanted to collect tolling fees from any tanker passing and to assess each ship.

“Iran needs to monitor what goes in and out of the strait to ensure these two weeks aren’t used for transferring weapons,” said Hosseini, whose industry association works closely with the state. “Everything can pass through, but the procedure will take time for each vessel, and Iran is not in a rush,” he added.

Decisions on the conditions for passing the strait are taken by Iran’s Supreme National Security Council. Hosseini’s remarks suggest Iran will require any tankers to use the northerly route close to its coastline, raising questions over whether western or Gulf state-linked vessels will be willing to risk transit.

Based on these reports, the “ceasefire” allows Iran to continue charging tolls and to selectively allow passage. In addition, since the logistics of doing so are not trivial, the throughput capacity will be vastly reduced:

Martin Kelly, head of advisory at maritime intelligence group EOS Risk, said that there was “no way” that the backlog of ships waiting to get out could be cleared in two weeks.

Around 10 to 15 ships might be able to transit the strait per day as the process was “quite time-consuming”, he said, down from 135 ships before the war.

Finally, all of this comes amidst the ongoing risk of reprisal whereby Iran proclaimed, “If any vessels try to transit without permission, [they] will be destroyed”.

In short, the reality seems to be something a whole lot fuzzier than “all-clear”. In fact, it’s not too much of a stretch to call the various inconsistencies of the ceasefire agreement a list of potential excuses to re-engage in warfare. As a result, the baseline expectation should be re-escalation of the conflict — either relatively soon or after the problems fester for a while longer. For now, it’s just interesting that markets are so sanguine and uncritical of such a transparently flawed process.

Investment landscape II

In the market review I mentioned how earnings expectations seem to be too high based at least partly on a slow adjustment to incorporate rising costs. On Wednesday morning Rob Armstrong ($) provided even more evidence of inflated earnings estimates:

Analysts expect first-quarter earnings growth to be strong. The forecasts for the S&P 500 index (as compiled by FactSet) is for 13 per cent earnings per share growth. The optimism doesn’t end there. Growth for the second, third and fourth quarter of this year are expected to come in at 19, 21 and 19 per cent, respectively. If that’s right, 2026 earnings growth will accelerate significantly relative to the past several years.

One distinct problem with these estimates is they are jarringly dissonant with estimates for economic growth. GDPNow estimates as of Thursday are 1.3% — a very long way off from 20% earnings growth. Further, much of the benefit expected from lower taxes and tax refunds is being consumed by higher gas prices.

Another problem is an age-old phenomenon of estimates lagging real-time slowdowns in economic growth. As Armstrong explains:

What you can see is that in moments when earnings fall sharply, such as 2018, 2020, and 2022, the market (light blue line) falls well before analysts’ forward estimates do (dark blue line):

There are reasons for this and they involve a little bit of “inside baseball” in regard to sell-side equity analysis:

For an analyst covering, say, big-box retailers or software companies, incorporating the impact of an oil shock in the outlook is not a core skill. Easier to set the war aside, and look and give a forecast that assumes the benign status quo is quickly restored.

The bottom line is that Wall Street earnings estimates are persistently lagging indicators during downturns. In addition, because sell-side analysts are typically slow to incorporate negative changes, downside adjustments can be dramatic when they finally are made.

With earnings season right in front of us, investors will be able to judge for themselves both the magnitude and potential duration of disruption for companies. My bet is on the “over”.

Investment landscape III

The war in Iran has been challenging to assess for a lot of reasons, but significantly due to the fact that it is largely being judged by events in very short time frames. It is a lot less mysterious when viewed from some distance, with perspective.

For example, Robert Pape ($) argues the current status of the conflict in Iran is “the clearest indication yet of a shift in power”. He goes on:

For decades, a central pillar of American global leadership has been the ability to guarantee the stability of critical economic flows—especially energy. That guarantee underwrote alliances, anchored markets, and reinforced U.S. credibility.

That guarantee is now in question.

Despite sustained air operations and overwhelming force, the United States has not been able to ensure reliable transit through the most important energy chokepoint in the world under conditions of asymmetric threat. The result is not a temporary disruption. It is a loss of confidence in a core function of U.S. power.

Ben Hunt also recognizes the erosion of US power demonstrated by this episode. He says that regardless of the outcome of the war in Iran, it “accelerates the American abdication of its incredibly privileged global position and the Chinese ascension to that throne. Crashing the Car of Pax Americana is no less certain for its slow-motion denouement, and this is what it feels like to descend into The Great Ravine”

One thing these two perspectives do is to significantly reframe what has happened. This has not been a random squabble in which some punches were thrown and both sides walked away no worse for the wear.

Nope. What is abundantly clear for the whole world to see is the US and Israel started the conflict AND failed to achieve strategic objectives. In short, they started a fight they have not been able to finish, at least not yet. It’s a highly visible erosion of global power.

This is likely to have ramifications far into the future. Countries that have been depending on the US for security have reason to feel less secure. Countries fearing retribution from the US have reason to be a little less fearful. And countries prodding for vulnerabilities have found some new ones to potentially exploit.

While the immediate consequences of this transition may not be very noticeable, it would be a mistake to assume there are no consequences. The cumulative effects of power erosion will accrue over time in a very meaningful way. This will make for pretty significant and sustained headwinds for US financial assets. Since it is taking time to play out, it will also create an opportunity for longer-term investors to position accordingly while the signs are nearly invisible to those focusing only on the short-term.

Implications

With stocks closing Thursday within just a percent or two of where they were when the strikes on Iran first started, it certainly looks like a triumph of hope over experience. Of course, ongoing volatility suppression also nudges behavior in the same direction as does the psychological effect of denial.

What all of these factors point to is a continued under-reaction to negative developments all the while the negative effects continue to accrue as latent energy. In plain language, the longer markets go without adjusting to negative developments, the bigger and more disruptive the selloff will be when it finally does arrive.

This is an important setup for long-term investors. Judging by market prices alone it’s not going to look like much is happening. As a result, it will be easy to be lulled into the belief that a standard 60/40 (stock/bond) allocation will be fine. Unfortunately, by the time it is obvious that is no longer the case, much of the damage is likely to have been done.

Note

Sources marked with ($) are restricted by a paywall or in some other way. Sources not marked are not restricted and therefore widely accessible.

Disclosures

This commentary is designed to provide information which may be useful to investors in general and should not be taken as investment advice. It has been prepared without regard to any individual’s or organization's particular financial circumstances. As a result, any action you may take as a result of information contained on this commentary is ultimately your own responsibility. Areté will not accept liability for any loss or damage, including without limitation to any loss of profit, which may arise directly or indirectly from use of or reliance on such information. 

Some statements may be forward-looking. Forward-looking statements and other views expressed herein are as of the date such information was originally posted. Actual future results or occurrences may differ significantly from those anticipated in any forward-looking statements, and there is no guarantee that any predictions will come to pass. The views expressed herein are subject to change at any time, due to numerous market and other factors. Areté disclaims any obligation to update publicly or revise any forward-looking statements or views expressed herein.

This information is neither an offer to sell nor a solicitation of any offer to buy any securities. Past performance is not a guarantee of future results. Areté is not responsible for any third-party content that may be accessed through this commentary.

This material may not be reproduced in whole or in part without the express written permission of Areté Asset Management.

While performance could easily have been worse, investors were left frazzled nonetheless. The emergence of a war in Iran with no warning and day-to-day changes in narrative created a climate of unpredictability which left investors frustrated and exhausted. One headline captured the psychology: “’Numb, Overwhelmed, Petrified?’ FAs Say Clients Are Anxious.”

In such an environment, how can investors make sense of what is going on?

The Reality: An Escalation Trap

For starters, the war in Iran causes all kinds of problems for investors who tend to be confounded by geopolitics. Even in the best of times, investors tend to assume geopolitics away — partly as being “unpredictable” and partly as being transient. This is wrong, and it’s a cop-out. There is a logic to geopolitics, and there are frameworks that make it understandable.

One of the most relevant today is Professor Robert Pape’s theory of the “Escalation Trap”.

Pape’s background in air power, political violence, social media propaganda, and terrorism make him particularly well-positioned to analyze the war in Iran.

One of the key points Pape makes is that military success is often mistakenly conflated with political success. In the case of Iran, the US military has been incredibly competent with targeting and tactics. However, that success does not automatically translate into political success. Ben Hunt ($) explains why such a disconnect can occur:

There’s an old military saying... The enemy gets a vote. Meaning that no matter how badly you’re beating the other guy on the battlefield, no matter how much you would sue for peace if the situation were reversed, no matter how much you believe that you have a dominant strategy that constrains the other guy’s choices, there is ALWAYS a range of choices for the other guy and you do NOT have the final say on what that choice might be.

It can work for a while, this mirroring of your own raw preferences onto others, particularly if you start from a really strong position and can just steamroll the other players. But eventually you run into someone you can’t steamroll. And they vote in a way that you weren’t expecting. And then you lose.

Iran has voted in a way Trump didn’t expect. While the bombing campaign has been extremely successful in destroying physical targets, Iran has not acquiesced. In fact, on the political realities that matter most, it has actually gained advantage. It now controls the Strait of Hormuz, which means it can extract tolls and be selective about which ships pass. The longer this continues, the more it becomes normalized. Meanwhile, its uranium supply has dispersed and there is virtually no intelligence on where it has gone — increasing the risk of radiological weapons reaching anywhere in the Middle East. For those keeping score, none of this constitutes US success.

In short, whatever threat was considered to have made the situation untenable before, the situation is much more untenable now. As Pape ($) explains, “we are approaching the decision point where it becomes much harder [for US involvement to stop].” He goes on:

Wars don’t become uncontrollable gradually. They become uncontrollable when one side crosses into a form of escalation that changes the structure of the conflict. That threshold is ground force entry. Ground war is different. It produces sustained exposure, longer timelines, and political and military commitments that are hard to unwind.

This invites the question: what are the real signals that a ground war is coming? Pape’s answer is, “Not rhetoric. Not deadlines” — but rather, logistics. The presence of thousands of Marines in theater with more on the way is a strong signal. There are several others. This is an escalation trap in real time.

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Cascading Consequences

The main message from Pape and Hunt is that there is a much greater chance of severe disruption than markets, consumers, or President Trump are acknowledging.

Rory Johnston states flat out: “If the Strait of Hormuz remains closed, there is no doubt that the global price of crude oil will explode to all-time highs.” The reason is that in wealthy, advanced economies, there is almost no price too high to destroy demand. Conversely, developing countries face a disastrous lifestyle adjustment.

Nearly all analyses assume the Strait will reopen and become fully functional again. This flies in the face of the fact that Iran currently controls it. Not only is it effectively closed to normal traffic, but Iran is charging tolls on selected traffic. Given the realization of its newfound power, Iran is highly unlikely to concede it without a fight.

Trump has already floated the prospect of the US simply walking away and letting others figure out the Strait. With this new reality, no country that depends on regular delivery of products from the Gulf can assume future supply will be uninterrupted. This is a defining event. From now on, everyone is going to demand larger safety stocks, greater defense capabilities, and better resilience.

In addition, every other strait in the world is now also vulnerable to the same kind of shakedown — the proof of concept has been established at Hormuz.

Disruptions should also be expected elsewhere. As John Dizard notes, it doesn’t appear as if there was any planning for indirect consequences:

I think that the White House or the planning team was looking solely at oil flows. They may have looked at the US’s relatively good supply balance, but they didn’t look at products. They didn’t look at the US requirement to import sulfur, for example. For the US to produce phosphate fertilizer, it has to process its own phosphate rock with sulfuric acid. Most — around half — of traded sulfur in the world goes through the Strait of Hormuz. It’s a byproduct of refining very sulfurous, or “sour,” crude. Sulfur wasn’t being considered as a pain point in the past. Now it is. You need sulfuric acid in order to produce copper, steel, nickel, and many other products. Apart from fertilizer, you really need it to keep an industrial society running.

As it stands, we are already in the first wave of industrial production getting throttled due to shortages of sulfuric acid. Without a clear resolution in the next couple of weeks, companies will need to start shutting down.

More regional disruptions are developing as well. Dizard points to a serious fuel supply crunch in California, given refinery closures and the state’s dependence on imported fuel from Asia. He also notes Europe is heading toward diesel rationing, jet fuel rationing, and serious shortages more broadly.

The Great Disconnect: Why Markets Aren’t Reacting -- Yet

Despite all the signs of continuing conflict and the likelihood of severe disruption, analysts and investors remain unusually sanguine. To understand why, it helps to consider some historical context.

Dating back to the Global Financial Crisis, investors have relied heavily on public figures to support financial assets. First, it was the Fed with Quantitative Easing as “the only game in town.” Then it was government by way of fiscal stimulus during the pandemic. Then Treasury played a role by suppressing pressure on long-term bond yields by issuing disproportionately large amounts of short-term bills. More recently it has been President Trump regularly declaring a “golden age” for America.

In each case, large swaths of investors essentially outsourced the investment function to public authorities — and now an entire generation of analysts knows of no other way.

It is also important to realize that such policy success was much less a function of omnipotent leaders than it was the good fortune of having adequate capacity. The Fed was able to keep rates so low for so long partly because there was no practicable policy alternative from Congress and partly because there was no political opposition to it. The government was able to keep economic growth at reasonably healthy rates only by massively outspending its revenues and running its debt burden progressively higher. Both courses are rapidly running out of room.

This conditioning explains a great deal about why equity strategists remain so calm today. As Bob Elliott ($) observes, “Nearly all of them are making the same basic case that with earnings ‘accelerating’ and prices down, the stock market has already endured a near 20% valuation drawdown in response to the war.” Such arguments seem reasonable on the surface since earnings growth is expected to be nearly 18% in both 2026 and 2027. The problem is that actual earnings are doing no such thing.

The dissonance in earnings estimates is mainly a quirk of sell-side analyst behavior. Oil industry analysts are quick to raise estimates because higher oil prices are easy to plug into models. Analysts in other industries, however, are biding their time: “if this blows over swiftly, there’s no reason to update full-year estimates — that’s a pain to do, so they wait with unchanged views”. As a result, it’s more accurate to say earnings estimates are stale than that they are rising.

Lessons for Investors

So there are good reasons for investors to feel anxious. The dominant narratives being told about the war in Iran significantly understate the consequences. The Trump administration does not have control of the situation, and in the absence of control, the universe of possibilities — especially negative ones — expands greatly.

There is no magic formula or silver bullet that can suddenly make everything OK. The war in Iran is likely to be longer and more consuming than people have been expecting, and its consequences are already rippling through the global economy.

This presents a double whammy for investors. It heralds the end of a halcyon era during which investors could simply follow the guidance of public officials and expect “number go up.” It also reveals the disturbing reality that the price paid for perpetuating that narrative was the mortgaging of our future. In short, the best days for investment returns are behind us — at least for a long time.

The time it takes for this new reality to become widely appreciated will be a key driver of financial asset prices. A great deal of muscle memory has been developed for letting risk assets ride. For many, the fear of missing out is still greater than the fear of losing money. Many people simply don’t have the bandwidth in their personal lives to draw the lines from geopolitical developments to stock returns. And there will be no small amount of denial.

But the passage of time will reveal that the odds have changed. No longer is goldilocks the baseline expectation — it is the outlier. Once again, mistakes and bad bets will have consequences, which will prove especially problematic in a highly leveraged world.

Conclusion

Investors are right to feel anxious. The dizzying pace of narrative changes combined with a wobble in stocks in the first quarter are signs of deeper issues at hand. The potential for a significant slowdown in economic growth combined with supply-side pressure on prices has risen significantly. This is simply the result of eyes-wide-open risk assessment.

In order to make the most of this new environment, investors will need to do two things they have been conditioned to eschew for the last eighteen years. One is to hold official narratives lightly at best — which probably means either doing their own homework or finding someone who is really good at it. The other is to manage risk. After nearly two decades of deferred consequences, risk management will again become a pre-eminent concern.

The new environment will be especially unkind to investors who are planning on sitting, waiting, and wishing for things to get better. Conversely, investors who embrace independent research and risk management will be able to chart a productive course forward and avoid a lot of obstacles along the way.

The silver lining is this: there are more accessible sources of quality information than there ever have been, and there is a real logic to macroeconomic and geopolitical developments that can be followed and understood. This may well mark the beginning of a golden age of investment analysis — even as it ends a golden age of simply riding the tide.

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Note

Sources marked with ($) are restricted by a paywall or in some other way. Sources not marked are not restricted and therefore widely accessible.

Disclosures

This commentary is designed to provide information which may be useful to investors in general and should not be taken as investment advice. It has been prepared without regard to any individual’s or organization's particular financial circumstances. As a result, any action you may take as a result of information contained on this commentary is ultimately your own responsibility. Areté will not accept liability for any loss or damage, including without limitation to any loss of profit, which may arise directly or indirectly from use of or reliance on such information. 

Some statements may be forward-looking. Forward-looking statements and other views expressed herein are as of the date such information was originally posted. Actual future results or occurrences may differ significantly from those anticipated in any forward-looking statements, and there is no guarantee that any predictions will come to pass. The views expressed herein are subject to change at any time, due to numerous market and other factors. Areté disclaims any obligation to update publicly or revise any forward-looking statements or views expressed herein.

This information is neither an offer to sell nor a solicitation of any offer to buy any securities. Past performance is not a guarantee of future results. Areté is not responsible for any third-party content that may be accessed through this commentary.

This material may not be reproduced in whole or in part without the express written permission of Areté Asset Management.

As always, if you have any comments or just want to follow up on something in more detail, let me know at drobertson@areteam.com.

Market observations

Here’s a friendly reminder that amidst all the hubbub about Iran, things aren’t getting any easier for the “Saudi Arabia of capital”, i.e., Japan. With the yen pressing the 160 per US dollar threshold that has prompted intervention in the past, the country may be forced to do so again. The main question is whether buying time will be sufficient this time around or whether policymakers will need to escalate their response. Watch this space.

Technology I

Yes, Iran and oil still dominate the news but as a result several important developments in Big Tech and AI have not received due attention. This is a good time to catch up on what’s been happening just outside of the spotlight on geopolitics.

Paul Kedrosky ($) starts off with the observation that progress on large language models (LLMs) has likely slowed rather than accelerated. Further, he states, “A new layer has emerged that has changed AI dynamics for good, putting much of current AI training spending at risk”:

The takeaway is this: Large language models are the new silicon. Orchestration layers, like Claude Code and Codex, are the new operating systems. Applications are the new productivity suite. As raw model improvement slows, value migrates up the stack. This will have huge implications, from model commoditization, to inference traffic, to stranded training spending.

He concludes, “Large language models are the new semis, with similar dynamics and boom-bust cycles”.

The Economist ($) picks up on this thought and expands on it:

Times are changing fast. Demand for AI computing is shifting from training models to getting them to answer real-world queries, a process known as inference. McKinsey, a consultancy, estimates that by the end of the decade inference will account for three-fifths of demand in AI data centres.

The transition from AI training to inference has significant implications for key providers. For example, since “Training and inference place different demands on hardware”. More specifically, inference demands “constant memory access” which is where “modern GPUs fall down”. As a result, Nvidia “will have plenty of competition” in this phase — which will create a different competitive landscape.

Technology II

At the same time the AI development cycle is changing the landscape for semiconductor providers, the growing presence of AI is also rippling through the economy in various ways.

One is risk. Paul Kedrosky ($) reports that the perceived risk of misconduct with AI, as revealed in a survey of “513 financial-sector C-suite executives in January 2026” has vaulted from negligible to top billing over the last three years.

Kedrosky then ($) follows up on how AI presents a unique challenge to the insurance industry:

Broadly, however, reinsurance works only as long as risks remain weakly correlated across lines. That assumption is becoming unreliable.

When macro forces propagate losses across many categories simultaneously, diversification stops working the way the industry assumes. The historical edge of reinsurers—large data sets and diversified books—then becomes less protective, because both were built for a world where shocks were more compartmentalized than they are now.

Because “Reinsurance is fundamentally a correlation-management business”, affordable insurance will only exist to the extent that AI claims remain “weakly correlated”. As a result, AI risk is increasing at the same time its insurability may be decreasing.

Yet another risk is that AI creates an illusion of stronger growth at the same time it camouflages employment vulnerability.

Once again, Paul Kedrosky ($) notes, “GDP can rise because of AI investment even while the consumption economy weakens.” This is because AI is added as a lump sum to GDP when it is made — as an investment.

At the same time, when new technology displaces workers, new jobs have typically formed around new opportunities for cognitive work. In the case of AI, however, it “is attacking the exact sector — cognitive work — where new tasks (not merely jobs) have historically formed after prior automation episodes”. The combined effect is that “output continues to rise even as the income that supports consumption falls”.

Kedrosky summarizes:

The result is a strange possibility The economy can grow rapidly, at least in accounting terms, while the demand side weakens badly. That is the essence of Ghost GDP.

Technology III

All of this is causing the narrative around AI to shift. This shift is probably most recognizable in the form of two recent jury decisions against Big Tech. Matt Stoller ($) reports:

Over the past week [as of 3/26/26], jurors have made two different important decisions to hold big tech accountable. In one trial, a Los Angeles jury found Meta and Google liable for addicting and harming a child. They assessed the companies $6 million, opening the floodgates for thousands of similar lawsuits. In a related but different one, a New Mexico jury penalized Meta firm $375 million for violating state unfair trade practice and nuisance laws, based on a suit brought by the state’s attorney general, Raúl Torrez.

One important takeaway is that a new legal approach succeeded and therefore will open the door to a lot more lawsuits:

Starting in 2017, savvy plaintiff lawyers like Carrie Goldman adopted a different view of [tech] platforms. Multi-trillion dollar corporations like Google and Facebook are not akin to newspapers’ published content. These companies make products. Facebook is more like a firm that sells microphones than a newspaper publisher. And so product liability, not the First Amendment law, applies.

Since product liability now applies, there are thousands of similar cases that can now draw upon the evidence and tactics used at this trial.

Another takeaway is the increasingly negative sentiment jurors are expressing towards tech companies and their leaders:

At one pivotal moment, Zuckerberg went on the stand, and had to explain why he overruled 18 experts concerned about beauty filters. His argument? He said he wanted to promote “free expression,” instead of being “paternalistic” and “overbearing.” The jury found these comments callous, but also thought him dishonest. As one juror said, Zuckerberg “changed [his testimony], and that didn’t sit well with us.”

This negative sentiment is also getting expressed with the size of awards:

A law firm that advises on jury selection found that “the jury landscape has fundamentally shifted. 72% of Americans now see their role as sending messages to corporations—a dramatic increase from 2022.” And that’s what happened in the case against Meta and Google on addicting children. “We wanted them to feel it,” said one juror. “We wanted them to realize this was unacceptable.”

From my point of view, this backlash is well deserved and long overdue. My only surprise is that it has taken this long. Regardless, Big Tech is facing some stiff headwinds now on the legal front.

In summary, Big Tech companies have been the engine driving the US economy and US capital markets for many many years now. On fronts both cyclical and secular the tide is beginning to shift against them. All signs point to much tougher sledding ahead.

Geopolitics

As I was reading through reports on oil and geopolitics I came across this tidbit from Rory Johnston ($) that got me thinking:

Ukraine intensifies attacks on Russian infrastructure to ensure the Kremlin doesn’t profit off Iran War: Reuters reported this week that Ukrainian attacks on major ports, pipelines, and tankers had halted “at least 40%” of Russia’s export capacity, prompting “the most severe oil supply disruption in the modern history of Russia.”

A loss of 40% of Russia’s 6+ MMbpd export capacity is a gargantuan sum (~2.4 MMbld, see above chart) that, in any other month, would be the sole and overwhelming focus of the oil market. But, given the current environment, its enormity pales in comparison to the loss of Middle Eastern supplies from Hormuz. This creates a pro-cyclical force on top of the already dire Hormuz stoppage: the impetus for Ukraine to continue ramping up attacks on Russian oil assets will rise alongside the tightening oil market. In plain words, this Ukrainian tactic is adding a geopolitical multiplier effect on top of the largest oil supply shock in history.

I have not read this anywhere else so reporting seems to be minimal. It seems to be an important piece of information. In addition, Johnston is right, a 40% loss of Russia’s export capacity is “a gargantuan sum” and comes in addition to the the massive losses from the Strait of Hormuz.

Finally, this introduces yet another dimension of the war in Iran. In the context of inflated oil prices and the temporary removal of sanctions on Russia, Ukraine has every incentive to deprive Russia of the benefit of that windfall. That’s not going to change unless and until oil prices drop and sanctions are restored. In the meantime, as Claude summarizes, Ukraine continues to target Russian export capacity “aggressively” and “with escalating precision”.

Observations is free to read but it is not free to produce. I do so in order to help investors have a fair chance at getting ahead with their investments and to promote financial literacy.

If you find this kind of work valuable, please consider subscribing, sharing this post on social media, or even, heaven forbid, recommending it in person!

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Oil

Now that we’re a full month into the war in Iran we can start anticipating some much more tangible risks. The reason, as Paul Krugman explains, is “because shipping oil from the Persian Gulf to major markets takes 4-6 weeks”. As a result, “Deliveries to Asian markets will end this week; deliveries to Europe will end next week”. Supplies thereafter will have to come from limited storage or from new sources. In short, the first major wave of impact from the effect closure of the Strait of Hormuz is about to hit the physical market for oil.

Krugman observes:

Ever since this war began I’ve noticed a sharp divide in sentiment among experts. Finance and macroeconomics experts have been relatively sanguine about our ability to ride out this storm. But talk to or read energy experts — people who focus on the physical side of the oil crisis — and their hair is on fire.

Rory Johnston ($), who does analyze the physical oil market, shares Krugman’s concern: “Let me be clear: If the Strait of Hormuz remains closed, there is no doubt that the global price of crude oil will explode to all-time highs.”

He goes on to explain that “In wealthy, advanced economies, there is almost no price too high.” The reason is because even significant price hikes will not significantly curtail demand. The real harm will come to those in emerging markets:

We should expect a disastrous lifestyle adjustment for people in those developing countries. The world will get smaller, power will be in shorter supply, and the tens—if not hundreds—of millions of people dependent on liquefied petroleum gas for cooking fuel will be forced to shift to dirtier biomass alternatives.

Interestingly, the consequences of the war seem to be underestimated even if it ends quickly. The Economist ($) examines “how long normalisation would take if the war ended today [as of publication on March 22]”.

For one, it will take two to four weeks to restart the wells (constituting 10% of global production) that have been shut in. In regard to Qatar’s Ras Laffan liquified natural gas complex, “Repairs will take three to five years, Qatar’s energy minister says, and a planned expansion will be delayed.”

Additional time will be required for ship captains to judge the Strait safe enough to finally pass through and for ships around the world to reposition into their pre-war logistics network formations. The Economist concludes, “Thus even if fighting stopped now, it would be four months before markets regained some semblance of normality.”

The main point is even in the best of circumstances, there will be significant disruptions to global economies. At some point, arguably soon, the finance and macroeconomics experts who have been relatively sanguine will be hit square in the face by the reality that people who focus on the physical side of the oil crisis have been warning about.

Investment landscape

One of the joys of reading and analyzing (and even doing investment research at times!) is coming across someone who knows their stuff inside and out, who effectively communicates their views, and through that, reveals a powerful perspective that suddenly explains so many things that had previously been inscrutable. My most recent experience with this phenomenon involves Robert Pape, the professor of political science at the University of Chicago who specializes in air power, political violence, social media propaganda, and terrorism. In short, he is uniquely well-suited to analyze the war in Iran and lays out his thesis in this Youtube video (h/t PauloMacro ($)):

One of the key points Pape makes is that military success is often mistakenly conflated with political success. In the case of Iran, the US military has been incredibly competent with targeting and tactics. However, and it’s a big “however”, that success does not automatically translate into political success. In fact, in this case, it has done just the opposite. While the bombing campaign has been extremely successful in destroying physical targets, it has also caused a transition to a more aggressive Iranian leadership and increased the prospects of radicalization. This is happening while its uranium supply has dispersed and there is virtually no intelligence on where it has gone to. Oh, and the Strait is still closed. That’s not success.

Pape ($) also picks up the issue in his Substack. There he explains “we are approaching the decision point where it becomes much harder (that this can stop)”. He goes on:

Wars don’t become uncontrollable gradually. They become uncontrollable when one side crosses into a form of escalation that changes the structure of the conflict.

That threshold is ground force entry.

Ground war is different. It produces:

• sustained exposure

• longer timelines

• political and military commitments that are hard to unwind

Of course, this invites the question, “What are the real signals that a ground war is coming?” Pape’s answer is, “Not rhetoric. Not deadlines” but rather, “Logistics”. Indeed, this is the real power of Pape’s analysis — with a solid framework and guiding logic, you don’t need to be told what is going to happen by news headlines or social media posts; you can discern the trajectory by the evidence.

Finally, and importantly, Pape ($) states in another post, “A political declaration does not end a war when the underlying strategic reality remains unchanged.” This is a key reality that I believe the market has not reconciled itself to yet. Trump is not in a position to simply “declare” the war is over. He kicked open a hornet’s nest and the strategic reality is that Iran will be an ongoing and incremental global security threat until the effort is made to eliminate it or defuse it. Neither will be easy. Fortunately, Pape gives us the tools to develop a much clearer understanding of what is going on and therefore a much better idea of what to expect.

Implications

The on again/off again, back and forth news stories and narratives have been frustrating for everyone. While Trump takes a great deal of pride in his unpredictability, the patience of investors seems to be wearing thin. A big part of the reason is that stocks are down too. Investors keep looking for some sign of stability to latch on to.

One way to manage through the chaos is to become more proactive in conducting research. Yes, there is a lot of noise out there, but there is also a lot of excellent research and insight that used to be reserved for high-paying institutional clients. The challenge today is less one of access and more one of differentiating information from narrative.

Another thought to consider is the possibility that the era of “number go up” is ending. I’ll have more to say on this in the Quarterly Review, but the main point is policymakers are increasingly constrained by finances and politics. As a result, they are rapidly running out of capacity to keep their electorates happy.

Once this becomes widely understood and acknowledged, the outlook for risk assets will darken severely. It will be good to have a lot of cash when it does.

Note

Sources marked with ($) are restricted by a paywall or in some other way. Sources not marked are not restricted and therefore widely accessible.

Disclosures

This commentary is designed to provide information which may be useful to investors in general and should not be taken as investment advice. It has been prepared without regard to any individual’s or organization's particular financial circumstances. As a result, any action you may take as a result of information contained on this commentary is ultimately your own responsibility. Areté will not accept liability for any loss or damage, including without limitation to any loss of profit, which may arise directly or indirectly from use of or reliance on such information. 

Some statements may be forward-looking. Forward-looking statements and other views expressed herein are as of the date such information was originally posted. Actual future results or occurrences may differ significantly from those anticipated in any forward-looking statements, and there is no guarantee that any predictions will come to pass. The views expressed herein are subject to change at any time, due to numerous market and other factors. Areté disclaims any obligation to update publicly or revise any forward-looking statements or views expressed herein.

This information is neither an offer to sell nor a solicitation of any offer to buy any securities. Past performance is not a guarantee of future results. Areté is not responsible for any third-party content that may be accessed through this commentary.

This material may not be reproduced in whole or in part without the express written permission of Areté Asset Management.

As always, if you have any comments or just want to follow up on something in more detail, let me know at drobertson@areteam.com.

Market observations

Last weekend, the FT ($) reported:

Thierry Wizman at Macquarie believes markets are beginning to price in the worst case. “One of the reasons things have been so violent is that a lot of people were positioned for central bank rate cuts this year. Now we’ve swung away from an easing outlook to maybe even a tightening outlook,” Wizman said.

Of course, the reason why “a lot of people were positioned for central bank rate cuts this year” is because Trump has been moaning loudly about his desire to have lower rates ever since he got in the White House. The lesson being that what Trump says and what he does are not always, or even fairly consistently, linked together.

Gold

Amidst a lot of bad takes on why gold is down 15% since the aggression against Iran started, Robin Brooks presents a clear-headed analysis of possible explanations for gold’s disproportionate decline:

There’s three theories that are doing the rounds in markets. First, the crazy run-up in precious metals before the war no doubt sucked in lots of retail investors who didn’t trade things like gold before … Second, it’s likely that lots of people were sitting on big gains in precious metals. A rise in uncertainty makes you want to take your chips off the table, so people - reasonably - may have locked in some of those gains. Third, the rise in volatility put other positions - especially in the hedge fund community - under water. That kind of thing means people get hit with margin calls, for which they need liquidity.

These are all reasonable hypotheses that have some merit. Nonetheless, Alyosha ($), a veteran gold trader, has a completely different (and plausible) hypothesis:

I think the GCC has been selling gold because no one else on earth has any incentive to sell gold in quantities large enough to knock it down $1500 in a bizarre down-move at a time when gold should at least be steady. Also… the only major event for several weeks is the war so whoever is buying and selling anything in enough size to move markets… those flows are war-related.

Strong points. Alyosha is absolutely right that the timing and magnitude of gold sales is a clue — and ought to narrow the list of suspects. Relatedly, the US government would certainly have an interest in maintaining a strong US dollar through any conflict. It has the capacity to sell gold if it wants/needs to, but it could also ask a country like Saudi Arabia to do so on its behalf as a quid pro quo for carrying out the attacks on Iran. In addition, Zerohedge reported on Thursday that “Turkey’s central bank sold and swapped about 60 tons of gold, worth more than $8 billion”.

Perhaps the main point is that claims by a number of commentators that gold is no longer a safe haven due to its recent declines are off the mark. First, most evidence points to liquidity being a trigger for selling more than anything else. Second, since stocks have not moved much, there isn’t a good case to be made that the last few weeks have been a risk-off event. As such, what happened to gold is not about long-term safety. In my opinion what investors should be far more concerned about is why stocks have moved so little during this affair.

Investment landscape I

One of the more interesting aspects of the Iran war has been the cadence of headline-grabbing news items. As Matt Stoller ($) discusses, this very much appears to be by design:

But I would add an additional factor - the Trump administration has focused on manipulating markets as part of their war strategy. The most important scorecard for the White House is the value of stocks, so they cannot let them fall. That’s true for a number of reasons. The administration is composed of rich men, and they do not want to lose money. Also, the GOP establishment is run by Wall Street, so Trump’s hold on the Republicans falls apart if equities truly fall.

Stoller then goes on to show how the “market manipulation part of the war strategy is playing out”:

1. The War’s Start Was Timed to Avoid Shocking the Stock Market

The war began in the early morning of February 28th, a Saturday. While there were certainly reasons to launch it at that moment, it’s also true that the administration had 36 hours of uninterrupted strikes before the Asian markets and U.S. futures opened the next Sunday evening …

2. Week #1: Trump Calms the Markets …

3. Week #2: Trump Talks Up the Markets …

4. Week #3: Scott Bessent Claims the Strait of Hormuz Is Open …

5. Week #4: Trump Threatens Escalation

As Stoller concludes, “It’s a very odd situation, to have military threats and timing dictated in part by what will worry speculators.” This is surely true, but it’s good to be reminded of just how odd it is before we all become so acclimated to the cadence we barely even notice any more.

Traders have “listened” to Trump by trading on his comments even when those comments have been inconsistent and repeatedly reversed. Traders aren’t dumb so there must be a reason. The top reason on my list is it is Common Knowledge that Trump will ultimately get his way. Everyone knows that everyone knows it is a losing proposition to bet against the President.

This creates a genuinely interesting conundrum though. As Stoller observes, “the half-life of these kinds of comments is shortening”. This is “the boy who cried wolf phenomenon”. If you cry too many times, people stop listening to you. At some point, everyone will realize that everyone else knows Trump is not in control of the situation. This is what I have been referring to as a “mass realization event”. It’s coming. The manipulation, the volatility, the back-and-forth narrative changes are not costless.

Investment landscape II

The Trump administration’s aggressive spin of the war in Iran applies more broadly than just to the cadence. For example, in an interview with Grant Williams, David Mullin ($), a geopolitical expert, explains, “The three installations that Trump bombed [ during Operation Midnight Hammer in June 22, 2025] there were two more hidden and deeper than a GBU-57 could reach.” The two additional facilities were reported on at the time but that fact was overwhelmed by Trump’s vocal claims that Iranian nuclear capabilities were “obliterated”. The news was there, but only if you made the effort to look for it.

A similar pattern of aggressive spin is playing out in regard to the Strait of Hormuz. The Trump administration is framing the opening of the strait as mainly a matter of timing. However, a short article in the FT ($) on the 19th piqued my curiosity:

At least eight vessels have this week transited the strait by taking an unusual route around Larak Island, off the coast of Iran, according to FT analysis of transponder signals from MarineTraffic, a ship tracking platform.

Why the “unusual” route around Larak Island? That does not seem like a coincidence. So I asked Claude and it confirmed, “Iran has set up its own shipping channel north of Larak Island, rather than the main international channel south of the island.” Claude also noted, “Tehran is trying to impose a traffic control system through the strait, permitting safe passage for friendly vessels while leaving others fearful of attack.” One ship was reported to have paid a $2 million toll.

As a result, it very much appears the new Larak Island route is not a coincidence, but an effort by Iran to formalize a new vetting system. Per Claude, “Ships have been approved on a case-by-case basis, but a new vetting and registration system is reportedly under development by the IRGC.” This was effectively confirmed by the FT on Wednesday ($): “Iran has circulated a letter to member countries of the International Maritime Organization saying ‘non-hostile vessels’ can transit the Strait of Hormuz ‘in co-ordination with Iranian authorities’.”

One point is the Trump administration’s aggressive spin of events in Iran is also misrepresenting and/or omitting material facts. Another is the opening of the Strait is not a binary event; Iran’s developing system of selective opening is a third possibility. As a result, a case can be made that Iran is actually realizing a major benefit from the conflict: It has realized the power of closing the Strait and established proof of concept of how to benefit asymmetrically.

Of course, Iran’s ability to maintain control of the Strait is the key and as of this writing, there is a good chance the US will send troops in, ostensibly to wrest control from Iran. The outcome of the standoff, whether in the form of military conflict or de-escalation, will significantly determine the short to intermediate future of the region.

Observations is free to read but it is not free to produce. I do so in order to help investors have a fair chance at getting ahead with their investments and to promote financial literacy.

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Investment landscape III

In any environment, and especially so in times of aggressive media spin, it is good to have sources on the ground who are familiar with the territory. As a result, the perspective of Radigan Carter, who has both served in the military and worked in the Middle East, is invaluable. In a recent post on X (h/t Mike Green), he highlights an important aspect of Shia Islam that is relevant to the conflict in Iran:

The Shia tradition is built on the story of Husayn ibn Ali, the third Shia Imam, who knew he would die at Karbala in 680 CE. He had 72 companions against thousands. He went anyway. In Shia theology, standing against injustice is obligatory especially when you cannot win in conventional terms. Defeat and death are not failure, capitulating in the face of overwhelming injustice is the failure.

In short, Shia Muslims have a very different code for success than Trump does. As a result, Carter thinks “most people are underpricing how long this conflict drags on.”

With that insight as a starting point, he goes on to outline a framework whereby it takes time for the Trump administration (and financial markets) to fully appreciate the gravity of the situation. During that time, real cost increases will begin to cascade through the global economy. By summer, these costs will be materializing in poor results for companies. Given this will all be happening just months before midterm elections, policymakers will be quick to react. When they do, that will be a great buying opportunity to buy stocks according to Carter.

There are several points to commend Carter’s analysis. For one, his insights into Shia Muslin theology, and therefore sociology, are important. For another, he has a framework. That makes it easier to recalibrate as necessary. If you are surprised by something, then you can isolate the elements that need to be re-evaluated. Finally, he explicitly incorporates policymaker response.

The one element of Carter’s framework I am most suspect of is the effect of the policy response. He assumes the Fed will lower rates AND that will cause a significant rebound in stocks. I’m not so sure. As I have mentioned many times in the past, the Fed funds rate is an extremely flawed vehicle for transmitting monetary policy to the economy. It is more of a signal. At a time when revenue growth is slowing, costs are rising, and unemployment is rising, lower rates may not be sufficient to boost animal spirits.

In addition, lower short-term rates also mean lower interest income for wealthy savers — exactly the ones who have been keeping the economy running by spending and would also be hurt most by a downturn in stocks. Nope, I’m not at all convinced lower short-term rates will do much to spur a rebound.

In addition, there are two bigger issues which Carter doesn’t address. US stocks will be hit by more than just a cyclical slowdown. For one, higher commodity costs and greater national security needs are going to demand greater quantities of capital. That will raise capital costs and force repatriation of US assets by foreign owners.

For another, high amounts of financial leverage mean that higher volatility and lower asset prices will force widespread de-grossing. To the extent risk assets fall in value, that will add force to the downward spiral: Lower prices mean lower collateral values which means more forced selling which means lower prices.

Carter is right to look for situations that can finally create some attractive buying opportunities, but the problems at hand will not easily be solved by policy. A successful rebound will require the right type and mix of policy, the right magnitude, the right timing, and sufficient credibility. I’m guessing policymakers will not get all of those things right the first time around.

Investment landscape IV

While Iran has stolen the headlines for the last few weeks, and rightfully so, it is also important to keep the conflict in perspective. For one, other countries are watching and taking lessons and learning about US military tactics, strategy, and logistics, constantly probing for weak points.

At the top of the list is China. While US media reports commonly highlight the closure of the Strait of Hormuz as a vulnerability of China’s, and it is to some degree, it has been reporting less on what China gains from the conflict. Here’s David Murrin again:

But one of the Chinese criteria [in the Iran conflict] is to empty the magazine depth of THAADs and SM-3s [two of the U.S. military's primary missile defense systems]. And so they may judge, for example, that this [conflict] hasn’t gone on long enough to do that. It hasn’t drawn the THAAD batteries from South Korea yet. It hasn’t scraped the Asian basin of what air defenses it has to reinforce the ones which are fading around Israel … And I do think emptying the missile magazine depth is really one of their optional criteria that they’d be crazy not to take.

Also at the top of the list is Taiwan. For example, the FT ($) reported, “Taiwan is concerned that the Iran war is depleting stocks of long-range cruise missiles that would be vital for the US to help it defeat any Chinese invasion.”

So, Iran is about a lot more than a rogue nation trying to develop nuclear capabilities. It is also an important part of a bigger geopolitical chess match. Every decision and every move in Iran has ramifications for other parts of the game. Namely, every munition used to attack Iran is one less that can be used to protect Taiwan — and everyone knows it.

Investment landscape V

In addition to there being a broader geopolitical perspective to the Iran war, so too is there a broader financial markets perspective. This was beautifully captured by Ben Hunt in a Market Pulse summary ($)

A paradox is emerging in which the war simultaneously strengthens the dollar’s short-term position through traditional crisis demand while eroding the institutional foundations that support its long-term dominance. Treasuries are not functioning as a safe haven, fiscal deficits are expanding under wartime and stimulus pressures, and the media language that once argued forcefully that there is no alternative to US largecap growth is fading. The convergence of rising inflation expectations, weakening growth signals, and retreating confidence in dollar-denominated assets points to a market caught between competing time horizons—seeking dollar safety now while quietly pricing that the post-war world may look structurally different.

This analysis helps both explain the unusual cross-asset behavior since the war started and also pinpoints the problem of applying the conventional cyclical playbook. The very crisis that is creating short-term demand for the US dollar is also “eroding the institutional foundations that support its long-term dominance.” As I said last week, “The main point is this war ought to be taken seriously”.

This message is made even more urgent as the US continues to escalate militarily. Thousands of Marines and Army paratroopers will be within striking distance of Iran when this letter posts. Assuming they do engage, there will be a very narrow path to return the geopolitical arena and global economy back to “normal”.

Implications

The most important implication for long-term investors is the Iran war is catalyzing a process that was already in place that will result in a “post-war world [that] may look structurally different”. This is exactly what I have meant when I have referred to an “inflection point”. Major changes are coming. Maybe not immediately, but they are coming.

These major changes will herald in a world that will be extremely unfamiliar to most investors and will be extremely unfriendly to conventional 60/40 (stock/bond) portfolios. Investors who do not appreciate this will take a lot of wrong lessons from the last four weeks.

Finally, while there are probably several reasons for Trump’s on again, off again comments on the war, one possibility is simply to buy time. The US Treasury is seasonally short of funds in front of the April 15 tax deadline and relatively flush after tax revenues flood in. It is distinctly plausible that Bessent is exploiting the ambiguity in an effort to defer a selloff in stocks until a time when there will be considerably less funding pressure. Something to think about.

Note

Sources marked with ($) are restricted by a paywall or in some other way. Sources not marked are not restricted and therefore widely accessible.

Disclosures

This commentary is designed to provide information which may be useful to investors in general and should not be taken as investment advice. It has been prepared without regard to any individual’s or organization's particular financial circumstances. As a result, any action you may take as a result of information contained on this commentary is ultimately your own responsibility. Areté will not accept liability for any loss or damage, including without limitation to any loss of profit, which may arise directly or indirectly from use of or reliance on such information. 

Some statements may be forward-looking. Forward-looking statements and other views expressed herein are as of the date such information was originally posted. Actual future results or occurrences may differ significantly from those anticipated in any forward-looking statements, and there is no guarantee that any predictions will come to pass. The views expressed herein are subject to change at any time, due to numerous market and other factors. Areté disclaims any obligation to update publicly or revise any forward-looking statements or views expressed herein.

This information is neither an offer to sell nor a solicitation of any offer to buy any securities. Past performance is not a guarantee of future results. Areté is not responsible for any third-party content that may be accessed through this commentary.

This material may not be reproduced in whole or in part without the express written permission of Areté Asset Management.

As always, if you have any comments or just want to follow up on something in more detail, let me know at drobertson@areteam.com.

Market observations

As John Authers ($) shows, Trump’s attacks on Iran have accomplished at least one goal — they have kept other issues such as the Epstein files and affordability problems out of the news for a while. Perhaps another case of “flooding the zone”?

In the midst of war it’s not surprising the US dollar has risen. What is surprising is that amidst the high level of uncertainty, gold has fallen — and by quite a bit.

Some of this is probably the reversal of a weak US dollar trade, however the large moves suggest something more. One good candidate is liquidity. Highly exposed producers and importers of oil may be looking to raise cash now with the most liquid assets they own. If that’s the case, there will be bigger problems down the road as other assets start to get sold off too.

Credit

While the Iran war has taken all the oxygen from the newsroom away, credit problems continue to simmer away. Chris Whalen digs into the private credit market and highlights one of its glaring warning signals:

According to KBW, nearly 9% of private investment income is now being paid via payment-in-kind or “PIK,” a stunning level of default that equates to a “B” bond rating for the entire $2 trillion portfolio … The hidden credit risk on the books of US banks created by PIK is cause for concern since it increases the uncollected principal due to the bank … Banks that accept PIK payments without declaring the loan in default are essentially zombies. As soon as a bank receives a PIK payment, the full amount of the loan should be charged off.

So, a significant portion of private investment income is being made in name only via PIK. Effectively, this is just a way of deferring the writeoff. As a result, not only can more writeoffs be expected, but the problem could really snowball if banks stop supplying loans to the private credit industry. “Risk concealed”, as Whalen calls it.

The FT ($) also picked up on the same theme this week.

The private cap­ital industry’s prob­lems are far worse than Wall Street has acknow­ledged, as tra­di­tional met­rics obscure weak­nesses in the lever­aged buy­out mar­ket, accord­ing to a top credit hedge fund.

A “sub­stan­tial por­tion” of the private equity industry is already “stressed or dis­tressed”, said Tony Yoseloff, man­aging part­ner and chief invest­ment officer at Dav­id­son Kempner Cap­ital Man­age­ment, which man­ages more than $38bn of assets. “You’re not look­ing at a prob­lem five years from now, you’re look­ing at a prob­lem that exists today.”

Yoseloff’s rationale is as simple as it is compelling: “There were way too many sus­pect loans that were made when interest rates were lower.” Once again, risks have been concealed and as they come to light, they will surprise a lot of people. When that happens, liquidity is likely to get tight again.

Politics

On several occasions I have reported on polls showing the eroding popularity/increasing disapproval of Trump. A great deal of the change is due to marginal voters who happened to vote for Trump in 2024 for reasons other than strong advocacy. Among the more common reasons for the change include anti-incumbency sentiments and increasing disapproval based on increased knowledge. For many, the more they learned about what Trump’s policies meant in practice, the less they liked them.

Despite what seems to me to be pretty clear evidence of significantly eroding political support, I still see Trump supporters who seem to think the country is pretty evenly balanced between Trump/MAGA/Republicans and Democrats. One of the more compelling pieces of evidence disconfirming the belief of a fairly even political split is the following graph from John Authers ($):

One point is this information is derived from betting markets so it should be fairly free of bias and therefore should be taken seriously. Another point is, (holy cow!), look at how massively the probability of a Democratic midterm sweep has increased! A sweep was not even in the lexicon six months ago and now it is almost an even bet. This is a striking illustration of how unpopular the Trump administration and its policies have become.

A final point is that with a Democratic sweep now emerging as a serious possibility, the universe of political possibilities opens significantly. Not only would it become much, much harder for the Trump administration to pursue its agenda, but impeachment becomes a real possibility as well. Increasingly, the challenges to the Trump administration are becoming existential.

Observations is free to read but it is not free to produce. I do so in order to help investors have a fair chance at getting ahead with their investments and to promote financial literacy.

If you find this kind of work valuable, please consider subscribing, sharing this post on social media, or even, heaven forbid, recommending it in person!

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Geopolitics I

The vast majority of headlines on the war in Iran focus on Trump and what he is doing as if that is the only relevant factor in determining the outcome. In contrast, Rory Johnston ($) highlights that the political environment in Iran also matters — and makes it almost impossible to achieve any great degree of certainty:

More practically, evidence suggests that the leadership of the Iranian regime is deeply fractured—or at the very least publicly inconsistent in its messaging. Tehran was far from a monolith in the best of times and, in this moment of acute stress (i.e., following the death(s) of countless members of the prior leadership), each faction in Iran is leading its own charge. For example, Iran’s president publicly apologized to its Gulf state neighbours for the attacks against their countries; but, at that exact moment, additional Iranian missiles and drones were landing in those very countries. Indeed, central authority has increasingly been diffused down to regional commanders—even within the IRGC—and the instruction is, more or less, to cause chaos. In summary, there is zero guarantee that the person negotiating bilateral deals is coordinating with the person whose finger is on the drone launch button.

To my ears, the idea of “regional commanders” sounds a lot like the “tribal leaders” in Afghanistan. And that means a decentralized leadership regime that is both hard to eradicate and hard to establish consistent communication with. As a result, it is also hard to establish agreements in which all parties can have a high degree of confidence.

Now, map those characteristics onto a hypothetical peace deal in Iran. What ship captain is going to be absolutely certain the “person whose finger is on the drone launch button” is completely aligned with the agreement? Which shipping insurance company? How long might it take to establish such confidence?

I think Johnston’s assessment that there is “zero guarantee” is right. As a result, it is very difficult to see a very clear resolution to the conflict in any kind of short-term horizon. Best guess is this is going to be around for a while — and that means the likelihood of harm to the global economy is pretty high.

Geopolitics II

One of the more interesting developments in the Iran war this week is the suggestion that Trump may delay his long anticipated meeting with Xi in China. After all, a great deal of the rationale for market optimism has been based on a continuation of the trade truce between China and the US that was established last fall. During the interim, however, neither the US nor China’s has gone out of their way to ensure continued peace between two superpowers.

While the two parties agreed to “continue to maintain the stability of tariffs” at talks in Paris, little other progress could be discerned. Scott Bessent, normally stiff as a board in public communications, tied himself in linguistic knots trying to explain Trump’s position:

“If the meetings are delayed, it wouldn’t be delayed because the president demanded that China police the Strait of Hormuz,” Bessent told CNBC’s Brian Sullivan in Paris. “If the meeting, for some reason, is rescheduled, it would be rescheduled because of logistics.”

While the ambiguity is at least somewhat understandable, the sudden stroke of coyness is less so. Why play games with a meeting that ostensibly defines the ground rules for the two superpowers and has been scheduled for months? It begs the question of whether something much bigger is going on.

Claude (AI) suggests two main takeaways.

1. The deeper analytical point from CNBC’s op-ed is worth noting: whether inadvertent or by grand design, China will read the US taking action against two of its key petro-state partners in quick succession as evidence that, despite a quieter rhetorical climate in bilateral relations, Washington’s long-term strategy to limit China’s global competitiveness has not changed.

2. The consensus from analysts watching the pre-summit maneuvering is quite clear: temper expectations significantly. Deliverables have likely narrowed to commercial purchases such as soybeans rather than any grand bargain, with the two leaders expected to frame the meeting as the opening of a longer conversation to unfold across the rest of 2026

This leaves a lot of open space for possibilities. Could it be an opening to ratchet up hostilities between one another? Perhaps. Could it be an opening for the two major powers to coordinate more closely? Also possible. Less likely, in my opinion, is continuation of a fairly stable peace between the two. Yet, that is what the market is pricing.

Investment landscape I

Thus far, the effective closure of the Strait of Hormuz has mainly just affected near-term oil prices. As a result, there hasn’t been a great deal of fear in financial markets in regard to longer-term effects. Hakung Kim ($) illustrates this point by comparing inflation expectations to oil price:

John Cochrane justifies this fairly benign observation with economic theory:

Economists like me are usually quicker to look to substitution in demand and elasticity of supply than most people looking at such things. There is a lot one can do to use less oil when the price rises. And there is a lot of production capacity that is not worth tapping at $65 but very worth turning on at $100.

In short, “hold your horses before getting too upset by oil prices; there are a lot of ways the economy can adjust”.

While these points are fair and should certainly be considered, they also contain at least a hint of abstraction that often distances economic theory from practice. For example, the FT ($) captured the sentiments of oil producers with the comment from Permian Basin oilman, David Arrington, “These swings really high and really low aren’t really good for any­body.”

True enough. While $100 oil can make marginal fields worth tapping, you have to have some degree of certainty the price will stay around $100 to invest. If you think oil can be $50 in a couple of months, you don’t invest. The main point is the uncertainty Trump has introduced to oil markets makes it extremely difficult for economic actors to adapt to.

Matt Klein ($) provides three big takeaways from the current uncertainty in oil markets:

• The current threat to supply is unprecedented

• Prior changes in prices required to reduce demand and/or increase supply were far larger than what we have seen so far, and the adjustment periods also took longer, even though the changes in volumes were also far smaller than what is currently happening

• The U.S. is still extremely sensitive to disruptions of crude oil imports despite being a net exporter of petroleum+products, at least when it comes to inflation

On the last point, Klein goes into some detail on how crude is not a uniform commodity but rather is composed of different grades with different qualities. Likewise, refineries have different capabilities for processing feedstock and different geographic regions have different demand slates.

As a result, when you disrupt the global petroleum ecosystem that has essentially been optimized across all of these variables, you get some combination of lower efficiency, higher costs, and supply that is mismatched to demand.

If, for example, the US were forced to rely entirely on its own oil production to source refineries, some refining functionality will lie dormant or be under-utilized (and therefore represent a stranded asset) and there will likely be a shortage of middle distillates such as diesel and jet fuel. It’s not very likely the result would be catastrophic for the US, but it would still be inflationary.

Investment landscape II

Even before the attacks on Iran’s enormous Pars gas field this week, the consequences of the war were rapidly becoming far more onerous. Not normally one to wallow in pessimism, Alyosha ($) compared the prolonged closure of the Strait of Hormuz to a “very bad case of gangrene blood poisoning”:

Using this metaphor, I think global stasis is well past stage 4. Stage 5 is irreversible tissue death and stage 5 will occur when all GCC wells are shut in, effectively for our purposes a date circa April 1, in my opinion.

Finally, if another 3 weeks of blocking the strait and 20 mm bpd are shut in… gangrene reaches the stage of septic shock and multiple organ failure and the condition becomes fatal. At that point fatal infection can spread several inches every hour and is irreversibly fatal.

In a prior piece, he ($) detailed the reasons why:

In a three weeks, perhaps mid April… almost all GCC wells will have been capped. Shut-ins are not reversible pauses; reservoir impairments will render a portion of the wells permanently unrecoverable.

Oil revenues [of the five most exposed Middle Eastern producers] normally fund 75% of total government income, or roughly $450–500 billion per year. At current loss rates, 3 weeks and 200 million barrels, a $15 billion shortfall is already drawing down a significant percentage of sovereign reserves and credit lines.

The main point is this war ought to be taken seriously. For one, we are rapidly approaching a threshold at which very serious economic harm will be done. For another, as Israel’s unannounced attacks on the Pars field and Iran’s vows for retribution attest to, it is also spinning outside of anyone’s control.

A final, and significant point, is that US asset markets to date are barely reacting. Bob Elliott ($) highlighted the dissonance as well as the likely future impact:

The macro consequences of an oil shock are relatively clear: higher inflation, slower real growth, and tighter monetary policy. And yet, US asset markets are pricing in basically no impact from the rise in oil prices. It’s a peculiar set of cross-market pricing given what will no doubt be a dominant drag on the US economy ahead.

Investment landscape III

One of the long-running themes of Observations is the excessive levels of debt of major global economies and the increasing constraints those debts impose on policymakers. Robin Brooks does a nice job updating and refreshing that perspective.

As he notes, bond yields can be affected by monetary policy regarding short-term rates so it is important to disentangle those short-term considerations from longer-term signals about debt sustainability. He does so by comparing 10-year yields to 10-year yields 20 years forward. The graphs for various major economies are below.

The first point is there are clearly situations in which the forward yield presents a much more ominous warning of debasement. The most striking differentials are occurring in Japan, France, and Italy. Other countries such as German, the US, and UK are also showing signs of significant vulnerability, however.

This is the landscape in which the war in Iran is landing. Given the precarious starting point, the addition of some combination of higher prices, lower demand, greater credit problems, and increased supply constraints seem quite likely to push someone over the edge. It is increasingly looking like only a matter of time.

Implications

Traders are always looking for an opportunity to make a buck so when the bombs starting falling on Iran, oil prices went up. That’s fine for an initial reaction, but looking beyond that requires an analysis of both the duration of the conflict and an assessment of how it resolves. High prices today will mean low prices tomorrow if/when a tsunami of stranded oil finally gets released and reaches the market. It’s tough to figure out which way to bet — or when.

As the FT’s Unhedged newsletter ($) highlights though, there is a third way to look at the possibilities:

After the war, [Doug] Leggate [of Wolfe Research] argues, global inventories will be refilled to new higher levels, and associated costs such as shipping and insurance will be greater, putting a higher floor under oil prices. Dan Pickering of Pickering Energy Partners agrees, saying that “the things that are happening are probably setting up for a more bullish outlook than before the war . . . Whatever you do, you want enough dry powder so that on the day or week the war ends, you can buy.”

This approach is very similar to my own philosophy. Just last week I noted, “the day has been pulled forward in which there is a mass realization the Trump administration is not going to make things better — and indeed may be making them much worse.”

So, that’s the play. While the shorter-term consequences of Trump’s theatrics are hard to predict, the longer-term consequences are more predictable and persistent. Namely, the longer-term result of Trump’s various forays is the persistent accumulation of collateral damage that makes the supply of commodities more expensive and the operation of the economy less efficient.

It will probably take a crisis for the mass realization event to happen, but it sure looks like Trump is trying his best to make that happen.

Note

Sources marked with ($) are restricted by a paywall or in some other way. Sources not marked are not restricted and therefore widely accessible.

Disclosures

This commentary is designed to provide information which may be useful to investors in general and should not be taken as investment advice. It has been prepared without regard to any individual’s or organization's particular financial circumstances. As a result, any action you may take as a result of information contained on this commentary is ultimately your own responsibility. Areté will not accept liability for any loss or damage, including without limitation to any loss of profit, which may arise directly or indirectly from use of or reliance on such information. 

Some statements may be forward-looking. Forward-looking statements and other views expressed herein are as of the date such information was originally posted. Actual future results or occurrences may differ significantly from those anticipated in any forward-looking statements, and there is no guarantee that any predictions will come to pass. The views expressed herein are subject to change at any time, due to numerous market and other factors. Areté disclaims any obligation to update publicly or revise any forward-looking statements or views expressed herein.

This information is neither an offer to sell nor a solicitation of any offer to buy any securities. Past performance is not a guarantee of future results. Areté is not responsible for any third-party content that may be accessed through this commentary.

This material may not be reproduced in whole or in part without the express written permission of Areté Asset Management.

As always, if you have any comments or just want to follow up on something in more detail, let me know at drobertson@areteam.com.

Market observations

Monday was a crazy day in markets as stocks started down more than 1 1/2% and oil spiked to $120. By the end of the day, stocks were up nearly 1% and oil had fallen $30 from its peak. All on the basis of Trump suggesting the Iran war was almost over.

One point is this kind of volatility, especially in oil, is not costless. As PauloMacro ($) points out:

In the course of one trading session, he [Trump] has singlehandedly made the crude futures market “untradable” in the words of one commodity friend, and with a $40/barrel daily range he probably blew up every producer’s hedge book.

This will have lasting consequences. Higher volatility makes everything more expensive.

Another point is how quickly narratives about the war in Iran descended into farce. While such chaos and inconsistency ought to be major warning signs for stocks, they have instead clung within a few percent of all-time highs. Insouciance barely begins to describe the heedlessness of stocks amidst such tangible risks.

One thing that was not transient was the concern of Trump cabinet members for their own safety. As Zerohedge reports:

The Iran conflict has ignited a massive surge in demand for nuclear-proof bunkers across America … Ron Hubbard, owner of Atlas Survival Shelters, reports being “inundated with calls” since the conflict erupted, with enquiries spiking “tenfold” … Hubbard revealed that two senior Trump Cabinet members are new customers.

This reminds one of the maxim, “watch what they do, not what they say”. It also strongly suggests the longer-term risks are far greater than Trump himself is letting on. Thanks to the cabinet members for giving us the clearest insight yet on how the war in Iran is going.

Outside of oil prices, which obviously jumped with the war in Iran, the biggest signal so far of lasting effect on financial markets is the 10-year Treasury bond yield. After having started discounting disinflation a few weeks ago, yields reversed course as the war started and having been rising since. This despite a moderate CPI report on Wednesday.

As Bob Elliott ($) describes, the rise in oil prices creates a double whammy for the US economy:

At these levels [of oil prices], headline PCE inflation will likely peak above 4% just as nominal spending has slowed to the point where zero real PCE growth looks likely … Absent a very swift reversal of the conflict impacts, it’s hard to see how we can get anything close to the 2-3% real growth still expected by the consensus for ‘26.

Economy

One of the more prominent narratives arguing for strong economic growth is the productivity boom that artificial intelligence is going provide. Kevin Warsh made this case, among many others, and it has a nice intuitive ring to it.

Paul Kedrosky ($) puts a big kabosh on the theory though in language any Econ 101 student can understand:

In short, since AI capital spending is categorized as investment (“I” in the GDP equation), it is added to GDP when the money is spent, regardless of outcome. If you take out the AI capital spending, the “productivity” increase almost completely vanishes. This isn’t to say productivity can’t improve in the future, just that today’s measure significantly overstates the effect. Good to know.

Inflation

The war in Iran is giving a lot of unindoctrinated investors a chance to learn more about how oil fits into the global economy. Namely, as a basic feedstock, its regular flow is a critical factor in countless other industries.

Matt Klein ($) elaborates on the subject:

Without the ability to export, storage facilities for crude are filling rapidly, and some producers have already responded by slashing output. The problem is not just that the Strait of Hormuz is unsafe for tanker traffic, but that much of the infrastructure for extracting, storing, refining, and exporting fossil fuels from the Gulf is currently under attack from Iranian drones and missiles.

Gas and refined products are harder to store, however, which explains why international prices for LNG, jet fuel, and diesel have roughly doubled over the past week.

The supply crunch is already flowing through to the price of fertilizer, which is made from natural gas, which could in turn affect the northern hemisphere’s spring planting cycle and, eventually, food prices.

The main point is you can’t just turn off the flow, wait a while, and turn it back on again without any negative consequences. It takes time for the flow to normalize through the entire system.

One of the main consequences is price. To the extent interim shortages emerge in certain parts of the oil ecosystem, they get arbitrated by price.

This ties in with a broader theme I have been incorporating which is that the risk of inflation has more to do with supply than demand. This is a nonconsensus position. Most inflation watchers focus on things like labor markets and retail spending, i.e., demand. Those things matter, but don’t tend to change significantly or quickly. In a world of excessive debt and geopolitical conflict, however, supply scenarios can change significantly and quickly.

Klein highlights:

That [the Iran war] would make this the third negative supply shock to hit the global economy in the recent past, following the pandemic, which began almost exactly six years ago, and then Russia’s war of aggression on Ukraine, which started almost exactly four years ago.

John Auters ($) chimes in with evidence from inflation swaps — which show both 1-year and 2-year swaps rising — and the 1-year now approaching 3%.

In short, not only are these supply shocks becoming frequent enough to not be dismissed as rarities, there is increasingly a “risk that the latest ‘shock’ alters people’s beliefs about what ‘normal’ inflation looks like going forward.” The bottom line is that inflation expectations are in the process of becoming unanchored. Once that happens, there is very little the Fed can do to stem the tide; the war is lost before the fighting starts.

Observations is free to read but it is not free to produce. I do so in order to help investors have a fair chance at getting ahead with their investments and to promote financial literacy.

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Geopolitics I

As the contours of war with Iran continue to take shape, it is interesting to compare perspectives. Yes, the US has overwhelming military advantage and yes, Iran was already struggling to begin with. Also, yes, China is a disproportionate loser to the extent it relies heavily on oil from Iran.

However, Craig Shapiro from the Alethea Narrative offers a very different interpretation of events:

China has moved from passive observer to active architect of the post-conflict energy order. By engaging Iran directly through a BRICS framework to negotiate safe passage for Chinese tankers, Beijing has done something strategically profound. They did not wait for the US response architecture to work. They went around it entirely. If Chinese tankers transit while US-aligned shipping cannot, Hormuz is no longer a chokepoint — it is a toll booth where access is a function of geopolitical alignment with Tehran rather than international maritime law. The UN Convention on the Law of the Sea becomes unenforceable at the world’s most critical energy passage. China has positioned itself as the indispensable energy security mediator at precisely the moment the US security guarantee has visibly failed to secure anything.

Now, from what I can tell, the idea of China negotiating safe passage for Chinese tankers, thereby turning Hormuz into a “toll booth” rather than a chokepoint, is highly speculative. However, China has a pre-existing relationship with Iran as a large buyer of its crude and it is quite plausible that the two sides might try to coordinate along the lines Shapiro describes.

What can be properly inferred is the importance of Hormuz to the world and therefore the value of it to Iran in any geopolitical context:

Strategically they [Iran] are winning the more important contest. They have demonstrated that closing Hormuz is more strategically powerful than any weapon in their arsenal — more powerful than their nuclear program, their missile capability, or their proxy network. They have recruited China as an active diplomatic participant. They have split the two largest global powers on Hormuz access policy.

By this telling, the war on Iran has resulted in some short-term benefits to the US, but at the longer-term expense of undercutting an already weakening global economy, exposing the Trump administration’s own lack of strategic planning, undermining the security arrangements the US has with most of the Gulf states, and quite possibly improving China’s resilience by way of selective access to Hormuz.

Oh, and by the way, since the Trump administration has very vocally made any face-saving offramps almost impossible for Iran, the overhead of ongoing risk will remain.

Geopolitics II

Judd Legum at Popular Information ($) shares another interesting and thoughtful hypothesis regarding Iran. According to this theory, Trump was persuaded to attack Iran at the behest of Saudi Arabia through his son-in-law Jared Kushner:

At a press conference on Monday evening, President Trump said his son-in-law, Jared Kushner, was one of a handful of top advisers who convinced him to launch major combat operations in Iran. The disclosure raises additional questions about the role of Kushner, who is being paid tens of millions of dollars annually by Middle Eastern governments that were reportedly lobbying Trump to attack Iran.

“The situation was very quickly approaching the point of no return… based on what Steve and Jared and Pete and others were telling me, Marco is so involved, I thought they were going to attack us,” Trump said, referring to Middle East envoy Steve Witkoff, Secretary of War Pete Hegseth, Secretary of State Marco Rubio, and Kushner, who has no formal title.

“Within a week, [Iran was] going to attack us, 100 percent. They were ready,” Trump said at a different event Monday. “They had all these missiles, far more than anyone thought, and they were going to attack us.”

This telling introduces a whole new slew of possible causes for the attacks. Maybe Saudi Arabia (i.e., MBS) wanted them and finally found the right channel. Maybe Kushner was used as a highly conflicted go-between to finally persuade Trump. Maybe Trump was just duped into doing something he didn’t really understand or appreciate.

Another telling element of this perspective is that any notion of an imminent pre-emptive Iranian attack was absolutely NOT corroborated by US intelligence:

The claim that Iran was planning an imminent attack against the U.S. — the conclusion that Trump took away from his discussions with Kushner and others — is directly contradicted by U.S. intelligence agencies.

In conclusion, while it is very hard to say much with certainty about the situation in Iran, there are some useful takeaways. First, it is pretty clear the decision-making has been amateurish. Easily avoidable mistakes were made. Second, Trump’s tendency for impulsive and unilateral action was on display again. Not so bad for unimportant matters but disastrous for national security situations. Third, decisions were made with virtually no strategic thinking, no knowledge of the environment, and no regard for consequences. A loose canon if you will.

It’s hard to say exactly how this will affect the ultimate outcome, especially since Iran has a fair amount to say in the matter. Nonetheless, the day has been pulled forward in which there is a mass realization the Trump administration is not going to make things better — and indeed may be making them much worse.

Investment landscape

So far this year, we have seen bond yields both go down, because of the risk of economic slowdown, and go up, because of the risk of inflation. Which is right? Arguably both.

In regards to the argument for slowing economic growth, I have regularly mentioned several factors. The slowdown in consumer spending (largely due to contraction in real incomes), continued pressure on lower income consumers, deteriorating performance in private credit, slow growth in commercial and industrial loans, and now, higher gas prices as well. I haven’t been as worried about labor, but if corporate profits slow down, companies will reduce headcount.

Likewise, I have also regularly argued the case for longer-term inflation. The main point is inflation is about the only feasible way out for overindebted countries running large fiscal deficits like the US. Ongoing geopolitical tensions and increasingly regular supply constraints are mainly symptoms of the debt problem. The only real question is when the Trump administration decides to pull the trigger on a regime of financial repression that will herald a new era of inflation.

There are several possible triggers for such action: Recession, war with China, exploding commodity prices, etc. The main point is the catalyst must be significant enough to provide a plausible excuse to do too much. That means engaging “emergency” powers, increasing money supply (possibly through government loan guarantees), and suppressing bond yields.

Once that process starts, then inflation is off to the races and there will virtually nothing the Fed can do about it. At this point, it’s mainly just a matter of time — and we’re closing in.

Implications

While it is impossible for me to ignore the enormous human costs of turbulence and ill-conceived public policy, it is also impossible to not recognize the enormous opportunity to capitalize on the changes that are coming — to the economy, to financial assets, and to society. I keep hearing the Dickens’ line, “It was the best of times, it was the worst of times,” ringing through my head.

PauloMacro ($) seems to be in a similar place:

Putting aside all human elements of the ongoing tragedy in the Middle East, my recent realization amidst the insanity underway is we are staring at the biggest opportunity set for macro in decades, and that is quite a statement considering we have already had Covid and Russia/Ukraine. It’s like sitting in cash watching a river of money flow by when all that is needed is to kneel down and put your hands in it. Like noodling for giant cashfish. All you need is your hands and pull. I’m not saying it’s easy — far from it. But I’m saying the opportunity set is immense and almost nobody is around anymore who has any experience trading this. In its quest for high Sharpe/low vol with leverage, the entire asset management industry is set up entirely the wrong way for what is happening. The asset reallocation, capital flow, and outright wealth destruction ahead is of historic proportions.

I couldn’t agree more — “The asset reallocation, capital flow, and outright wealth destruction ahead is of historic proportions.”

Most clearly, sitting around in a 60/40 (stock/bond) allocation is going to be one of the worst moves. Even slight tweaks on that aren’t going to meaningfully improve things. The only real way out will be a dramatically different allocation.

I am considerably less certain about the opportunities for short-term trading, however. On one hand, I do think there will be a lot of great opportunities for trading, at least partly because there will be a lot more volatility. On the other hand, it will be so easy to lose money when Trump instantaneously reverses himself as he did on Monday. I’m sure good traders can manage that process, but I’m not a trader.

As much as anything it will be important to monitor market reactions in order to calibrate how much recognition of change has taken place. I expect this to be a long and drawn out process — years — and for it to unfold intermittently, not linearly. As a result, it will be easiest and most rewarding to position early, before there is widespread appreciation of the magnitude of change.

Note

Sources marked with ($) are restricted by a paywall or in some other way. Sources not marked are not restricted and therefore widely accessible.

Disclosures

This commentary is designed to provide information which may be useful to investors in general and should not be taken as investment advice. It has been prepared without regard to any individual’s or organization's particular financial circumstances. As a result, any action you may take as a result of information contained on this commentary is ultimately your own responsibility. Areté will not accept liability for any loss or damage, including without limitation to any loss of profit, which may arise directly or indirectly from use of or reliance on such information. 

Some statements may be forward-looking. Forward-looking statements and other views expressed herein are as of the date such information was originally posted. Actual future results or occurrences may differ significantly from those anticipated in any forward-looking statements, and there is no guarantee that any predictions will come to pass. The views expressed herein are subject to change at any time, due to numerous market and other factors. Areté disclaims any obligation to update publicly or revise any forward-looking statements or views expressed herein.

This information is neither an offer to sell nor a solicitation of any offer to buy any securities. Past performance is not a guarantee of future results. Areté is not responsible for any third-party content that may be accessed through this commentary.

This material may not be reproduced in whole or in part without the express written permission of Areté Asset Management.

As always, if you have any comments or just want to follow up on something in more detail, let me know at drobertson@areteam.com.

Market observations

One of the interesting signals from the market theatrics early in the week was the continued tendency for buying the dip. Even as positioning and sentiment were caught severely offside relative to the Iran attacks, retail investors plowed money in and sold volatility. Stocks reversed a significant decline on Monday to finish flat and reversed a bigger decline on Tuesday to finish only modestly down. Wednesday saw big incremental declines in volatility.

This buying may prove effective, but it was not driven by positive fundamental developments. If anything, uncertainty remained every bit as high as at the Monday open. One of these days, the buy the dip reflex is going to prove extremely damaging.

Another interesting anomaly in market action this week was the 10-year Treasury bond yield. Normally, in times of turbulence, yields go down as investors seek the safety of Treasury bonds. That didn’t happen this time.

One can point to the uptrend in prices paid that was reported on Monday, although the PPI indicated the same thing on Friday and yields fell. No, the bump up in yield as markets were gyrating stands out as a warning flag. Namely, the market is cottoning on to the notion that Treasuries just aren’t considered to be the safe havens they used to be.

As Judd Legum reports ($), the consequences of war are definitely a matter of perspective. On one hand, it is certainly a deadly endeavor for some. According to Legum:

By Monday, the war had claimed the lives of at least six U.S. soldiers, hundreds of people in Iran, and dozens more in neighboring Gulf states. The bombardment of Iran reportedly destroyed a girls’ primary school, killing about 150 people, the vast majority of them students.

On the other hand, specific information about high-level political decisions presents a profit opportunity for others:

In the hours before the strike, six newly-created accounts on the prediction market Polymarket raked in nearly $1 million by betting that the U.S. would strike Iran by February 28.

Credit

Just like in a coming storm when the drops of rain start small and intermittently and gradually become bigger and more frequent, so too is the fallout in credit markets gradually becoming more intense.

Most of the problems reported so far have been in private credit. This is partly because the companies tend to be smaller and more vulnerable to economic vicissitudes and partly because an influx of retail investors are not so well suited to the limited liquidity of private markets. Blue Owl has been the key perpetrator this year by limiting redemptions.

Blue Owl’s problems have only heightened scrutiny of other providers, however, and now Blackstone’s flagship Business Development Company, Blackstone Private Credit Fund (BCRED) was “slammed with a record amount of redemptions, amounting to a whopping 7.0% shares” according to Zerohedge ($). The company is making good on the redemption requests for now, but clearly investors are unsettled.

In addition, what had been mostly concerns in the private credit market are now migrating into public credit markets. For example, BBB credit spreads are clearly bouncing off of rock bottom levels:

Lower credits have been trending up since last summer:

There’s a lot more that could be said about credit, but suffice it to say, the problems are not going to magically disappear any time soon. The things to monitor are the trend in spreads and the availability of funding. Once funding dries up, then the clock starts winding down — either investments get pushed out via fire sales or the company goes under — just like in the GFC.

Public policy

Amidst the headlines of US and Israeli attacks on Iran, the squabble between Secretary of Defense Hegseth and Anthropic CEO Dario Amodei mainly stayed out of the limelight, but may end up being at least as big of a deal. For one, the issues of autonomous killing and mass surveillance are extremely serious and deserve serious consideration. For another, the easiest and most efficient thing to do would have been to just drop the contract and select a different provider. Instead, according to The Bulwark ($):

Hegseth has issued Anthropic an ultimatum: Change your policy, or we’re going to start getting nasty. This could happen in a couple different ways. The Defense Department is threatening to use the Defense Production Act to compel Anthropic to drop its usage requirements. Or it could go the exact opposite direction, declaring Anthropic a “supply chain risk”—which would not only eliminate DoD’s Anthropic contract, but also forbid any business that contracts with DoD from working with Anthropic in any way. Both of these, it is hardly sufficient to say, would be enormous, unprecedented escalations.

Superficially, this looks like an amateurish move to project power by marking one’s territory. However, the implications are vast.

From a business standpoint, the threat of compelling Anthropic to bend to the DOD’s orders outside of war time now must be perceived as a threat to all American industry. Dan Ball, “who worked in a senior AI-policy role at the White House last year, helping the Trump administration develop its AI Action Plan”, “seemed to struggle to summon words powerful enough to express his incredulity at what he called the DoD’s “giant escalation”. He continued:

“I will say this in no uncertain terms, bipartisan, regardless of administration,” Ball said. “This would be one of the worst things for the American business climate I have ever seen the government do.”

The message from Hegseth, although almost certainly unintended, is that corporate CEOs no longer have final authority over their resources or strategic direction. Nope. The Trump administration can take over at any time and for any reason. Now, try discounting that cash flow stream. Try raising capital. If it can happen to one of the brightest prospects in one of the most important industries, it can happen to anyone.

While this issue hasn’t been amongst the leading news stories, it has generated plenty of backlash across the country and the AI world. The FT ($) reports, “Amazon, Google and Microsoft staff are urging executives to back Anthropic in its escalating dispute with the Pentagon, pressing them to refuse any contracts that would enable autonomous weapons or mass domestic surveillance”.

Interestingly, this backlash has created unusual incremental support for Anthropic. As The Daily Shot shows, “Anthropic’s blacklisting by the Department of War has driven record downloads of its Claude app”:

Source: The Update Read full article

In addition, as Axios reports, backlash is manifesting in other ways. For instance, “The Instagram account ‘quitGPT’ gained about 10,000 followers following the news, according to its operator.” In addition, “A Reddit post about OpenAI winning the Pentagon contract racked up 38,000 upvotes under a post saying “Cancel and Delete ChatGPT!!!” Indeed, “quitgpt” is now a website and a movement to boycott ChatGPT as a protest to both OpenAI and the Trump administration.

All of this will make for an interesting case study for business school some day. Is the Department of Defense simply asserting its rights over a vendor’s technology or is it overstepping its authority in ways that undermine free market principles? Is Anthropic being self-righteous about the application of its technology or taking a very principled stand in order to avoid great harm to humanity? By the way, why isn’t the government taking a more active role in arbitrating safe and useful applications of such an important new technology?

If nothing else, this squabble has increased awareness of the dearth of oversight for artificial intelligence. Imagine how we would feel if a bunch of tech bros were competing with one another to build atom bombs?

Observations is free to read but it is not free to produce. I do so in order to help investors have a fair chance at getting ahead with their investments and to promote financial literacy.

If you find this kind of work valuable, please consider subscribing, sharing this post on social media, or even, heaven forbid, recommending it in person!

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Geopolitics

The market was obviously ruffled by Trump’s attack on Iran, but also not meaningfully disrupted. The key to which way it might swing will be the duration of the conflict. Energy markets can sustain modest interruptions. At some threshold, probably measured in weeks, the potential for major disruption increases exponentially. Where we might land on that scale is what everyone is trying to figure out.

For it’s part, the Trump administration’s rationale is a mystery and doesn’t reveal many clues. Ed Luce from the FT ($) describes Trump’s war aims as “kaleidoscopic”:

Trump him­self is in sev­eral minds about his aims. In the first 72 hours, he has vari­ously said he wants to elim­in­ate Iran’s nuc­lear weapons pro­gramme, end Iran’s abil­ity to export ter­ror­ism, over­throw its regime or find a new leader inside it with whom he could do busi­ness.

On Monday, Marco Rubio ($) added another:

the US knew that Israel was poised to attack Iran, which would retaliate against the US. “We knew that if we didn’t pre-emptively go after them before they launched those attacks, we would suffer higher casualties,” he said.

Political support is not a factor because most of the country is opposed to the attack. Maybe Trump started the war just because he could? Maybe it was used to squeeze China which is a persistent importer of crude oil? The possibilities are vast.

Interestingly, just last week I highlighted an FT report that indicated, “Foreign officials who visit Washington for meetings with US counterparts in an effort to understand Trump’s approach to China often say in private that they cannot detect a real strategy and leave Washington more confused.” Apparently that confusion is widespread.

What is far clearer is that Iran’s response has had a greater degree of strategic design. Matt Stoller ($) reports:

The Iranians haven’t hit back with major missile barrage, but are using a “drip attack,” which is to say, firing small barrages of rockets and drones across Middle Eastern nations, from Israel to Bahrain to Iraq to Kuwait to Saudi Arabia to Jordan to the UAE. They have hit some military bases, but are aiming mostly at soft civilian targets and energy infrastructure, and even data centers. Israelis are in bomb shelters, and some U.S. bases have been hit.

This is having the effect of imposing real costs on the US military in terms of lives and equipment, sowing panic across the Middle East, and instilling doubt in the minds of US partners. In short, it appears to be a classic strategy of attrition.

This creates a significant impasse with no easy answer and no big clues. As a result, the assessment must be, just as I discussed last week in regard to China, a “big uncertainty”.

Interestingly, this conclusion may provide a clue of its own: What if the whole point of the Trump administration is to introduce greater uncertainty to the world? After all, if Trump wants to run a geopolitical protection racket, there’s no better way to do it than to highlight exactly how uncertain and dangerous the world can be.

I have no idea if this a motivating factor or not, but it does check a lot of boxes in regard to behavioral patterns we have observed. The obvious risk to such a strategy is that the Trump administration can dial up the risk at will, but it doesn’t have nearly as much control to dial it down.

Investment landscape I

While the attacks on Iran clearly ignited a firestorm of geopolitical consequences, so too did they send a number of consequences cascading through financial markets. Robin Brooks ($) mentions the obvious potential for oil prices to spike, which they have, but also looks to the second-order effects on currencies.

Brooks notes, for example, “Oil exporting countries will get bid up. Oil importers will get sold.” He goes further by saying, “I also think markets will zero in on Turkey (TRY), India (INR), Japan (JPY) and South Korea (KRW) as big energy importers. These currencies will get sold.”

Three of these four countries, India, South Korea, and Turkey are in the emerging markets ETF, EEM. Two of those, India and South Korea, have double-digit weights. It should be no surprise, then, EEM has gotten walloped since the attacks started.

This development highlights a couple of interesting phenomena. One is that the rotation out of US assets is getting violently halted. Another is that just when emerging markets were looking like a really attractive alternative/adjunct to US assets, they got clobbered. Unfortunately, this is the history of emerging markets.

Fortunately, a number of emerging markets are in much more sustainable fiscal condition than developed countries and are therefore well placed for long-term success. The key is “long-term”, however. First, they will have to prove their ability to weather storms on their own.

Investment landscape II

The other currency Brooks mentioned as having potential for weakness is the Japanese yen. As it turns out, the yen has gotten weaker relative to the US dollar since the attacks on Iran. As it also turns out, this is exceptionally bad timing for Japan as its new prime minister tries to prevent a debt crisis while its economy is also slowing down. A weak currency eliminates one of the few remaining policy levers.

Now, Japan also needs to incorporate the potential of significantly higher costs of imported energy. The possibility of greater price pressure and lower growth makes the policy challenge even more delicate.

Recent weakness is worth noting because historically the yen has been a safe haven. As Neil Newman, Japan strategist at Astris Advisory, ($) explains in the FT, “in past crises, the yen tended to rise on bets that Japanese companies would rapidly repatriate overseas earnings.” The fact this is no longer happening highlights the degree to which Japan’s fiscal and economic condition has worsened.

However, there is potentially a silver lining. As Zerohedge ($) reports, one of the main drivers Japanese repatriation in the past has been a decline in global investment values:

Critically, in the three episodes, a drop in “carry” asset prices is what caused the YCT [yen carry trade] unwinding, not higher policy rates or bond yields in Japan.

While we have not seen a significant decline in global asset prices yet, if it were to occur that would almost certainly be factored into the repatriation decision. In such an event, Japan’s policymakers would have less of an uphill battle to lure investments back to Japan as a means of strengthening the currency. Of course, solving the problem for Japan would also exacerbate problems elsewhere.

Implications

The market continues to demonstrate a remarkable ability to shrug off bad news. By Wednesday close, the S&P 500 was virtually at the same level as on the preceding Friday, before the war started.

While traders and investors have had plenty of practice looking through blips in the past, there are a number of factors that point to a setup for a bigger fall this time around.

For starters, the conflict is clearly escalating and the consequences are increasing. Just a few more days of restricted oil flow from the Strait of Hormuz and much bigger consequences follow. Stocks are completely ignoring this — for now.

In addition, US Treasury bond yields are increasing which means they are not being viewed as a safe haven, as they have in the past. This heightens the potential for a highly correlated selloff in which there are few places to hide.

Just as important, bond volatility is on the rise again. This tightens global financial conditions at a time when markets are already vulnerable.

Taken together, the implication is higher potential for another crash of the carry “trade”. By the very nature of the carry dynamic, self-reinforcing processes push things too far. As a result, when they break, they break hard. This is not a good time to be blissfully ignorant.

Note

Sources marked with ($) are restricted by a paywall or in some other way. Sources not marked are not restricted and therefore widely accessible.

Disclosures

This commentary is designed to provide information which may be useful to investors in general and should not be taken as investment advice. It has been prepared without regard to any individual’s or organization's particular financial circumstances. As a result, any action you may take as a result of information contained on this commentary is ultimately your own responsibility. Areté will not accept liability for any loss or damage, including without limitation to any loss of profit, which may arise directly or indirectly from use of or reliance on such information. 

Some statements may be forward-looking. Forward-looking statements and other views expressed herein are as of the date such information was originally posted. Actual future results or occurrences may differ significantly from those anticipated in any forward-looking statements, and there is no guarantee that any predictions will come to pass. The views expressed herein are subject to change at any time, due to numerous market and other factors. Areté disclaims any obligation to update publicly or revise any forward-looking statements or views expressed herein.

This information is neither an offer to sell nor a solicitation of any offer to buy any securities. Past performance is not a guarantee of future results. Areté is not responsible for any third-party content that may be accessed through this commentary.

This material may not be reproduced in whole or in part without the express written permission of Areté Asset Management.

As always, if you have any comments or just want to follow up on something in more detail, let me know at drobertson@areteam.com.

Market observations

Robin Brooks argues “Something important is going on with the Dollar”, namely, the correlation with with economic data “is in the process of flipping back to negative”. The cause he attributes “is that fiscal policy and debt are out of control, which puts growing pressure on the Fed to keep rates low”.

In addition to the correlation flip hypothesis, Brooks also thinks the US dollar is headed lower:

The fact that the Dollar fell after yesterday’s SCOTUS decision also sheds light on what happened in April 2025. As I’ve been arguing, the sharp fall in April 2025 wasn’t about tariffs. Instead, it was about the perception that US policy making has become chaotic and amateurish, a perception that yesterday’s SCOTUS ruling will only have reinforced. Besides the correlation shift that I see coming, this is the other source of Dollar weakness ahead: policy chaos out of Washington, DC.

While only time will tell if Brook’s theories are right, they are useful in highlighting the potential for some market signals to get screwed up.

I didn’t watch the State of the Union address on Tuesday, but I did read several accounts of it. From what I can tell, it mainly provided incremental evidence of how Trump operates and what his priorities are.

To those points, he spent very little time on affordability even though that is persistently the biggest issue for Americans. This tells me he just does not care about the issue, that’s not who he is.

What he does care about is attention and external validation. That is reflected most directly in the record long speech and in the game show theatrics.

Finally, his main emphasis was on highlighting how great everything was. Rather than addressing real issues head-on, he turns up the dial on the hard sell. He’s not trying to fix or improve, he’s trying to persuade.

None of these insights are new or especially surprising. But they do provide additional conviction about what to expect from Trump and his administration.

Economy

Adam Josephson continues on the beat of US consumer spending. He has ($) shown, for example, “that mandatory categories such as health care, insurance and rent are consuming an ever-larger share of Americans’ budgets”. In addition, he shows “In December as an example, three of the four fastest-growing consumer spending categories were housing and utilities, health care, and financial services and insurance”:

As a result, while the headline CPI numbers may appear to be relatively benign, they belie the reality that for a large proportion of Americans, their real disposable income is going down.

Bob Elliott ($) follows up on the same phenomenon from a different angle. He notes, “data released last week put a continued spotlight on how household reduced savings rate has been critical to keep spending up while income growth has stalled”. He refers to this “shift from an income-driven expansion to a dissavings-driven expansion” as the “biggest macro economic transition in the last few years”.

As a practical matter, savings here are like ballast; they are what keeps consumer spending on a fairly even keel, even when real income is fails to keep up. The bigger question is what it implies for future consumer spending.

On this issue, I tend to be less optimistic than Elliott. He is right that with financial assets at record highs on consumer balance sheets, there is room to spend some of them down. However, that is only true for owners of financial assets. For everyone else, that means drawing down safety buffers or increasing debt.

Furthermore, spending from asset sales as opposed to income growth is a psychologically different exercise. What if asset values go down? What if it’s hard to get another job, or at least one that pays nearly as well?

This situation could also affect anticipated tax refunds. For those who have been maintaining spending by selling down assets, is it more likely they use tax refunds to further increase spending or to replenish depleted savings? I bet there will be a fair amount of the latter, which could significantly constrain the economic impact of those refunds.

If consumers were completely indifferent to spending from income versus spending from dissaving, there should be very little impact on growth in consumer goods companies. But that is not what we are seeing. We are seeing widespread pressure on consumer spending across the board and it is affecting both volume and prices. I wouldn’t expect the situation to improve much until real income growth picks up again.

Politics

There was too much commentary about the IEEPA tariff decision released last Friday, but it was an important decision so I will try to focus on the most relevant implications.

As Matt Stoller notes, the decision opened the door for more overt criticism of Trump administration policies. He highlights from Graham Platner, a Senate candidate:

Today’s Supreme Court tariff decision absolutely CANNOT become another $175 billion giveaway to corporations. They hiked prices due to Trump’s illegal tariffs, and WE paid the price.

Susan Rice, who served in the Obama and Biden administrations, “publicly said that corporations and law firms who illegally do Trump’s bidding are going to face investigations if there’s a change in control during the midterms.”

Ruben Gallego, Senator from Arizona, posted:

All the mergers approved under the Trump administration need to be undone. Big business has to understand there are consequences when they team up with corrupt government.

Stoller draws an analogy to the Biden administration after the chaotic withdrawal from Afghanistain in 2021 in summarizing:

political capital is fickle. Trump had it, and everyone was scared. He’s lost it, and fewer and fewer people are. Most foreign leaders have cottoned on as well.

Trump, it seems, is now a lame duck.

G. Elliott Morris also ($) provided an interesting take on both the decision and Trump’s reaction to it:

But let’s focus on the narrow analytical question of how this will play with the public. In attacking the Court and doubling down on unpopular tariffs, the president has blundered a major political gift for the sake of ideology and a blind pursuit of his trade war. As I see it, the Court, by striking down Trump’s tariffs, permitted him to defiantly retreat from one of his most unpopular policies; he could have simply blamed the judiciary and moved on.

Instead, Trump put himself on the wrong side of two issues where supermajorities oppose him: tariffs, and obeying rulings by American judges.

Personally, I think this is some pretty keen insight by Morris. A professional politician would have recognized the opportunity the decision presented to pivot and move on from policies that weren’t working. The fact that he didn’t suggests Trump isn’t especially concerned about public opinion and that policies such as tariffs can be more correctly regarded as vanity projects than thoughtful public policy.

This provides more incremental evidence that stated Trump administration policy objectives should be heavily discounted — because they are often just pretext for something else.

Trump’s reaction to the tariff rejection also presents a big problem for Republican politicians who do rely on favorable public opinion. They must now be much more calculating in how much support to give Trump and how visibly to give it in order to protect their own chances at re-election.

Finally, just as Matt Stoller suggested, with fewer and fewer people being scared of Trump, the likelihood of pushback, friction, and political attacks increases enormously. Everything gets harder for the Trump administration from here on out. If he keeps resisting, it will get even harder yet.

Geopolitics

Outside of a few tidbits here and there, we are hearing very little about relations between the US and China. This is striking partly because the relationship is ostensibly the primary source of geopolitical tension. In addition, nothing about the National Security Strategy released last fall indicated otherwise. So, why so little attention to the matter?

Helpfully, Demetri Sevastopulo did ($) address the matter in a recent FT article:

But the question now is whether Trump is using a tactical détente to help the US cut its reliance on China for rare earths or whether this is the start of a different approach where the US puts greater focus on trade and economic issues ahead of more traditional national security.

Kyle Bass doesn’t mince words in calling the relationship “nothing more than a high-stakes hostage exchange”:

“America is held captive by China’s stranglehold on rare earth metals and critical minerals essential for our tech and defence industries, while Beijing desperately clutches at Nvidia’s AI chips to fuel its military modernisation to challenge US supremacy,” says Bass. “It’s turned into a desperate race for both nations to extricate themselves from this precarious entanglement before the other gains the upper hand.”

Another view, coming from Ryan Hass, director of the China Center at the Brookings Institution, is that Trump is viewing the relationship with China through a different lens": “Trump in his second term has his eye on his legacy, and blowing up relations with China isn’t a legacy-enhancing exercise. Putting the relationship on a new plane could be.”

Importantly, the dissonance between a fairly contentious National Security Strategy and the possibility of putting the relationship on a new plane highlights the kind of uncertainty that accompanies almost everything associated with Trump. Indeed, as the FT reports:

Foreign officials who visit Washington for meetings with US counterparts in an effort to understand Trump’s approach to China often say in private that they cannot detect a real strategy and leave Washington more confused.

As a result, the best way to treat the US-China relationship is as big uncertainty — due to the uncertain and unanchored tendencies of Trump himself. It could be a road to war or it could be “strategic stability”. One thing that is not likely, however, is a benign, long-term outcome. The genesis of the friction was a US-dominated financial and economic system that China could no longer tolerate. Now it is a “precarious entanglement”. Either each country has the exact same vision for a different future (which is negligibly close to impossible) or there will continue to be friction.

Observations is free to read but it is not free to produce. I do so in order to help investors have a fair chance at getting ahead with their investments and to promote financial literacy.

If you find this kind of work valuable, please consider subscribing, sharing this post on social media, or even, heaven forbid, recommending it in person!

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Investment landscape I

One of the key elements of a national strategy to rebuild industry (as I mentioned two weeks ago) is to use the government’s authority over the banking system to favorably deploy bank lending to targeted industries. In confirming my own suspicions this would be hard to do in the US, Marc Rubenstein ($) wrote in the FT that what banks are actually doing is just the opposite.

For example, in regard to Wells Fargo, a bank long known to focus more on “Kitchen tables, not league tables,” Rubenstein observes, “Yet rather than the growth in lending, the bank’s trading book has caught the eye. Against loan growth of 8 per cent, trading assets have grown 35 per cent.”

Rubenstein also notes LLoyds Bank in the UK and US Bancorp making similar transitions towards capital markets business. The causal factors reported include:

• “market-based financing is growing more strongly than bank lending and so to stay relevant to clients, banks need to adapt”

• “volatility that once plagued capital markets businesses has moderated”, and

• “It also helps that regulators are softening their view of trading businesses”

In short, despite the Trump administration’s vocal claims to focus on rebuilding industrial capital, it’s actual actions are doing just the opposite. Namely, low volatility and lax regulation incentivize banks to shift to wholesale lending and capital markets activity at the expense of commercial lending. That is not going to rebuild industrial capacity.

Of course, this current policy focus can change, but until it does, there isn’t a good reason to expect industrial companies to lead the charge in growth.

Investment landscape II

With regard to politics and public policy, opinions are often differentiated on the basis of different assumptions. One of those assumptions is about what it takes to succeed. As Mike Green ($) relates, one of the common narratives is severely flawed:

We tell ourselves a comforting story about success. It goes like this: The economy is a sorting mechanism. “Talent” (intelligence, grit, risk-tolerance) naturally rises to the top. If you are smart and unafraid, you will win. Everyone else is just drafting off your wake.

It is a seductive narrative. But it is physically wrong.

While IQ has heritable components, Wealth is not a biological trait. It is an environmental condition. The most rigorous recent work on this, such as Fagereng, Mogstad, & Rønning (2020), uses adoption data to sever the biological link. Their finding is stark: Genes explain very little of who gets rich. Inheritance—specifically the ability to accumulate assets without interruption—explains almost everything. A more accessible version that extends the dataset to the UK is available here.

The main point Green makes is that volatility affects all of us, whether it be in the form of a high risk/high reward career tradeoff or in the form of “random life shocks” such as “unemployment, health crises, or family emergencies”. Since each of us will encounter such events in our lives, the key to success is the ability to weather such events with as little detrimental impact as possible. The way to do that is through starting wealth, i.e., inheritance.

Green ($) explained further in a follow up piece:

in a world governed by geometric growth and volatility, talent doesn’t win—buffers do. The “Gifted Poor” went extinct at 25x the rate of the “Normie Rich.” [in his simulation] The market selected for safety, not skill.

The Insight: Redundancy—starting wealth—is THE driver of outcomes. Without a buffer, the low-wealth agent is trapped in a sub-critical regime where growth is challenged, regardless of skill or effort. We have built a system where the “Cost of Survival” is set by the average, but the “Ability to Survive” is denied to the median.

What Green describes is how our system of economic and social mores has manifested in a way that inherently exacerbates inequality rather than moderating it. Unfortunately, the narratives we tell ourselves only serve to perpetuate the problem.

The good news is that Green goes a long way in properly diagnosing the issue. If we want a more meritocratic society, in which talent is a bigger driver of outcomes than starting wealth, there is a very clear path to doing so: Reduce the volatility tax. That means implementing public policy measures that mitigate life events such as health emergencies, job transitions, and the cost of higher education such that when those events do strike, they are easily smoothed over and aren’t knock out blows.

Of course, the body of public policy that would accomplish this would look very different from what we have now. But that’s kind of the point. As much as some people would like to believe it, talent just isn’t the top driver of wealth accumulation. In order for public policy to change, that belief system will probably have to change too.

Investment landscape III

Interestingly, Green’s modeling of wealth accumulation is closely related to a subject I have been interested for some time: Ergodicity economics. Having just finished the book, An Introduction to Ergodicity Economics by Ole Peters and Alexander Adamou, the subject is still top of mind.

According to Claude, ergodicity economics “represents a fairly fundamental challenge to how mainstream finance thinks about risk and return”. Indeed, this is what originally caught my attention about ergodicity economics (and probably Green’s as well) — over time I have observed that the historical averages finance people and wealth advisors use create an overly optimistic view of the returns that can be expected from financial assets. Partly this realization was a result of me stringing tons and tons of performance numbers together using geometric averages in various jobs. As Claude describes:

Standard finance uses ensemble averages — the average outcome across many parallel worlds or many investors — to evaluate decisions. But an individual investor experiences time averages — sequential outcomes through a single life. When a system is non-ergodic (and wealth processes almost always are), these two averages diverge dramatically. The expected value of a bet can be positive while the time-average growth rate is negative, meaning most people who take the bet will eventually be ruined even though the “average” outcome looks attractive.

The practical upshot is that geometric mean return — not arithmetic mean — is the right metric for evaluating investment strategies over time. The gap between them grows with variance: geometric mean ≈ arithmetic mean minus half the variance. This means volatility is not just a discomfort measure but an actual drag on compoundable wealth. High-variance strategies that look attractive on arithmetic return bases are frequently wealth-destroying in the ergodic sense.

So, one key point is “The gap between them [geometric and arithmetic averages] grows with variance”. That is exactly the issue Green highlights. In wealth management, it means high variance strategies “are frequently wealth-destroying in the ergodic sense”. This is NOT something most wealth advisors address. Bottom line, higher variance means higher likelihood your actual returns will be disappointing and can even be wealth-destroying.

Another key point regards diversification. Since lower variance “directly increases the time-average growth rate by reducing variance drag,” diversification does a lot more than just reduce discomfort; it increases the rate of wealth accumulation. This is why “risk-sharing arrangements (like insurance) create real wealth in a mathematical sense, not just utility in a subjective sense”.

This last point can be generalized such that it is much more broadly useful. If the idea is that pooling resources and cooperating are mutually beneficial by way of reducing the “variance drag”, then any “truth-seeking” endeavor (such as financial and macro analysis) will be boosted by considering multiple perspectives. In this case, the “pooling of resources” helps tease out intellectual blind spots and bad assumptions — that can prove disastrous at certain times.

Whether it is about accumulating wealth or accumulating knowledge, big losses are hard to overcome. That’s a good lesson to live by.

Implications

Interestingly, the piece I have seen the most commentary on this week is one by Citrini that explores the potentially negative consequences of AI (artificial intelligence). I scanned through the report and found it to highlight a number of the same issues I have reported on in Observations and also found it to be consistent with my approach of conducting occasional thought experiments. In this respect, the report was good science fiction; it made you think.

In my opinion, and much as I do with Observations, the Citrini report did at least as much to highlight flaws in the current economic structure as to reveal any particular side effects of AI. For instance, it is only because so many businesses and jobs in the US economy are essentially about rent extraction that they are especially vulnerable to AI disintermediation. Yes, this is likely to affect white collar jobs. No, it’s not because AI is so inherently destructive.

Likewise, it is only because there is so much leverage across the economy and financial system that there is so much risk. If so many companies and businesses weren’t levered up on the basis of overly optimistic estimates many years into the future, there wouldn’t be so much risk.

I suspect the Citrini report has struck fear into so many people because it exposes a vulnerability that has been hiding in plain sight for a long time. A lot of businesses and a lot of good paying jobs don’t provide much real value, even if they generate sales that tally up to GDP. As AI continues proving that to be the case, a lot of businesses and good paying jobs will go away. We’ve known about moral hazard and zombie companies since at least the GFC in 2008. AI is just the development forcing the inevitable reckoning.

This possibility is certainly unpleasant for a lot of people but that doesn’t make it wrong.

Note

Sources marked with ($) are restricted by a paywall or in some other way. Sources not marked are not restricted and therefore widely accessible.

Disclosures

This commentary is designed to provide information which may be useful to investors in general and should not be taken as investment advice. It has been prepared without regard to any individual’s or organization's particular financial circumstances. As a result, any action you may take as a result of information contained on this commentary is ultimately your own responsibility. Areté will not accept liability for any loss or damage, including without limitation to any loss of profit, which may arise directly or indirectly from use of or reliance on such information. 

Some statements may be forward-looking. Forward-looking statements and other views expressed herein are as of the date such information was originally posted. Actual future results or occurrences may differ significantly from those anticipated in any forward-looking statements, and there is no guarantee that any predictions will come to pass. The views expressed herein are subject to change at any time, due to numerous market and other factors. Areté disclaims any obligation to update publicly or revise any forward-looking statements or views expressed herein.

This information is neither an offer to sell nor a solicitation of any offer to buy any securities. Past performance is not a guarantee of future results. Areté is not responsible for any third-party content that may be accessed through this commentary.

This material may not be reproduced in whole or in part without the express written permission of Areté Asset Management.

As always, if you have any comments or just want to follow up on something in more detail, let me know at drobertson@areteam.com.

Market observations

Almost Daily Grant’s (Thursday, February 19, 2026) reports “good news and bad news” in the private credit world:

Blue Owl Capital (ticker: OWL) announced yesterday that it has sold $1.4 billion in direct loans “to leading North American public pension and insurance investors,” while also permanently halting quarterly shareholder redemptions from its off-exchange, retail-focused vehicle Blue Owl Capital Corp. II after suspending the mechanism in November.

While OWL claimed it was able to get “99.8 cents on the dollar for the outgoing assets on average,” that result begs the questions of why the number shouldn’t have been even higher given the decline in rates and credit spreads over the last year and a half and whether the sold loans were simply the most liquid ones, i.e., the ones that could be sold. The ordeal also begs the question of whether retail investors will continue to plow money into private assets given the increasingly obvious risks.

Mohamed El-Erian didn’t miss a beat by rhetorically asking on X, “Is this a “canary-in-the-coalmine” in reference to similar conditions in August 2007.

As stocks struggle to regain momentum, one thing that hasn’t changed is the commitment from retail investors to buy the dip. Most recently retail jumped in with both feet to buy beaten down software stocks as indicated in the graph from The Daily Shot:

Increasingly, this pattern of buying the dip is looking more like a conditioned reflex rather than any kind of thoughtful decision. As Substacker LeShrub put it, “the CEOs of the SAAS companies aren’t buying their own stock, so why should I?” In the context of increasingly worrisome market conditions, it certainly looks like retail may be about to get a real-life lesson on risk management.

Popular Information ($) reports that as prediction markets become increasingly popular, so too do their shortcomings. For example:

Remarkably, more than $100 million was wagered on what song Bad Bunny would play first during his halftime show. That kind of market has raised concerns about insider trading. Not only is Bad Bunny in control of which song is played, but this information is also known in advance by dancers, musicians, crew, and anyone who happened to be around during rehearsals.

Perhaps coincidentally, perhaps not, the enforcement environment for prediction markets is getting substantially downgraded (per Almost Daily Grant’s (Tuesday, February 10, 2026)):

a Monday Barron’s report details the evisceration of Chicago’s enforcement division at the CFTC: “In recent months, the office has become a ghost town,” with a 20-strong team of enforcement attorneys pared to just one. That aggressive downsizing is particularly striking in light of office’s prominent role in major CFTC enforcement actions since its 1975 establishment

Joe Kozinzeski, who spent 26 years at the CFTC before his position was eliminated last year, puts it this way to Barron’s: “If I was a different person, I would launch a crypto scam right now. Because there’s no cops on the beat.”

That’s one way to keep markets rolling, at least for a while anyway.

Japan

Takaichi faces tough fight to change constitution ($)

https://www.ft.com/content/72e705b5-b635-4034-99ba-040c2d6fc694

Sanae Takaichi wasted little time this week celebrating her record electoral victory in Japan before declaring her ambitions to tackle something even greater: changing the country’s constitution.

Such an undertaking could only be pursued realistically by a government with a rare two-thirds supermajority. Japan’s prime minister met that threshold in the lower house on Sunday. But even then, the hurdles to changing the world’s oldest unamended supreme constitutional text are dauntingly high.

With sentiments from a big electoral victory still running high, Japan’s prime minister is looking to strike while the iron is hot by changing the constitution. As the FT reports, however, accomplishing this is still no straightforward task since Takaichi would probably need to “engage in ‘horse-trading’ with minority parties” in order to reach the required two-thirds majority in the upper chamber of parliament.

The flexibility to do so is still “to be determined” as turnout for the election was one of the lowest in modern times. Older voters may not be so inclined to change. In addition, Takaichi will need to do all this under the watchful eye of China which is monitoring the potential for any change in Japan’s historical stance on pacifism.

In short, while Takaichi has proven popular and politically adept thus far, her ambitions in regard to constitutional change and the attendant constraints of that endeavor are likely to reveal a great deal about ability of Japan to manage through its challenging debt overhang.

Tomoya Masanao, head of Asia-Pacific portfolio management at Pimco Tomoya Masanao, picks up on the same issue in the FT ($). Namely, Masanao asks, “Can implementation can match intent?”

One area of concern is “the scope and scale of fiscal investment remain uncertain”. Apparently, more details are due to be released in June, but until then markets are mainly assuming Takaichi can thread the needle by spending just enough to boost growth but not so much as to spook bond investors. The outcome will also depend on the speed and degree to which productivity from new investment increases productivity.

Relatedly, as fiscal spending increases, markets will need to determine the degree to which such spending is permanent or temporary. An inherent amount of skepticism is reflected in the old Ronald Reagan quip, “Nothing lasts longer than a temporary government program.” Investors in Japan will be strained to see any government spending as being “just the right amount”.

Such concerns became all the more poignant this week when Japan reported GDP growth well below expectations and its Ministry of Finance reported debt issuance could rise by 28% in 2029 as compared to 2026. These numbers highlight exactly how difficult the challenge will be to avoid either a debt or a currency crisis.

Observations is free to read but it is not free to produce. I do so in order to help investors have a fair chance at getting ahead with their investments and to promote financial literacy.

If you find this kind of work valuable, please consider subscribing, sharing this post on social media, or even, heaven forbid, recommending it in person!

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Investment landscape I

One of the bigger stories the last few weeks has been increased concern about how AI (artificial intelligence) services will impinge upon formerly profitable businesses. Software was the first industry to get whacked and now everyone is looking for others.

As Robert Armstrong ($) reports, software is a target-rich environment because margins are so high:

One obvious point is those margins had grown especially high lately so it is not surprising at all that there might be some give-back. The more important possibility, however, is that the clear, uptrending direction of margins over the last twenty years may be at risk of reversing.

This is a point Matt Stoller ($) picks up on in detail. As he explains, “The stated reason for high profits is the marginal cost of selling another unit of software is zero. If your product catches on, profits roll in.” This is the key underlying assumption driving the rising trend in margins: When the marginal cost is zero, margins continue to rise as revenues go up.

As Stoller reveals, however, that was only a small part of the truth with software companies: “Every compelling business software product is, as former venture capitalist Benedict Evans said, the result of someone identifying an organizational problem, sitting down and mapping out a workflow for how to solve it, and then embedding it into a software package.”

Notably, such systems tended to not be well-liked partly because the end users were not involved in the purchase decision and partly because it was less important to create quality software than to establish standards for industries. Subpar quality software often combined with bad corporate behavior: “They charge junk fees, their products have bad looking interfaces, and their products are often crappy and extractive.”

Stoller summarizes:

In other words, it’s not that generative AI is that good, it’s that software industry models in the U.S. are shaped around monopolization, offering low quality and bad security for high prices, increasingly with customer support from chatbots. So poorly done AI-built software is just not that much worse than what exists now.

Ultimately, the high margins of incumbent software providers are not a result of zero marginal cost production of an additional unit. Costs actually do go up, in the form of dealing with hacking, the need for customer service, fixing bugs, and helping with new use cases. It’s just that if you don’t cover these things, you are offloading the costs to customers and keeping the profits for yourself. Monopolization and lock-in are a helluva thing.

This establishes an entirely different perspective on the software business. Namely, it’s less of an awesome business model than a license for bad corporate behavior. What is has not been (generally) is a service offering that has been extremely useful for customers to solve problems and improve efficiency.

As such, AI tools, as imperfect as they may be, are now good enough to be viable substitutes for products that haven’t been good for a long time. I believe this is exactly why so many software investors and business owners are scared right now — they know there is a good chance the gig is up. They milked it for a long time but did so at the expense of creating a lot of ill will. That means lower revenues, lower margins, and virtually zero terminal value. It will take time, but the recent selloff is just the beginning.

Investment landscape II

With a lot of focus on Kevin Warsh as the presumptive new chair of the Fed, attention has shifted to what monetary policy is likely to look like under his leadership. As Conks ($) highlights in a recent Substack post though, some, arguably more important, changes are already underway.

One of the more important changes is the transition to a new policy rate benchmark (from the Fed funds rate to some rate driving the repo market), which was mentioned in the October 3, 2025 edition of Observations. The discussion then from Dallas Fed President Lorie Logan appears to have traction and is moving forward. Conks dives into the details of that transition.

For most investors, it is the implications of that change that matter more than the details. For those, Claude proved to be a useful assistant. One of the more important implications is the potential for even greater procyclical dynamics from the Fed:

Repo markets tighten when dealers face balance sheet constraints, which typically happens when volatility rises and economic conditions deteriorate. A Fed targeting repo rates might feel compelled to ease policy or inject liquidity precisely when they should be allowing financial conditions to tighten. This creates potential for accommodating excessive leverage during good times and forced interventions during bad times.

There are also other important implications though. One is the tenuous, and eroding, link between monetary policy and credit creation:

This entire evolution [of policy rates] reflects that the Fed has already lost effective control over traditional monetary transmission. Banks don’t need to borrow reserves because they’re swimming in them (thanks to QE and the LCR). The real marginal cost of dollar funding now lives in repo markets serving leveraged investors, not in interbank markets serving commercial lending. Changing the target rate acknowledges this reality but doesn’t restore the Fed’s ability to influence credit creation in the real economy through reserve scarcity.

This is why the Fed’s existing rate cuts haven’t done much to boost the economy. The Fed funds rate just doesn’t have much of an effect on longer-term rates like mortgage rates which really do affect finance costs for people. So, one major point is that despite all the talk that goes into monetary policy, changes in the Fed funds rate just don’t translate very completely into changes in financial conditions for consumers. This also helps explain why reports about consumers struggling have become so prominent even as rates have come down.

So, if the Fed’s monetary policy doesn’t really address conditions that affect most borrowers, what is it doing? The answer is increasingly that it is ensuring the smooth functioning of Treasury markets:

this suggests monetary policy will become increasingly focused on financial stability (keeping Treasury markets functioning, preventing dealer failures) rather than traditional macroeconomic stabilization. The Fed’s reaction function will be more sensitive to market stress signals and less sensitive to inflation or employment data that doesn’t threaten financial system stability.

For those in the back, “The Fed’s reaction function will be … less sensitive to inflation or employment data”. In other words, the Fed is conceding it can no longer do much to steer the economy, so it is going to focus mainly on trying to keep the financial system from blowing up.

This is, or at least ought to be, jarring. While the new role of the Fed substantially mitigates the more apocalyptic possibility of a Treasury market meltdown, it does so at great cost. One cost is it leaves virtually no institutional protection against inflation. Another cost is it virtually eliminates the Fed put except as a memory of an old belief system.

It’s only a matter of time before markets start pricing this emerging reality. When they do, the potential for much lower stocks and much higher bond yields will be among the most damaging effects.

Investment landscape III

One of the more prominent topics of discussion recently is productivity. It comes up as a validation for why investment in industrial businesses is so important and as a claim for why AI might increase economic growth.

While there is an element of truth to such claims, it is important to understand that investment in physical capital is hard — and risky. There are a million things that can go wrong. Regulation, competition, and costs can change in ways that undermine the investment. Skilled labor is required to build it properly and skilled labor is required to keep it in good running shape once it is built.

The same is true of investment in new technologies such as AI. Even though great potential may exist, it normally takes quite a while for all of the investments and changes to cycle through into recognizable net benefits. In short, as the graph from The Daily Shot shows (by way of a Fidelity report), the historical pattern shows that productivity normally only shows up after a “relatively long lag”.

This is a big part of the reason why so much manufacturing was offshored the past few decades — it just wasn’t worth the effort, costs, and headaches to do so domestically. Financial engineering was easier and actually less risky because it didn’t require such breadth and depth of operational skills. As The Daily Shot also shows, high investment has been an expressway to underperformance:

For better and worse, this is the predicament facing companies and industries seeking to rebuild industrial capacity today. Not only is it inherently hard to do, but a lot of the skills and talent to do so have long since been lost or have moved on to greener pastures. Not only will a lot of capital be required, but also a lot of training and skill development. None of these things make the payback come faster or stronger.

A recent story in the Dispatch ($) highlighted the proposition of re-industrializing in regard to shipbuilding. For one, it’s a laudable goal:

The U.S.—with roughly $30 trillion in annual GDP—is the world’s largest economy, and operates one of its largest navies. And yet, in 2024, the U.S. built 0.04 percent of the world’s new merchant ships, measured by gross tonnage (complete 2025 statistics aren’t yet available). That was a down year, but even in better years, the U.S. typically accounts for only 0.2 percent of global tonnage.

For another, it will be enormously expensive to do so:

Currently, few ships are under order at U.S. shipyards, and [those] that are are enormously expensive. The Hanwha Philly Shipyard is currently constructing three Aloha Class freighters for Matson Navigation Company—the largest container shipping vessels built in the U.S.—for $330 million each. Hanwha bought the shipyard itself for $100 million. A similar vessel in an Asian shipyard would cost roughly $75 million, industry observers estimate.

So, the US will be paying $330M/$75M = over four times as much as the going market rate for the benefit of doing so domestically. Guess who’s going to pay for that?

The main point here is to shine some realism on the prospects for new investment, whether it be for re-industrialization or AI buildout. One, by virtually all historical examples, it will take quite a bit of time for productivity to be positively affected. Two, the buildouts will be very costly and will involve difficult tradeoffs that will negatively affect consumers, taxpayers, and investors. They don’t just happen. Three, the priority for capital investment will draw resources from other possible uses such as consumer products which will likely lead to higher prices.

The US may very well navigate “towards a new Maritime Golden Age by expanding commercial shipbuilding capacity”, but it will be a long, hard road to get there. Ditto other industries.

Implications

While the Trump administration continues to tout a pro-growth policy agenda, it also continues to vastly understate the real challenges that are likely to emerge.

On one hand is the potential for significant inflation driven by supply shortages. Whether caused by trade conflict, the redirection of certain supplies to national security priorities, or the dearth of skilled labor, a number of things are going to be harder to obtain. In such cases, higher prices will be the arbiter of incremental demand. Consumers will have to pay up or do without.

On the other hand, the massive buildout of AI infrastructure is likely to lead to a large surplus in the supply of AI-delivered cognitive services. That means both cheaper substitutes/alternatives for many services and as such, it also means fewer white collar jobs, and therefore discretionary income, for the people who used to provide them. That means deflation.

At the same time, the replacement of cognitive services by cheaper AI-delivered services means lower revenue and lower GDP growth, all else equal. Of course, that can create new growth opportunities over time, but the initial impact is contraction, not growth.

In aggregate, this sounds a lot like stagflation. Here, the uncertain part is less about the destination, than the journey. How long will it take for traders and investors to realize the Trump administration party line is overly optimistic? Is it likely to happen soon or will a take a while? Is the realization more likely to be gradual or to happen all at once as a result of some “event”?

Perhaps scariest, what happens when an obvious threat to stock and/or bond prices does NOT elicit an emergency response by the Fed? What happens when investors realize they are totally on their own?

Note

Sources marked with ($) are restricted by a paywall or in some other way. Sources not marked are not restricted and therefore widely accessible.

Disclosures

This commentary is designed to provide information which may be useful to investors in general and should not be taken as investment advice. It has been prepared without regard to any individual’s or organization's particular financial circumstances. As a result, any action you may take as a result of information contained on this commentary is ultimately your own responsibility. Areté will not accept liability for any loss or damage, including without limitation to any loss of profit, which may arise directly or indirectly from use of or reliance on such information. 

Some statements may be forward-looking. Forward-looking statements and other views expressed herein are as of the date such information was originally posted. Actual future results or occurrences may differ significantly from those anticipated in any forward-looking statements, and there is no guarantee that any predictions will come to pass. The views expressed herein are subject to change at any time, due to numerous market and other factors. Areté disclaims any obligation to update publicly or revise any forward-looking statements or views expressed herein.

This information is neither an offer to sell nor a solicitation of any offer to buy any securities. Past performance is not a guarantee of future results. Areté is not responsible for any third-party content that may be accessed through this commentary.

This material may not be reproduced in whole or in part without the express written permission of Areté Asset Management.

I have recently read two strategy outlooks that gave me a lot to think about so I thought it might be useful to walk through that process. The first piece was an interview of Michael Every by Grant Williams. The second was contained in several editions of the Solid Ground newsletter by Russell Napier.

I consider both of these strategists to be extremely good at what they do, to consistently offer valuable insights, and to be straight-shooters. Both have lived abroad and studied global markets for most of their careers and that provides an interesting perspective relative to US-based analysts.

In addition, I found both their theories to be interesting on their own, but also complementary in interesting ways. I also found shortcomings in both that I believe are revealing.

In going through this compare and contrast exercise, I enlisted the help of ChatGPT (Chat) and Claude to help analyze both theories and to virtually extend the conversation.

So let’s give this shot …

As always, if you have any comments or just want to follow up on something in more detail, let me know at drobertson@areteam.com.

Theory 1

THE GRANT WILLIAMS PODCAST: Episode 115, Michael Every ($)

https://www.grant-williams.com/podcast/the-grant-williams-podcast-michael-every/

And my logic for that [the real potential for the liberal world order to collapse], and here is, big drum roll, Greatest Hit, was that effectively that the liberal world order we have built, if you really stripped it down to its moving parts, was for various reasons, undermining American military industrial strength, which meant that American relative military strength compared to other players was declining. And that the only thing that was propping the liberal world order up at its base wasn’t the fact that we love rules and regulations or liberalism, it was American muscle.

But if you really use the same fundamental precept that I’m using on how the Soviet system worked, you would say the current American system, at least pre-Trump, let’s take it back to the pre-Trump, post Cold War, post-globalization, post GFC U.S. What did that system really look like? Effectively, it’s a free market system, but with no long-term planning. So it’s the complete inverse of what the Soviet system was. There are no five-year plans. As a result, there is no incentive whatsoever for capital stock to be built up. People just don’t invest in anything productive whatsoever. And as a result, as I already mentioned, therefore your military industrial complex gets weaker and weaker, even though your job is to be the military hegemon and prop everything up. And without that, the whole system starts crumbling. So that’s the first point.

So, this is an outline of Every’s diagnosis of the problem. For several decades, the US has not invested sufficiently to maintain its base of productive capital, at least partly because there was no plan to do so. Now, it’s becoming increasingly evident the military industrial complex has weakened to the point of presenting a major threat to national security. Something needs to be done.

In framing out the possibilities, Every likens the situation to that of the Soviet Union under President Gorbachev. The similarity is that both the US today and the Soviet Union at the time represent a “superpower [that] needs radical change”. But one problem is the inverse of the other: The Soviet Union had too much capital and needed to build a consumer economy; the US relies too much on consumers and needs to build out capital for a more industrialized economy.

Every sees a path forward for the US in an analogy with with the Soviet Union:

In the Soviet system, Gosbank was there to allocate credit based on what was needed for national security, which was they thought capital stock, military production, not consumer. So the Fed clearly cannot go just to the, well, we raise rates and lower rates and everyone can do whatever you want. It argues not just for lower rates, which I think is important. It argues for differential interest rates between different sectors. So if you’re a national security sector, why do you borrow at the same rate as a sector that’s completely irrelevant? Why would you not have differentiated borrowing rates by national security need?

In short, in order to accumulate massive amounts of capital, which the US needs to do in order to preserve national security, it will most likely need to pursue a path similar to that of the Soviet Union: State-directed, or at least incentivized, credit allocation.

Theory 2

Russell Napier made his big call for a monetary regime change back in 2020. The threat of Covid prompted emergency responses by governments and that opened the door for a very different world that than of central bank-led disinflation.

Namely, governments re-discovered their ability to control/create money through direction of the banking system. He believed this would create a pathway by which governments could stoke inflation, suppress bond yields, and gradually reduce debt burdens through the process of financial repression.

While that process mainly played out during the pandemic, governments largely relinquished control of money in the last couple of years. However, with the escalating conflict between China and the US and the Trump administration’s new National Security Strategy, Napier claims (Solid Ground newsletter, “China: How The New US National Security Strategy Intensifies China’s Debt Deflation & A New Cold War” (17/12/2025) ($)) that geopolitics and economic statecraft are now also part of the formula for a monetary regime change.

In short, Napier argues that “Monetary policy will shift from central-bank balance sheet expansion to commercial bank credit creation” and that “This credit will be directed toward an investment-led industrial strategy”. The combination will result in “higher broad money growth and structurally higher inflation”.

Pros

For starters, I find it especially interesting that two analysts with fairly different perspectives, share so much common ground. They both agree (Chat) that:

• 1980–2020 = era of disinflation, independent central banks, shareholder primacy.

• 2020s = security, industry, and sovereignty trump efficiency.

• Money will be created through directed bank credit, not QE asset swaps.

They also agree (Chat) on:

1. Central banks lose independence.

2. Bond markets will be managed.

3. Real assets > financial assets.

4. US–China conflict structures everything.

The difference is Every is a geopolitical macro strategist and therefore his mechanism of focus is power. That means focus on the political economy and class conflict, and state control of prices, labor, and trade.

Napier, meanwhile, is more of a monetary historian and as such, he focuses on credit, deposits, and balance sheets. This involves topics such as the plumbing of money creation, the distinction between broad money vs base money, regulatory levers and capital rules, and the relationship between Treasury and the Fed in what Napier calls a “bank credit revolution”.

In short, Napier looks at “How money will be created” and Every looks at “Why politics will force it”. Either way, they agree there is impetus for major reform.

AI evaluation

So, I asked Chat to evaluate the narratives of both strategists so I could compare and contrast with my own impressions.

Chat said Napier is right about undue focus on the Fed funds rate when broad money is the true driver of inflation, is convincing that political logic will dictate action, and that observable policy trends suggest state direction of credit is quite plausible.

On the other hand, Chat found Napier to be overly optimistic about credit growth given the potential for weak demand, insufficiently skeptical about the friction caused by capital constraints, and insufficiently skeptical about the potential for forced credit growth to produce bad outcomes such as malinvestment, low productivity, and stagflation.

Chat listed the strengths of Every’s case to be his coherent structural diagnosis in that Trump administration policy direction is consistent with the idea of “capitalism with a national-security face”, policy direction is consistent with economic statecraft (vs, classic neoliberalism), and he identifies a potential path to relax fiscal constraints by re-territorializing Eurodollars with stablecoins.

Weaknesses include the difficulty of controlling capital flows and suppressing dissent in a democracy, the likelihood of suffering consequences like inflation before realizing benefits like increased capacity, and the under-emphasis of need for competent administrative control.

I also asked what the chances of success were. Chat gave a 25-30% chance Every’s “inverse perestroika” thesis would play out and a 25% chance that Napier’s “managed reflation” thesis would play out. I found it fairly interesting that Chat assumed a high probability of the Trump administration continuing to pursue a policy course of economic statecraft, i.e., tariffs and geopolitical squawking are not likely going away anytime soon.

While the assigned odds of success of 25% are not high, they are higher than I thought they should be given the wide range of factors that can trip up the plans — so I pushed back …

Pushback - Every

In particular, I asked:

The odds of success seem high because so many things have to work in conjunction. As a result, it seems the probability would be quite low. For example, pursuit at 70%, and alignment of partners despite coercion let’s call 60% and success of stablecoins let’s call 60% = chance of success of 25%. The odds of alignment despite coercion seem high, especially given ongoing incentives for defection, and stablecoins also seems high given the potential for alternatives. In addition, there are a million other things that could go wrong such as geopolitical conflict, recession, etc.

Chat replied:

You’re absolutely right to treat this as a joint-probability problem rather than a single political choice. Every’s thesis is internally coherent, but it depends on several independent systems all cooperating: domestic politics, allied behavior, monetary plumbing, and geopolitics. When you multiply conditional probabilities instead of admiring the narrative, the picture gets far more fragile.

After reformulating the evaluation as a joint probability problem and applying what it called “optimistic” assumptions, Chat ended up with a 9.7% probability of success. Chat agreed, “This isn’t one bet — it’s a parlay.” Additional pushback led to even lower rates of success.

Implications

I went back and forth like this for a while and will just summarize the most interesting points.

For one, markets aren’t pricing the low joint probability of policy success. Indeed, this is consistent with historical precedents that demonstrate “grand strategies fail more often than they succeed”.

I also raised the possibility that the inverse perestroika framework suggests a system that is already too-far gone; it’s already beyond simple repair. Chat agreed this is “a very strong—and uncomfortable—possibility”. It elaborated by saying, “You can’t rebuild a 1970 industrial republic on top of a 2020 asset-financial empire without destroying the empire first.”

As a result, Chat suggested Trump administration policy may be more properly framed as a “story to manage decline” rather than a “plan to fix the machine”. As a result:

The real question may not be:

“Will Trump’s strategy work?”

but

“What regime follows when it predictably underdelivers?”

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Pushback - Napier

In pushing back on Napier’s thesis, I asked:

Russell Napier argues that the banking system will be used to increase money supply to drive economic growth. I believe this is plausible and has some chance of working, but mostly the odds are against it. For one, government allocation of credit is likely to be less efficient than a free market driven allocation. For another, any decreases in the central bank balance sheet will decrease liquidity and demand for short-term treasuries which is likely to cause a major deleveraging and risk a major selloff. Finally, the transition to a more industrial economy is likely to be fraught as it will come at the expense of vested interests and a legal environment that has been very soft on antitrust and IP theft. Please evaluate Napier’s arguments and critique my objections.

Chat replied that it still thought Napier was “directionally right” that the next regime would rely on bank credit (rather than QE), that inflation risk is structural, and that real assets are likely to outperform financial assets. It also agreed with my points that credit direction does not necessarily imply productive growth, the “transition dynamics are dangerous”, and liquidity plumbing matters more than he suggests.

Chat laid out a matrix of scenarios with the chances of bank-led credit expansion generating real productivity on one axis and the chances of a liquidity transition occurring without a bond accident on the other axis. In this analysis, Chat determined a 25% probability of Napier’s core thesis of managed reflation, but an even higher probability (35%) of malignant stagflation.

Claude provided a nice summary of the “debate”:

Napier provides a coherent framework for how policymakers want to solve the debt problem through financial repression and controlled inflation via commercial bank credit expansion. Your objections correctly identify the key execution risks:

1. Directed credit may not be productive enough to generate the real growth needed

2. The liquidity dynamics are treacherous — getting the sequencing wrong risks a crisis

3. Political economy obstacles are formidable — industrial policy is hard in a complex democracy

Implications

While the exercise helped to identify and articulate my skeptical hunches, I still was not satisfied that the analysis fully captured the operational difficulty of massively changing the country’s economic and financing model. In short, even though a 25% chance of success for Napier’s core thesis is low, I still felt it was way too high.

So, I kept probing. I noted that increasing C&I (commercial and industrial) lending in the US would come at the expense of shadow financing for hedge funds, private credit, and private equity. I also noted this would be an awkward transition in the US which relies much more on market-based finance than on bank-based finance. I also asked how a policy of reindustrialization might work in the context of lax antitrust enforcement and an economy strewn with extractive business models.

Claude provided a good summary of the responses to these questions:

These are not fatal to Napier’s thesis, but they suggest:

• The path will be much messier than he implies

• Financial repression will need to be more explicit/coercive

• Crisis episodes are likely during transition

• Success is far from assured

Broader implications

The first observation I have is this type of analysis dovetails perfectly with my analytical style. Just as I state in Areté’s ADV that various analytical “methods are used to complement one another by way of establishing multiple perspectives”, so too are various knowledge domains useful for both providing incremental insights AND avoiding major blind spots.

To this point, Every’s expertise in “political superstructure” helps clarify the “motive force” while Napier’s expertise in the “monetary base layer” helps clarify the “transmission mechanism”. Per Chat:

Together they imply:

- The state will demand growth

- Banks will be forced to supply it

- Inflation will mediate the conflict.

However, as this discussion has highlighted, there is more to the story than that. As Claude summarizes:

The gap between policy intent and execution is where most such schemes fail. The legal/regulatory environment, labor markets, and political economy present serious obstacles.

That brings up another observation: Given the numerous and significant obstacles to major economic reform, Every’s theory of “inverse perestroika” casts an ominous shadow: Due to the analogy with the Soviet Union, it suggests the problems are far too deep to solve without significant pain. In short, the reform is coming too late.

By this reading, Americans are mostly in denial. They don’t yet realize how severely their industrial economy has been hollowed out, they don’t realize how severe a security threat that presents, they don’t have any appreciation for how expensive it is going to be to fix it, and they don’t realize how much all of that is going to blow back by impairing their quality of life. This isn’t a Democrat or Republican thing; it is a superpower got way too lazy thing.

With stock markets nudging up against record highs, inflation expectations fairly benign, and bond yields (and volatility) unusually quiescent, there appears to be a major disconnect between market perceptions and underlying reality.

Even with awareness of the endgame, however, managing the process of eventual popular realization will be a key challenge. As Chat highlights, it’s not so much about figuring out “what will happen?” but “how will beliefs travel from today’s consensus to something closer to Napier/Every?” In considering this, it reminds us, “Market regimes usually change through narrative cascades, not linear data updates.”

Indeed, this possibility, even likelihood, casts US public policy in a very different light. That policy is not so much designed to provide a clear operational pathway to an industrial renaissance, but rather to buy some time and political cover before the realization of a darker and messier future sets in. As such, day-to-day policy details are essentially irrelevant to the ultimate outcome and therefore serve as an unnecessary distraction.

Napier and Every are both right that several decades of imbalances and inattention have created an untenable situation in the US. They are also right that major reforms will need to take place. As I have highlighted, I am very suspicious that such reforms can be pulled off without significant pain — pain that is not being discounted by current securities prices.

Investment implications

With the caveat that none of this represents investment advice, I believe more strongly than ever that US stocks are significantly overvalued and that Treasury bonds do not present a good value for long-term investors. Gold is still one of the best ways to preserve wealth.

I also believe that given the enormous disconnect between underlying fundamentals and public perception, the chances of a disruptive event keep rising. The fact that the timing of such an event is inherently unknowable makes it all the more important to prepare ahead of time by being absolutely comfortable with one’s risk exposure.

The bottom line though is this is the type of environment that marks a change in investment regime and that can permanently alter the trajectory of one’s investment performance if one doesn’t adapt. Best take it seriously.

Note

Sources marked with ($) are restricted by a paywall or in some other way. Sources not marked are not restricted and therefore widely accessible.

Disclosures

This commentary is designed to provide information which may be useful to investors in general and should not be taken as investment advice. It has been prepared without regard to any individual’s or organization's particular financial circumstances. As a result, any action you may take as a result of information contained on this commentary is ultimately your own responsibility. Areté will not accept liability for any loss or damage, including without limitation to any loss of profit, which may arise directly or indirectly from use of or reliance on such information. 

Some statements may be forward-looking. Forward-looking statements and other views expressed herein are as of the date such information was originally posted. Actual future results or occurrences may differ significantly from those anticipated in any forward-looking statements, and there is no guarantee that any predictions will come to pass. The views expressed herein are subject to change at any time, due to numerous market and other factors. Areté disclaims any obligation to update publicly or revise any forward-looking statements or views expressed herein.

This information is neither an offer to sell nor a solicitation of any offer to buy any securities. Past performance is not a guarantee of future results. Areté is not responsible for any third-party content that may be accessed through this commentary.

This material may not be reproduced in whole or in part without the express written permission of Areté Asset Management.

As always, if you have any comments or just want to follow up on something in more detail, let me know at drobertson@areteam.com.

Market observations

Late the prior week, gold and silver got pounded. Both recovered significantly this week and the whole episode looked like the one in late October last year — a big dip for sure, but nothing permanent.

On Thursday this week, gold was modestly weaker but silver was down 10% to start off. It’s hard to attribute any specific cause but it looks to be an indication of deeper rumblings.

Deeper rumblings were also evident in a violent reversal of factor returns during the week. Robert Armstrong ($) reports:

As Yin Luo of Wolfe Research pointed out to me, we have seen a reversal in which “factors” — broad characteristics that drive stocks’ returns — are leading the market. He sent me the below screenshot of his factor dashboard from yesterday [Wednesday], showing that stocks with high dividend yields, low valuations and high return on equity did well yesterday, while momentum, high volatility and growth all got smacked down.

It’s pretty rare to see such extreme reversals in factor returns. When they do happen, it’s often indicative of a market turning point.

Yet another interesting phenomenon this week was Anthropic’s introduction of a new AI tool. As John Authers ($) reports, software stocks instantly got routed:

The downturn over the last few days for software stocks, however, is much more pronounced. The sector is down by more than 17% year-to-date. It turns out that AI can be bad even for software groups; the catalyst for Tuesday’s bloodbath was Anthropic’s latest AI tool. Thomson Reuters Corp., one of the casualties, plunged by as much as 20% — its biggest decline on record — on concern that the AI tool would deprive it of its large business in software for legal workflow. Any businesses at risk of being disrupted by AI can expect similar treatment.

One interesting point is that tech stocks got crushed because of AI — whodathunkit? Another is that business development companies and other private credit companies also got hammered because a large share of their holdings are software companies. So, the whole idea that AI is going to save the world is at least, shall we say, incomplete.

Finally, both Google and Amazon reported expectations of massive increases in capital spending. As a reminder, corporate share repurchases have been a big driver of the rally in stocks. As capex reduces free cash flows, share repurchases will have to come down — which will reduce at least some of the demand for stocks. On the other side of the equation, Wall Street’s IPO machine is firing up which will increase the supply of stock for investors to buy. On the margin, these two trends can be expected to provide headwind for stocks for the foreseeable future.

Economy I

As the decoupling of consumer sentiment from economic growth continues to confound experts, a few commentators have been able to shed some important light on the matter. For example, Matt Stoller ($) illustrates how dramatically the relationship between GDP and consumer sentiment has changed over the last fifteen years:

This observation isn’t a commentary about Biden or Trump, but about a structural change in the economy. You can see how people think about economic growth itself has shifted. Here’s the relationship between growth and consumer sentiment. They used to rise in parallel, higher growth meant more consumer confidence, but they started breaking down in the mid-2010s, and fell apart completely post-Covid.

Bruce Mehlman picks up on a similar thread. He finds that “Blue collar consumers are afraid” as indicated by record low consumer confidence — even lower than the Great Financial Crisis in 2008 and Covid in 2020.

He also shows there are good reasons for this apprehension. Namely, blue collar job growth has not only slowed in recent years, but is now contracting:

Regardless of the improvement headline GDP numbers are showing, it is clearly not translating to better conditions for a large swath of Americans.

Economy II

Another reason lower income Americans have lower confidence is because they have been experiencing higher inflation than the headline CPI (consumer price index) numbers suggest. Bruce Mehlman relays analysis by Torsten Slok at Apollo:

Data from the Fed shows that lower-income households are experiencing higher inflation because their consumer spending baskets place greater weight on categories like rent, electricity, food, transportation and other necessities whose prices have risen faster.

Matt Stoller homed in on the same research:

For instance, last November, the Atlanta Fed came out with a paper showing that from “2006 to 2020, poorer metropolitan statistical areas experienced annualized food inflation that was 0.46 percentage points higher than that of richer ones—amounting to a cumulative difference of 8.8 percentage points over the period.” The reason was consolidation, but the point here is there’s a different kind of inequality you can’t get from just consumer spending metrics.

Mike Green ($) demonstrated the phenomenon of differentiated inflation with a simple example:

Consider two products over a 10-year period:

Organic Milk (The Rich Basket): Innovation drives the price down. The wealthy experience deflation (-5%).

Polluted Milk (The Poor Basket): Consolidation and scarcity drive the price up. The poor experience inflation (+5%).

Finally, one of the weird but real idiosyncrasies of the CPI calculation is that it doesn’t include borrowing costs. As a result, none of the increased financing costs show up in official inflation statistics.

According to Green, the technocratic class is both analytically incompetent and politically oblivious. It fails both to see the differentiated effects of inflation and to appreciate the impact it has on the lives of people in different economic conditions. Knowing this, it gets a lot easier to see why lower income consumers are so disenchanted.

Economy III

One of the more dominant themes over the past forty-plus years has been supply-side economics. This theory claims that growth comes from the “supply” side, not from demand. As a result, policy should focus on increasing supply by means of production incentives, lower taxes, and less regulation. It is easy to see all of these characteristics in Trump administration policy.

This model worked decently at time when workers took home a much larger share of GDP in wages and when companies were smaller and less influential politically. The idea that a rising tide lifted all ships was right enough.

Over the years, however, that changed. The consistent favoritism towards supply benefited corporations and capital owners at the expense of workers. Wages as a proportion of GDP steadily fell. When demand was insufficient, government increased borrowing (and therefore increased fiscal deficits). When productive investments became scarce, business models were developed around consolidation (in order to drive pricing power) and extraction (by not sharing productivity improvements with workers and by forcing costly services onto consumers).

One indication of the degree to which GDP has become divorced from productive capacity is Matt Stoller’s highlight that “the second fastest growing sector of the economy in terms of GDP growth from 2019-2024 was gambling (according to the Bureau of Labor Statistics).

The end result is what used to be a decent model for economic growth has actually become a self-defeating one. Now, a rising tide from increased supply no longer lifts all ships but rather drives a progressively bigger wedge between rich and poor. The harder the supply side engine is run, the worse off most Americans become.

This presents an interesting quandary for the Trump administration. While it keeps pressing firmly in the direction of supply side economics, it is not only worsening economic conditions for most people, but also worsening political prospects for itself. This will keep getting worse until the administration changes course. Or, as the adage goes, the beatings will continue until morale improves.

Politics

G. Elliott Morris ($) reports on a surprising special election result in Texas:

Democratic candidate Taylor Rehmet has won a special election for Texas State Senate District 9 in Tarrant County — a seat Donald Trump carried by 17 points in November 2024, per The Downballot. As I’m writing this, approximately 99% of the vote has been counted, and Rehmet carried the seat 57.2% vs his Republican challenger, Leigh Wambsganss, at 42.8%. That’s a 14.4-point margin, and a 31.4-point swing vs Harris’s margin in 2024

Since Trump took office, Democrats have flipped eight Republican-held state legislative seats in special elections across five states. Republicans have flipped zero Democratic seats.

While special elections in general need to be taken with a grain of salt, a pattern is clearly emerging in which voters are “breaking hard against Republicans”. Although it would be irresponsible to read too much into this, it would also be irresponsible to ignore such a notable anomaly.

This presents an interesting hypothesis: Is Trump Mr. Backfire? In other words, does Trump actually accomplish the opposite of what he says he intends to? He campaigned to help the plight of workers, and they are suffering the most. He campaigned to drain the swamp and Washington is as corrupt as ever. He promised significant reform and Wall Street is still nearly always in a position of, “heads I win, tails you lose”.

This is still just a hypothesis, we’re still just one year into the administration, and a lot of things can change, but I’m finding it useful to consider the possibility.

Monetary policy

Since Kevin Warsh was announced as the next Fed chair, commentators have been busy both characterizing him and handicapping the way he will lead the Fed. This seems like so much misplaced analytical effort since Warsh, like Powell, is a lawyer by training. For better and worse, since he is not an economist, he does not have deep-rooted theoretical predilections.

Perhaps the most useful description came from Paul Krugman ($) who called him a “political animal”. This suggests he will be more inclined to operate on the basis of political expediency than intellectual proclivity. It brings to mind the quote often attributed to Groucho Marx, “These are my principles. If you don’t like them I have others”. Powell certainly changed his stripes once in the seat and confronting real challenges. The odds are Warsh will be in a similar position.

Robert Armstrong ($) identified an interesting angle on Monday by highlighting the following quote from Warsh:

The difficulty of [AI] for policymakers — let’s say central bankers, let’s say fiscal authorities — is that the economy is going to be growing, but it will not show up in the productivity statistics. So we are going to have to make a bet: is the economy becoming much more productive . . . my simple version of this is, everything technology touches gets cheaper.

One of the interesting points is that Warsh is clearly differentiating himself from Powell’s tendency to wait for data to come by expressing a preference to act before a phenomenon like AI shows up in economic statistics. While Powell’s backward-looking approach certainly has had its shortcomings, Warsh’s desire to guess the future has obvious shortcomings as well.

Relatedly, Warsh states, “ we are going to have to make a bet”. In isolation, this a striking claim for a central banker, or about any government official to make. Actually, no, we don’t have to make a bet. That is a very extreme position and arguably irresponsible for a central banker to make. Between making a bet about the future and waiting for old data to finally roll exists a vast space where smart people can do the best they can with the limited information they have and adapt as new data and different conditions merit. But apparently we aren’t getting that.

Since deliberation and judgment don’t seem to be Warsh’s thing, the best expectation is that Warsh already knows what he wants to do and will spend his tenure justifying it. Insofar as he is assuming disinflation, we can assume he will push for lower short-term rates. Now we just have to see how much authority he has to effect those desires and whether he changes his mind along the way.

Investment landscape I

One of the louder narratives early in this new year is that of dedollarization. Robin Brooks argues “The debasement trade took off after Chair Powell’s dovish keynote speech on August 22 at Jackson Hole” because “it chose sides, putting a greater weight on the labor market than on inflation”.

More recently, Brooks has argued that the dollar is resuming its downward trend due to “a perception of policy chaos” in regard to the Trump administration that was triggered by overtures about invading Greenland. The “crisis of confidence” this caused also accelerated efforts to “sell the Dollar forward in currency markets to protect themselves against future Dollar declines”.

While these are certainly viable arguments, they are given even more weight by the broader context of diminishing US financial hegemony. Last year, I highlighted the work of Ken Rogoff who had just published a new book on the US dollar, its history, and a prognosis for the future:

Rogoff was even more forceful in an FT ($) summary of his book that went under the headline, “America’s fiscal policy is going off the rails — and nobody seems to want to fix it”. In that, he concluded, “The US’s high debt and inflexible political equilibrium will be a major amplifier of the next crisis and, in most scenarios, the American economy and the dollar’s global status will be the losers.”

So, yeah, it looks like recent events are confirming the longer-term suspicions that the USD will continue to lose status on the margin.

Investment landscape II

“Gradually losing its status on the margin” is a very different thing than a “catastrophic fall” or “hyperinflation” or “loss of reserve currency status” or any number of claims that exaggerate a still very important change that is happening.

Grant Williams addresses this point brilliantly with another analysis of history — about the British pound:

Suez is remembered popularly as an episode of imperial hubris, a late and clumsy attempt by Britain and France to impose authority in a post-colonial Middle East. But it’s far more useful to understand it as a monetary event disguised as a geopolitical one, the final revelation of something that the world already knew to be true—that Great Britain no longer remained financially sovereign.

The United States manufactured the moment in which the world understood Britain could no longer guarantee its own currency without external patronage. From that point onward, sterling’s authority rested not on its own credibility, but on borrowed confidence … Confidence didn’t collapse, it simply reorientated itself in real-time.

In this example, Williams highlights two lessons:

1. “Britain didn’t become poorer overnight, but it became constrained, and that was the death knell for sterling as the backbone of the global monetary system.”

2. “Suez didn’t kill sterling, it merely removed the ability for its trading partners to wilfully ignore its frailty.”

He uses this historical study as a basis to examine the US dollar. By his reckoning, a critical change occurred after Russia invaded Ukraine in 2022 and Western sanctions targeted Russia’s central bank. The signal that decision sent globally was that “[central bank] reserves were not simply financial instruments subject to market fluctuations, but political assets vulnerable to external control”. In short, “reserves became visibly and overtly political capital”.

Since the US dollar is by far the largest reserve currency, this fundamental change in the perception of the nature of reserves is most detrimental for it. Suddenly, gold appeared relatively more attractive, not because of yield, but “because it offered independence and security”. That didn’t cause gold to “suddenly” jump in price, though. As Williams concludes, reserve systems don’t “lose control through mutiny, but rather through increasing obsolescence at the margin”.

So, the pressure on the US dollar is best viewed as a long-term headwind. On the margin, it will lose a little ground here and there, and every once in a while, it will take a bigger step down. It’s highly unlikely anything really big will happen overnight though.

After the US dollar’s wobbles the prior week, it bounced back a bit on news that Treasury secretary Scott Bessent said the Trump administration was still pursuing a “strong dollar policy”. According to the FT ($), he went on to say, “If we have sound policies, the money will flow in and we are bringing down our trade deficit, so automatically that should lead to more dollar strength over time”.

In classic Trump administration style, Bessent’s statement was in direct contrast to a claim made by Trump himself that he was fine with a weak dollar. The statement also contravened Stephen Miran’s argument that a weaker dollar is critical for reducing trade and financial imbalances. Also in classic style, Bessent assumed a strong dollar would follow “sound policies” even as other commentators are describing the administration’s efforts as “policy chaos”. Finally, Bessent claimed “we are bringing down our trade deficit” while the latest reading was for a massive increase in the trade deficit.

Given the lack of consistency, it is hard to place too much importance on Bessent’s statements, let alone any of the others. Mainly, the cornucopia of contradictions on dollar policy ought to be signal enough that it is at risk.

Investment landscape III

Japan is having its general election on Sunday (Feb 8) and with it the world will learn a little more about the new prime minister’s ability to corral political capital and steer the country through its enormous debt burden.

Takaichi Sanae has thus far generated the excitement of an emerging rock star by representing a fresh break from the past. She has done this with a mix of brutal honesty and hope.

As the FT ($) relates, her popularity is founded partly in a fresh appeal to women: “Takaichi appears to be offering a model for Japanese women frustrated with an unfair society, while also bringing some hope to a wider Japanese public shouldering a broad range of dissatisfactions”. As suggested, her support is also broadening: “cross-generational, middle class, actively enthusiastic for change and reaching for Takaichi as a symbol of something different and disruptive — is real”.

Obviously, she is still enjoying a honeymoon period and has not yet been tested with the severe problems facing Japan. Nonetheless, criticisms from business leaders that “they do not see her as a safe pair of hands” come across as both sour grapes from a patriarchal state that has underperformed on growth and from the main party (LDP) that is littered with a history of scandals that have undermined public trust. Maybe she won’t be up to the task, but the old style leaders sure didn’t work either.

At any rate, she also provides a model for other developed, aging countries that are probably past their prime and in denial about how painful meaningful reform will be. Here’s looking at you US.

Implications

The tone in stocks turned decidedly negative this week, largely due to the competitive threat of AI (artificial intelligence) tools to software companies and the threat that presents to private credit companies which are loaded with them.

One point is that it is perfectly sensible that AI tools would be a serious threat to companies whose core activities are coding and which have high margins. For as much as the AI narrative revolves around boosting productivity, what it is naturally designed to do is undercut incumbents who have been overcharging for a long time.

It is also perfectly sensible that in an environment of extraordinarily low credit spreads and extended positioning in stocks, such stocks could suffer large losses. When industry tailwinds predominate, investors are fine with companies talking about unicorns and rainbows. When competitive threats are here and now, they need to see cash flows.

While these developments get digested by investors, there are two big ideas to keep in mind. One is to consider which other industries with high margins and excessive pricing are vulnerable to being disintermediated by AI. My guess is there are a lot. This will be productivity improving for society, but business destroying for a lot of incumbents.

Another is to realize in an environment of high leverage, losses permeate the system quickly and can easily metastasize into larger liquidity events. When that happens, the most liquid securities get sold first regardless of what they do or what they are worth.

Note

Sources marked with ($) are restricted by a paywall or in some other way. Sources not marked are not restricted and therefore widely accessible.

Disclosures

This commentary is designed to provide information which may be useful to investors in general and should not be taken as investment advice. It has been prepared without regard to any individual’s or organization's particular financial circumstances. As a result, any action you may take as a result of information contained on this commentary is ultimately your own responsibility. Areté will not accept liability for any loss or damage, including without limitation to any loss of profit, which may arise directly or indirectly from use of or reliance on such information. 

Some statements may be forward-looking. Forward-looking statements and other views expressed herein are as of the date such information was originally posted. Actual future results or occurrences may differ significantly from those anticipated in any forward-looking statements, and there is no guarantee that any predictions will come to pass. The views expressed herein are subject to change at any time, due to numerous market and other factors. Areté disclaims any obligation to update publicly or revise any forward-looking statements or views expressed herein.

This information is neither an offer to sell nor a solicitation of any offer to buy any securities. Past performance is not a guarantee of future results. Areté is not responsible for any third-party content that may be accessed through this commentary.

This material may not be reproduced in whole or in part without the express written permission of Areté Asset Management.

With that said, let’s take a look at what’s been going on.

As always, if you have any comments or just want to follow up on something in more detail, let me know at drobertson@areteam.com.

Market observations

Risk assets took a dive on Thursday and then mostly recovered. As of Friday morning, stocks were set to fall again and gold and silver were set to fall by quite a bit. The news was a big selloff in software stocks, imminent conflict in Iran, the announcement of Kevin Warsh as the next Fed chair, and a potential government shutdown. Mainly, it looks like a huge rally in risk is ready to take a breather.

The big stories of the week were the weakness in the US dollar and the continued strength in gold. While this doesn’t mean very much to a lot of investors, one way to capture the impact is to base a more familiar asset, such as the S&P 500, in the two different denominations.

As The Daily Shot graphs show, the S&P 500 in US dollar terms hit a new high this week — which superficially looks awesome:

When the S&P 500 is denominated in gold, however, it hit a twelve-year low this week — which looks awful:

So, while it looks like the S&P 500 is doing great, it has actually been losing ground insofar as gold is a better long-term indicator of purchasing power. This means stocks have been failing to preserve wealth and the appreciation in dollar terms has mainly been a mirage.

Public policy

Mike Green ($) mentioned two papers from Hudson Bay Capital that perfectly crystallize the “‘Optimism’ narrative currently sweeping Wall Street”. The papers, titled “Tech Trumps Tariffs” (Nouriel Roubini) and “No, Stocks Aren’t in a Valuation Bubble” (Jason Cuttler) were described by Green as “sophisticated, compelling, and arguably the most dangerous documents I have read this year”.

Of course, this piqued my curiosity but also presented a conundrum: I had read another Hudson Bay paper by Stephen Miran entitled, “A User’s Guide to Restructuring the Global Trading System,” and found it to overbearing in political partisanship and underwhelming in analytical skill and policy nous. So, I decided to both save myself the annoyance of wading through more faux-analytical verbiage and to test my own objectivity by running both of the papers through ChatGPT (Chat).

Chat said the tariff paper’s top-line projection read “more like strategic optimism than an evidence-based forecast with uncertainty bands”. It also noted the paper was “more of a ‘don’t fight the tape’ framing than a serious valuation dissection”.

Chat found “two big tells” as an analytical paper: “The thesis depends on a single dominating assumption (AI quickly lifts potential growth toward 4%)” and “It downplays tail risks that would break the model (institutional decay, inflation persistence + Fed conflict, geopolitical rupture)”.

It characterized the paper as “good narrative framing,” “with selective confidence,” and “insufficient quantification of uncertainty” and described it as “persuasive as positioning; less persuasive as forecasting”. In short, it’s a sales pitch (my words).

The valuation paper didn’t fare any better. Chat described the implied conclusion as “politically loaded (and conveniently aligned)”. It recognized the paper’s claim that “an optimism regime may emerge via policies aligned with Trump’s MAGA objectives (tariffs, immigration restriction, deregulation, etc.)” was not “inherently wrong,” but is also “a distinctly partisan macro framing”.

One of the patterns I saw in the Miran paper and which arose again in this one is the tendency to “under-weights the tradeoffs”. As a result, Chat calls the valuation paper, “not rigorous enough to support the headline confidence”. Instead, it is best read as “a bullish strategic framing tool” and “a sales-quality justification for owning convex upside / right-tail exposure”. So, there you go.

One observation is that these papers are just not very serious as analysis. The ease with which a widely available tool like ChatGPT rips them apart analytically is testament to how unserious they are as policy recommendations. The fact that a lot of people are still looking to them for justification indicates exactly how much the “Optimism” campaign is more one of cheerleading than thoughtful policymaking. Green’s assessment as “dangerous” seems apt.

Japan

Last week I described Japan’s situation as “fragile” since it is now “left with only bad choices”. This week, rumors of potential currency intervention caused the yen to strengthen significantly against the US dollar and left traders wondering as to what might be next.

Robin Brooks quickly shared his skepticism that intervention would succeed in any meaningful way:

Intervention works best when it’s a complete surprise and when positioning in FX markets is very stretched. Neither is true now.

This means that risk premia due to Japan’s high public debt are being artificially suppressed in the bond market. As long as that’s the case, depreciation pressure on the Yen will continue.

Meanwhile, John Authers ($) reported on Rory Green’s thesis that fears of an imminent crisis are overdone:

1. The LDP may fail to win a large majority in the Feb. 8 election.

2. Takaichi is not Truss – Tokyo is clearly aware of bond market risk.

3. The primary deficit is trending to zero.

4. The BOJ and MOF have plenty of tools to address unwanted spikes in yields.

One thing that is clear is that the Japanese government and finance officials have stepped up their rhetoric. That suggests we may well have started the progression to financial repression. The next signpost will be actual intervention if the yen keeps slipping towards the 160 USD/yen level.

Investment landscape I

Robert Armstrong in the FT ($) summarized a recent piece by Michael Mauboussin, who is always worth a read:

Mauboussin’s broad argument is that you can’t make money by just being right. You have to understand why the people “on the other side” of your trade are wrong. What bias, factual error, analytical mistake, or structural market trap they have fallen into. You must be able to “articulate why an inefficiency exists and how it will be extinguished.”

Markets lose efficiency when investors lose diversity . . . One of the challenges in dealing with diversity breakdowns is that their effect tends to be non-linear. In other words, you can lose diversity consistently for some time and the asset price will not react. Then a small change on the margin leads to a large change in the price.

Regular readers of Observations will recognize this reasoning as an explanation for persistently high stock valuations: Several important constituencies keep buying stocks regardless of fundamentals — passive investors who mainly add to retirement accounts automatically, corporations with too few attractive investment opportunities to deploy free cash flow other than through share buybacks, and lots of other investors who believe public authorities will always intervene if stocks do start going down. Yet others believe in the AI (artificial intelligence) boom and still others don’t have a strong view about stocks but are afraid to miss out on what has been an incredible run.

The important element is that in aggregate, these cohorts represent “low belief diversity”; they are all long stocks for reasons other than pure investment merit. As a result, since so many participants have the same view, and are already over-exposed, there are few left “to sell to when things go wrong” and that makes markets “subject to violent changes”.

In short, the calm advance in stocks investors have been experiencing is subject to sudden and dramatic turbulence.

Investment landscape II

Jonathan V. Last ($) picked up on a phenomenon I have found to be curious as well: Trump can mention some idea like invading Greenland countless times and the media treats it as a serious threat. But then with one single denial, the media treats the issue as if the case is closed. As Last rightly recognizes:

But if everything Trump says is just positioning and in an ongoing negotiation then nothing he says can ever be taken at face value. He has not actually “ruled out” the use of force. Those are just some words he said, which can be abandoned, reversed, or ignored at any point.

Why the asymmetric consideration? As Last describes, “The media tends to treat Trump’s more insane statements as ephemeral, but then turns around and treats his climb-downs as binding”.

There are several possible reasons why media companies might do this, not least of which is to try to stay out of the administration’s crosshairs. But that is all the more reason why analysts of the investment landscape should take note. When the sterilized media version of Trump claims is tough talk followed by climb down, the very reporting reinforces the belief in guardrails. The objective reality is different. There is no stability with the Trump administration. Anything Trump says “are just some words … which can be abandoned, reversed, or ignored at any point”. Good to keep that in mind.

Investment landscape III

Greenland was the news item from the prior week and while that came and went through the news cycle, it was interesting to observe how other participants and how the rest of the world responded to Trump’s antics. Sometimes the most interesting things are observed as reflections in others.

Jonathan V. Last ($) captured some quotes from European leaders that strongly suggest Davos marked a turning point in international relations:

“Our American Dream is dead,” said an EU diplomat from a country that has been among the bloc’s transatlantic champions. “Donald Trump murdered it.” . . .

“No matter what solution is now found for Greenland, everyone must understand that we cannot sit back, relax, and be satisfied.” . . .

“We are experiencing a great rupture of the world order,” said a senior envoy from a country that was seen in the EU as a key American ally. Leaders will discuss “de-risking” from the U.S., the diplomat said — a term that has previously been reserved for the EU’s relationship with Beijing. “Trust is lost,” they said. . . .

“I think we are past Munich now,” said one, referring to a 1938 meeting where Britain, France and Italy appeased Adolf Hitler by allowing him to annex Czechoslovakia. “We realize that appeasement is not the right policy anymore.”

Jonah Goldberg ($) noticed that even the ostensibly-aligned political ideologies of the nationalist-populist parties in Europe were “appalled by Trump’s Greenland bullying”:

Here’s the problem in a nutshell. Getting pushed around by a nationalist superpower doesn’t feel any less humiliating than getting pushed around by a globalist superpower. Trump’s treatment of Europe is wildly unpopular, and nationalist politicians are politicians who have their own constituencies to answer to.

Shannon Brandao ($) noted how Trump’s framing of “tariffs and coercion as the price of access to American markets” had the effect of “casting allies as burdens rather than partners”. It also had the effect of recasting China as the anchor of globalization and something that “will continue with or without Washington”. It also cast China as “the adult in the room”. Brandao writes:

The paradox was striking. Even as doubts about Beijing remain deep, Washington’s rhetoric strengthened the perception that China—not the United States—is positioning itself as the defender of globalization.

Robin Brooks recognizes the same shift in geopolitical opinion and details the effects on US markets:

If there’s a crisis of confidence in US policy making - which is what’s happening - there’s a lot of hedging that needs to happen. Foreigners may not sell their US holdings outright, but they’ll sell the Dollar forward in currency markets to protect themselves against future Dollar declines. This is what happened last week and what also happened in April 2025.

One clear takeaway from these observations is that unilateral power has limits. In a regional, tribal landscape, hard power is key. In a global, interconnected world, relationships are also critical. In short, the larger the territory, the more important soft power is.

As a result, it is useful to see the impression of the Trump administration through the eyes of other global leaders. What they see in the US is a pugnacious, undisciplined power that eschews diplomacy. That changes things. It not only reveals the Trump administration as an outlier on the global stage, but also points to one of the emerging weaknesses of the US in international affairs.

Investment landscape IV

Patrick Watson shared an interesting insight recently. Based on an article in the Wall Street Journal that observes “people don’t dance anymore,” Watson reads through to a deeper meaning. He believes dancing was once a “low-cost kind of recreation”. In an age of pervasive mobile phones with cameras and social media, however, people can no longer dance “casually”, “spontaneously,” and “without self-consciousness”. The result is, “Dancing “has become risky and expensive” because “People are afraid they’ll look goofy”.

Sure, the costs are more social than financial, but participation is one of the areas where inflation initially takes hold. In the case of dancing, it now carries new costs which include “reputational risk,” “visibility risk,” “comparison risk,” and “opportunity cost”. Note, “No laws changed. Nothing was banned. The price just went up.”

Watson goes on to explain:

When participation becomes expensive:

• people substitute toward monetized experiences

• free sources vanish

• demand flows toward paid channels

Voila, that’s how you get inflation — “That substitution process is inflationary”.

So, one major point is this analysis provides an excellent early warning system. Wherever and whenever you see incremental friction, when things you used to do easily and freely become more difficult, those are the early signs of inflation.

Filtering through scam emails, scanning statements for junk and/or fraudulent fees, trying to stream a show without commercials are all examples of early stage inflation. Because you know what comes next? An offer to watch those shows without commercials for an additional fee.

As a result, the efforts by so many economists and policymakers to downplay inflation because the latest look-back on a basket of prices might have been lower than earlier in the year is rarely very useful for consumers and investors making decisions. At very least such claims should be weighed against realized experiences: Does your life have more or less friction in it than it used to? The answer to that will provide important context for where inflation is going.

Implications

The ICE shootings are a tipping point ($)

https://www.gelliottmorris.com/p/trumps-immigration-tipping-point

As I wrote last April, opinions change when voters get new information about an issue. The information that has been saturating U.S. political news in the last month is violence against citizens that is a direct result of the president’s policies.

Page and Shapiro [in their 1992 book The Rational Public] argue that opinion change requires new information to meet five conditions simultaneously: it must be received by enough people, understood, relevant to the policy question/issue domain, discrepant with prior beliefs, and credible. Most information fails at least one of these tests, which is why opinion on issues is usually stable.

G. Elliott Morris picks up on an extremely important phenomenon. Opinion change is inherently stable because it takes a lot to change it. In the case of the Trump administration and ICE behavior in Minneapolis, they are clearing that formidable hurdle.

Morris calls this a “‘tipping point:’ a point in time when a new piece of information causes many individuals to update their opinions in the same direction at roughly the same time, producing a noticeable break in the polls and notable, directionally aligned changes in policy”. This is the same phenomenon that Ben Hunt calls Common Knowledge. It’s when everybody knows that everybody knows something.

One point is this clearly and materially changes the political dynamic. Because opinions are normally stable, once they change, they are extremely hard to change back. This is very bad for the Trump administration.

Another point is the same phenomenon applies to the entire investment landscape. One of the prevailing beliefs, i.e., pieces of Common Knowledge, is there are guardrails that will prevent major losses in financial assets. Those guardrails include the belief that both political and public policy support will continue to buoy stocks and bonds. Now that the belief in the “correctness” of policy about immigration enforcement has broken, the threshold for believing there remain credible guardrails is now incrementally lower.

Perhaps most important for investors (and citizens) to keep in mind is recognizing change happens as a step function; a tipping point is reached. That means things can look fairly calm for a long period of time … and then change suddenly.

Note

Sources marked with ($) are restricted by a paywall or in some other way. Sources not marked are not restricted and therefore widely accessible.

Disclosures

This commentary is designed to provide information which may be useful to investors in general and should not be taken as investment advice. It has been prepared without regard to any individual’s or organization's particular financial circumstances. As a result, any action you may take as a result of information contained on this commentary is ultimately your own responsibility. Areté will not accept liability for any loss or damage, including without limitation to any loss of profit, which may arise directly or indirectly from use of or reliance on such information. 

Some statements may be forward-looking. Forward-looking statements and other views expressed herein are as of the date such information was originally posted. Actual future results or occurrences may differ significantly from those anticipated in any forward-looking statements, and there is no guarantee that any predictions will come to pass. The views expressed herein are subject to change at any time, due to numerous market and other factors. Areté disclaims any obligation to update publicly or revise any forward-looking statements or views expressed herein.

This information is neither an offer to sell nor a solicitation of any offer to buy any securities. Past performance is not a guarantee of future results. Areté is not responsible for any third-party content that may be accessed through this commentary.

This material may not be reproduced in whole or in part without the express written permission of Areté Asset Management.

As always, if you have any comments or just want to follow up on something in more detail, let me know at drobertson@areteam.com.

Market observations

The drama of the week was Trump’s tariff threats over Greenland. This left investors, politicians, diplomats, and everyone else are left trying to figure out what this really means and how serious it really is. For the time being, it appears Trump backed down.

One thing that is clear is Trump’s threats are real enough to command attention and as such are extremely disruptive. Nobody, except maybe China, can afford to ignore them altogether.

As a result, most of the world is captive to Trump’s capriciousness and his vindictiveness. And that means less time and attention for solving real problems.

FT Alphaville ($) reported recent proposed changes to the tax code (Section 892) are a “potential bombshell for the private market investment landscape”.

The issue is the distinction between investment and commercial activities which matters because it enables sovereign wealth funds (SWFs) to qualify as tax exempt for a wide range of lending activities.

This isn’t the first time the Trump administration has tried to find ways to penalize foreign owners of US financial assets. Dating back to November 2024, Stephen Miran highlighted the importance of “burden-sharing” in order to “capture back some of the benefits other nations receive from our reserve provision” in his paper, A User’s Guide to Restructuring the Global Trading System. Given the philosophical expectation of getting payback, there are likely to be more attempts.

These types of issues are technical, often hard to unpack, and subject to a whirlwind of political influences which makes them hard to predict with any specificity. Nonetheless, the Trump administration keeps pressing so investors should remain on alert.

Japan

Fireworks came out of Japan over the long weekend as the prime minister declared a snap election to solidify political support. The most visible reaction was the biggest-ever jump in Japanese Government Bond yields. Zerohedge ($) suggested three factors contributing to the frenzied trading:

First is worries around the snap election and prospect of “muscular fiscal stimulus”

Second is data showing life insurers were big net sellers of JGBs [Japanese Government Bonds] in December

Third was lackluster 20-year JGB auction

The bond market positions this election as a fiscal expansion story. Takaichi’s proposal for food tax cuts came with no concrete source of funding and only added to fiscal deterioration concerns.

Essentially, the incremental news bits caused the bond market to change its assessment of pro-growth and mild inflation to one of indiscipline in regard to spending. Robin Brooks agreed that Takaichi is “running on an end to ‘excessive’ fiscal austerity” and calls her course “highly irresponsible”.

Regardless, the fact the market’s assessment changed so quickly and its reaction was so violent is an excellent indication of just how fragile Japan’s situation is. Now it is left with only bad choices: Either it scales back spending plans which will be unpopular politically, or it will be forced to buy bonds again in an effort to suppress yields but at the risk of undermining the currency. Ultimately, it will need to find a third way — by selling assets to reduce debt, by selling foreign assets and repatriating capital to Japan, or something else. But now everyone knows the clock is ticking.

One lesson that arises from this episode is that debt is a far more onerous problem than governments are willing to admit and maybe even worse than they realize. As such, they don’t recognize limits to borrowing until they breach those limits. That was the lesson of Liz Truss in the UK. We'll see if it becomes a lesson for Takaichi in Japan.

Another related lesson is that optimistic views of “normalization” are looking less viable by the day. Just last week I highlighted Matt Klein’s view that “Japan may have finally exited its post-bubble stagnation”. This week it’s looking more like Bob Elliott’s thesis of currency crisis which also advances Russell Napier’s prospect of capital repatriation.

Nonetheless, even if these views are ultimately correct, the process of the situation unfolding AND markets fully discounting it is likely to be uneven. In other words, episodic — with bouts like Tuesday’s yield pop moderated by some recovery … and then another pop … and on and on.

Investment landscape I

Robert Armstrong ($) made an interesting observation regarding a change in the markets last fall:

In markets, inflection points are only recognisable in retrospect — sometimes years later. But it looks more and more like US stocks hit an important turning point on the last Wednesday in October. Up until that point, tech and consumer discretionary sectors had led the market, and highly speculative stocks of all sorts were popular. Since then, leadership has passed abruptly to solid old-economy sectors: materials, energy and consumer staples.

The shift to “solid old-economy” sectors makes sense on a number of levels. For one, by late October it was becoming clear the rate cutting cycle was drawing to a close. For another, value stocks, small caps, and pretty much everything except large cap tech had underperformed. There was plenty of room for some catch up.

The inflection has also dovetailed nicely with a higher-level theme of accelerating economic growth. The expectation of significant tax refunds, lower taxes, more investment spending, and less onerous regulation this year is consistent with the belief that old-economy stocks stand to benefit disproportionately from such tailwinds. Rising prices for metals round out the story nicely.

As Bob Elliott ($) highlights, however, the read on the first year of Trump administration policies is not positive:

Manufacturing investment and employment continue to fall and output remains subdued despite what has to be argued as the most conducive manufacturing policy climate in decades - tariffs are the highest in 100 years and the OBBB’s accelerated spending incentivizes new investment.

Elliott figures incremental new construction is the first place new policies would be expected to have an impact (due to new tax benefits in the budget bill), but he observes “construction related spending in the manufacturing sector continues to slow”. He also notes, “current real output in the manufacturing sector is on par with the same levels as 2021” despite a 25% pop in aerospace due to the recovery from the machinist strike at Boeing. In short, there is little indication thus far of a burgeoning manufacturing renaissance.

It’s still early days, but the absence of improvement in manufacturing bears watching. While industrial stocks are cheaper than tech stocks, tariffs continue to impinge upon profitability and small cap indexes are still riddled with unprofitable companies. If demand doesn’t pick up and drive greater revenue growth, any stock gains to date can be quickly reversed.

Investment landscape II

A big conundrum in the market right now is figuring out whether growth is about to take off or whether we need to prepare for greater instability. Mike Green ($) goes a long way in answering this question:

I received a research package from Hudson Bay Capital that perfectly crystallizes the “Optimism” narrative currently sweeping Wall Street. The papers, titled “Tech Trumps Tariffs” (Nouriel Roubini) and “No, Stocks Aren’t in a Valuation Bubble” (Jason Cuttler), are sophisticated, compelling, and arguably the most dangerous documents I have read this year. Please read them.

Their argument is the highest-conviction version of the “Soft Landing” consensus. They posit that we are on the precipice of a “positive supply shock” driven by AI that will raise US potential GDP growth to 4%, crush inflation, and justify an S&P 500 target of 9,000. Their thesis is elegant: Technology (AI) enables us to dematerialize growth, rendering physical constraints such as labor shortages and tariffs irrelevant.

As a reminder, Stephen Miran’s paper suggesting a Mar-a-Lago currency accord also came from Hudson Bay Capital. This establishes an ideological link between the organization and Trump administration policies. As such, it also provides some useful context in evaluating the claim of a “Soft Landing” based on a “positive supply shock”: Of course having an “elegant” thesis to substantiate claims of growth-promoting policy is helpful to the Trump administration.

As Green makes abundantly clear, however, as alluring as the theory may be, it is both wrong and dangerous. The reason is “it violates the laws of physics — specifically, the physics of our infrastructure networks”. It assumes that “Machine Labor” scales one-to-one with “Human Labor”; it doesn’t scale linearly because capital stock is physically capped.

We were deluded into believing this wasn’t the case for a period of time because “For twenty years (2000–2019), the US economy pulled off a magic trick. We grew GDP while keeping energy consumption flat.” It wasn’t really magic though, it was the result of offshoring. A lot of energy-intensive work got outsourced to other countries.

Now that the US is halting and reversing the offshoring, more energy-intensive industries are coming back to the US and that is going to require more energy. Building more energy infrastructure doesn’t come for free — which implies the cost of capital is going to rise again.

So, the idea of a “positive supply shock” that raises growth and tames inflation is a nice one, it’s just not one even remotely substantiated by the costly need for more energy to make it happen.

The issue of rapidly increasing demand for electricity is already making headlines and prompting policy discussions. For example, Zerohedge reported on an effort by the Trump administration to cap residential electric bills in the PJM regional power grid.

While this plan is a long way from becoming something implementable, the key points are 1) demand for electricity is rising rapidly mainly due to data centers, 2) as currently structured, the costs to increase capacity fall largely on residential customers, and 3) rising electricity bills are politically toxic.

This is where the rubber hits the road on the “positive supply shock” thesis and will be an important area to monitor over the next several years. Someone will have to pay for the buildout of the electric power infrastructure and that suggests the “shock” may have more to do with price than with supply.

Investment landscape II

Investors must learn to deal with instability ($)

https://www.ft.com/content/44adb246-ac64-4b56-9254-67f0f943d2dc

Investors often describe the current environment as “uncertain” but that word may understate what is truly different about this cycle. Uncertainty implies a range of possible outcomes around a stable centre.

What defines today’s US backdrop and probably much of 2026 is something more persistent and at times more disruptive — “instability”.

Instability is not about a single looming risk (including geopolitics) nor a binary outcome. It reflects an environment in which the relationships on which investors rely, between inflation and growth, labour and consumption, policy and markets, are constantly shifting.

This piece by Liz Ann Sonders contains a wealth of investment wisdom. Each piece is useful but it is even more powerful as a whole. It amounts to a playbook for identifying regime change and updating mental models accordingly.

In general, most investors do not see the big picture; they see the here and now. As a result, tariffs are often seen as one-off price increases. As such, they are not viewed as materially changing the rate of inflation.

Sonders shows how this thinking goes wrong. Since tariffs are “Now embedded in the policy framework,” she explains, “higher tariffs act less like one-off price increases and more like permanent step-ups in the cost structure of the economy.” Repeated permanent step-ups in cost structure cannot be easily gauged by a measure of the rate of inflation. It’s like death by a thousand cuts, but thinking each cut will be the last. In addition, “growing scepticism around the inflation data itself” makes matters even worse.

As a result, volatility doesn’t emerge from crises per se, but from the gradual evolution of expectations. With each step-up in costs, with each unexpected policy intervention, comes a “continual repricing of expectations”. It is this continual repricing along multiple dimensions that leads to instability.

As Sonders also highlights, “Instability resists clean answers”:

One of the mistakes in volatile environments is the search for a single, dominant storyline. Is inflation defeated? Is the labour market breaking? Are equities overvalued or unstoppable? These questions may be emotionally satisfying but they are analytically limiting.

Here the lesson is to avoid simple, “emotionally satisfying” explanations because they are almost certainly incomplete, and can be totally misleading. This makes investing a lot less fun in a sense, but it also makes it a lot more rewarding, at least on a relative basis, for those who put in the effort and have the discipline. Sonders finishes by explaining:

Navigating it [this more unstable investment landscape] requires balance, patience and a willingness to live without tidy conclusions — qualities that, in markets as in life, tend to age well.

Well said.

Investment landscape III

The FT’s Alphaville team ($) reported on developments in prediction markets that also speak more broadly to the entire notion of “democratizing” finance. The first observation is that prediction markets are now attracting attention from trading groups who are “hiring traders to arbitrage fleeting price discrepancies between contracts for events such as football games and elections.”

This type of evolution is reminiscent of online poker forums of the past. While these were fun outlets for poker players at first …

New poker players were finding their wallets drained by experienced types who played the odds methodologically, and/or by bots that did the same 24/7. It became known as the sharks-and-fish problem: once every poker table was populated by sharks, the survival time of any stray fish could be measured in minutes. Customer retention crashed. And, once all the fish had gone, the sharks followed.

In short, what started as a fun game became a business, and once it became a business, it wasn’t fun for anyone participating on a purely recreational basis.

Increasingly, this development pattern applies to many areas in finance, not least of which is stocks. Retail interest in investing has surged partly because of the regular upward trajectory of stocks and partly by the gamification of trading platforms, both of which make investing “fun”. Alphaville continues:

Winning is fun. Losing to a gamma-neutral Sequoia market hedging algorithm that snipes for mispricings and whittles away every inefficiency is not fun. Neither is it fun to lose to insider traders who’ll flush any market that benefits from an informed view. No one volunteers to be sharkbait.

Whether it’s prediction markets, crypto, stocks, or other vehicles, retail investors today are increasingly looking like the recreational poker players of yore: Soon-to-be sharkbait.

In the short-to-medium term, this is obviously bad for retail investors. In the longer-term, it is bad for US markets. If a large segment of investors gets burned and turns sour on stocks, there will be significantly fewer people to purchase stocks as aging Boomers sell them off. Unless some other group picks up the slack, there is a lot of potential for a significant revaluation.

Implications

As the volume of political rhetoric got dialed up even higher this week and markets reacted, it’s a good time to stay focused on the things that really matter. Alyosha ($) did exactly this by recognizing:

A bull market in gold is the arch enemy of all paper assets. So gold can hurt stocks and bonds now I think, because it’s taking a lot of money away from them … There’s a lot of stress in the world. Stress comes with losses, not profits and nothing exposes losses in paper assets faster than a bull market in gold.

The main point here is to listen to the signal that gold is sending. It’s not just another asset that happens to be going up; it is a macro indicator that foretells incremental stress to the cash flows that support stocks and bonds. Add to that observation the reality that investors are over-exposed to stocks and under-exposed to cash and there is the potential for a pretty severe adjustment.

Note

Sources marked with ($) are restricted by a paywall or in some other way. Sources not marked are not restricted and therefore widely accessible.

Disclosures

This commentary is designed to provide information which may be useful to investors in general and should not be taken as investment advice. It has been prepared without regard to any individual’s or organization's particular financial circumstances. As a result, any action you may take as a result of information contained on this commentary is ultimately your own responsibility. Areté will not accept liability for any loss or damage, including without limitation to any loss of profit, which may arise directly or indirectly from use of or reliance on such information. 

Some statements may be forward-looking. Forward-looking statements and other views expressed herein are as of the date such information was originally posted. Actual future results or occurrences may differ significantly from those anticipated in any forward-looking statements, and there is no guarantee that any predictions will come to pass. The views expressed herein are subject to change at any time, due to numerous market and other factors. Areté disclaims any obligation to update publicly or revise any forward-looking statements or views expressed herein.

This information is neither an offer to sell nor a solicitation of any offer to buy any securities. Past performance is not a guarantee of future results. Areté is not responsible for any third-party content that may be accessed through this commentary.

This material may not be reproduced in whole or in part without the express written permission of Areté Asset Management.

This year is starting off with the Trump administration’s guns a-blazing in pushing its activist agenda. The bull case is straightforward: fiscal and monetary stimulus will provide consistent tailwinds for financial assets. The bear case is also strong, however: the net policy impact is neutral to negative for consumer demand, the global rate cutting regime is over, and the elimination of institutional guardrails increases tail risk. The challenge for investors is figuring out what all of it means for financial assets.

Hot, hot, hot

There is an easy case to make that the Trump administration is going to “run it hot” and that investors should prepare for further market appreciation this year. The signature legislative act last year, the budget bill, extended tax cuts for many, will produce refunds for many this year, and creates new investment incentives for businesses.

In addition, the administration continues to press for lower rates. While markets are currently pricing in only one or two more rate cuts in 2026, the three cuts from last year are still working their way through and easing financial conditions. In addition, bond volatility (i.e., the MOVE index) has crashed to lows not seen since the pandemic era of ultra-low interest rates.

Finally, the Trump administration is also pushing ahead with efforts to reduce regulation. Various initiatives have focused on energy, permitting and approvals, bank capital requirements (lower), and enforcement (lower) among others. One of the clear effects has been to ease the way for corporate consolidation.

By this telling, stocks are in a “Goldilocks” environment with significant upside potential. It’s pretty clear a lot of retail investors are taking the message at face value and buying stocks hand over fist. Almost Daily Grant’s (January 6, 2026) reported:

retail investors are carrying an increasingly heavy load as the bull market stretches into its fourth year. Citing data from Citadel Securities, The Wall Street Journal relayed last week that the cohort accounted for 22% of domestic equity turnover in October, the highest share on record outside the February 2021 meme stonk revolution. That figure remained at or above 20% for the bulk of 2025, compared to a 10% baseline seen during the two years prior to the pandemic and about 15% during the 2022 selloff.

Devil’s advocate

That kind of aggressive buying is hard to square with the disconfirming evidence. It doesn’t take much of an adversarial review to expose significant weaknesses along each dimension of the Goldilocks view.

For one, it’s not at all clear tax refunds will provide such a big boost. Bob Elliott ($) dissects the refund mechanics and finds them less than compelling:

Most estimates [for tax refunds] suggest that this will amount to an incremental 500 bucks across roughly 100mln filers which amounts to essentially a 50bln incremental injection into the economy. But since the vast majority of these measures are deductions and not credits, the refunds will be concentrated among higher income households who of course have lower spending propensity.

As a result, we should expect only a fraction of that $50B and it should be expected to be spaced out through the year. In addition, those more modest benefits are going to be offset by the rollback in ACA (Affordable Care Act) premiums and cuts in SNAP (Supplemental Nutrition Assistance Program) benefits. The net result, Elliott concludes, is “Hardly the mix that would create a surge in demand to kick off the year”.

Nor are rates likely to provide a big incremental boost. Markets currently price only one to two more cuts in the US in 2026 and most other major central banks are already on pause or are raising rates. Vitor Constancio highlighted the divergent trajectories of major central banks and also showed how European central bankers have become incrementally more hawkish in recent months. He reported:

“More than 60% of respondents in a Bloomberg survey say officials are more likely to raise borrowing costs than lower them — a meaningful change from October, when only a third shared that outlook.”

Finally, not all regulatory action is uniformly positive either. Brandon Greeley ($) points out rules and regulations don’t just pop out of nowhere:

There is a saying in America’s military that every boring, senseless rule was written in blood once. The same is true for the institutions of America’s money. They were all designed, one after the other, after something exciting happened.

This isn’t to say that each rule or regulation was perfectly drafted and has perfectly withstood the test of time. It is to say, though, that there was a reason for drafting virtually all of them. Some crisis or some major failure served as the impetus. As a result, the wholesale elimination of such regulations invites repeats of all the original crises. This appears to be what the Trump administration is doing:

The Trump administration has treated not just the Fed, but all of them [regulatory agencies for finance] with disdain. Trump’s SEC has slowed enforcement actions, and abandoned cases. Trump advisers were reported to have considered absorbing the FDIC into the Treasury department in the transition to power. The administration has sought to close the CFPB. And now Trump has made clear his designs on the Fed, which doesn’t just set rates. It regulates banks. It distributes cash around the country. Its swap lines make the global dollar system possible.

Rules exist at least partly to ensure fair play. When people sense there isn’t a level playing field, they withdraw. That’s the big risk - consumers and investors pull back for fear of having adequate protection.

Right size the exposure

So, an objective analysis of the investment landscape alone reveals there are several good reasons for investors to be cautious in the new year. There are others.

One reason is the risk of loss. Of course, the perception of risk of loss has been significantly attenuated by the enormous quantity of fiscal and monetary stimulus the last few years, but that doesn’t change the actual risk of severe losses. Misperception makes it easy to become undisciplined. Oftentimes, the time to worry most is when confidence is highest.

The potential consequences are the key here and investors often underestimate the damage losses can cause. Part of the reason for this is a technical concept called ergodicity. It means that return averages can be misleading because individuals don’t get the average outcome — they get the one path they actually experience. While that one path can seem like so much bad luck at the time, it can also be a life-changing experience.

The reality that investment losses can be devastating and extremely hard to recover from is captured by Warren Buffett’s two rules:

1. Rule No. 1: Never lose money.

2. Rule No. 2: Never forget Rule No. 1.

The primacy of loss avoidance highlights the importance of diversification, the avoidance of leverage, maintenance of a cash cushion, and emphasis of risk management over return chasing. These activities aren’t always as much fun, but they do help insulate investors from the worst possible outcomes.

Unicorns and rainbows

Another reason to be cautious about markets in the new year is the possibility that bullish market narratives are being designed at least in part to recruit incremental retail buying so as to provide exit liquidity for others. Clearly the private equity industry has been working hard to increase retail investment to provide capital backfill after a few years of below average exits (sales) of portfolio companies.

The characterization of retail investors as gullible sources of capital can also explain the effusive praise of stocks by Wall Street: Someone is needed to keep buying stocks at record highs to keep the financial machine going. In more colloquial terms, someone needs to be left holding the bag.

Conclusion

There is an awful lot of enthusiasm for stocks in the new year. However, there is also a lot of political and economic disruption. Investors would do well to consider both perspectives as well as the downside risk if things turn south. The potential for tail risk, and the durable harm it can cause investment portfolios, is quite high.

Disclosures

This commentary is designed to provide information which may be useful to investors in general and should not be taken as investment advice. It has been prepared without regard to any individual’s or organization's particular financial circumstances. As a result, any action you may take as a result of information contained on this commentary is ultimately your own responsibility. Areté will not accept liability for any loss or damage, including without limitation to any loss of profit, which may arise directly or indirectly from use of or reliance on such information.

Some statements may be forward-looking. Forward-looking statements and other views expressed herein are as of the date such information was originally posted. Actual future results or occurrences may differ significantly from those anticipated in any forward-looking statements, and there is no guarantee that any predictions will come to pass. The views expressed herein are subject to change at any time, due to numerous market and other factors. Areté disclaims any obligation to update publicly or revise any forward-looking statements or views expressed herein.

This information is neither an offer to sell nor a solicitation of any offer to buy any securities. Past performance is not a guarantee of future results. Areté is not responsible for any third-party content that may be accessed through this commentary.

This material may not be reproduced in whole or in part without the express written permission of Areté Asset Management.

As always, if you have any comments or just want to follow up on something in more detail, let me know at drobertson@areteam.com.

Market observations

In what is becoming a fairly regular pattern, the Trump administration rolled out news over the weekend that jolted markets on Monday. The prior week it was Venezuela and this week it was the threat of criminally prosecuting Jerome Powell, the chair of the Federal Reserve. Markets are rolling with it so far, but it certainly begs the question of which straw will break the camel’s back?

In what is also becoming something of a regular pattern, the CPI (Consumer Price Index) came out relatively tame on Wednesday, but markets almost immediately discounted the benign headline number.

As John Authers ($) reported, it looked “like a ‘Goldilocks’ report,” and then went on to observe:

But the numbers didn’t generate a gleeful market response because a few too many oddities suggested that underlying inflation was stronger than it looked. Alternative measures for core inflation, including the trimmed mean (after excluding outliers), the median, the “sticky-price” rate of the goods whose price is hardest to cut, and the Fed’s “supercore” rate of services inflation excluding shelter all suggest that inflation is gently rising, and at or above the Fed’s 3% upper target:

One takeaway is it appears official economic statistics are losing their credibility in the market. If that trend continues, it is likely to lead to more players relying on their own numbers and interpretations — which is likely to lead to more volatility.

These comments on the credit card industry were posted in Almost Daily Grant’s from Tuesday, January 13th:

Klarna Group Plc Chief Executive Officer Sebastian Siemiatkowski has called for President Donald Trump to go further in shaking up the credit card industry, calling it an “extraction machine” that rips off poorer borrowers.

“If you look at the Fed’s own data, it shows that credit card rewards redistribute $15 billion annually from the poor to the wealthy, and that high FICO consumers gain $200 a year, subprime consumers lose $55,” he said in an interview on Bloomberg TV. “That isn’t [a] financial product. It’s a regressive tax with airline miles.” . . . Siemiatkowski has said in a social media post that the cap should be set even lower at 0%.

While Siemiatkowski’s comments come off as brash, they are actually pretty accurate. The credit card industry is just one of many that makes a business model out of ripping off poorer people for the benefit of richer people. Indeed, placing better controls on extraction businesses will be an important plank of any serious public policy effort to address affordability.

Economy I

Robert Armstrong at the FT ($) poses an interesting conundrum that is likely to affect investors for a good chunk of the new year: “But I still don’t quite understand how an economy that appears to be growing at 2 per cent in real terms, where consumption has been sturdy, business investment is growing, and corporate profits are expanding, can generate so few new jobs.” In short, is there some fundamental change happening that can justify decent economic growth without decent labor growth, or are expectations of economic growth too high?

He poses five possible explanations for the paradox including:

• “A labour supply shock [from increased immigration enforcement]”

• “Productivity”

• “The robots [including AI]”

• “A K-shaped economy”

• “Business sentiment”.

While all of these are plausible and probably did contribute to some degree, it is also interesting the number of other hypotheses ChatGPT could come up with:

• “Labor hoarding” + reduced churn (a.k.a. no-hire/no-fire equilibrium)

• GDP strength may be “capital-heavy” and not job-intensive

• Public sector employment shocks (and one-off distortions)

• Workweek / hours adjustment vs. headcount adjustment

• Mismatch: vacancies exist, but the “right” labor doesn’t

• Corporate strategy shift: margin defense over expansion

• Measurement / definitional issues

• Sectoral productivity boom in a few industries

These are all very plausible explanations as well. What we get is a smorgasbord of possible explanations that can be mixed, matched, and tested. What we are really trying to figure out, however, is what the experienced phenomena of the recent past might be able to tell us about the future …

Economy II

Somewhat serendipitously, Adam Josephson ($) recently reported some consumer credit statistics that dovetail nicely with some of the ideas above:

Americans are borrowing less on their credit cards even though a growing number of households are under financial pressure, this amid 4% GDP growth.

The rate on credit card debt in November was a whopping 21%, which has barely budged since the Fed has cut short-term interest rates by 175 basis points since September 2024.

The lower credit card borrowing volumes stand out not least of which is because they fly in the face of history. Typically, when US consumers have experienced slowdowns in income growth, they temporarily fill the gap by expanding credit. After all, the spending machine must go on!

The main thing that would disrupt the US consumer spending machine is if consumers were far less certain about their future income and therefore their ability to service incremental debt. It turns out, many of the factors listed above are consistent with a hypothesis of rising uncertainty for consumers.

For one, insofar as companies are experiencing greater productivity and have incentives to protect their margins, those productivity gains are not going to workers in the form of higher real wages. At a real, visceral level, workers understand this; it doesn’t pay to work harder because they don’t get the benefit.

In addition, business sentiment and labor hoarding both point to a frozen labor market. Workers also observe this. You have to keep your job because if you lose it, it will be extremely hard to find anything comparable. You effectively risk getting kicked out of your economic class.

Finally, for all but the wealthiest of consumers, a wide variety of policy changes are increasing their economic precarity. Tariffs are increasing prices paid, people who get health insurance through the Affordable Care Act are paying significantly higher premiums, students with debt are having to resume payments after the moratorium expired, and on and on.

It’s not usually any one thing but a whole range of things that are increasing the risks for workers and consumers. Further, the threat is not modest incremental losses, but rather step-function, life-changing impairments. If you get sick when you don’t have health insurance, that can be a life-changing event. If you go bankrupt, that can be a life-changing event. To make matters even worse, credit cards, the go-to consumer bridge loan, charge rates on the order of 21% and have not come down with the Federal Funds rate.

The bottom line is it appears consumers are not only becoming tapped out, but also not in a position to use credit to bridge the gap. The Trump administration’s announcement this week to cap card charges serves an indirect acknowledgement of this. If this is right, expectations for lofty economic growth this year are overstated.

Politics

In responding to Ed Luce’s inquiry into “the intangible costs of Trump’s language on America’s position in the world,” Jeremy Shapiro ($) sheds light on both Trump’s character and its implications for global affairs:

Only Donald Trump could make us miss hypocrisy. But perhaps his brutal extermination campaign against elitist euphemism has distracted us from the value of hypocrisy, or at least the role it plays in moderating US behaviour. Hypocrisy is famously the homage that vice pays to virtue. That means (I think) that the very act of being hypocritical means that you are acknowledging a moral requirement, even as you evade it. So, perhaps George W Bush never intended to bring democracy to Iraq and just wanted the oil. But when he claimed a more noble calling, he imposed some limits on what the US could and would do.

Like you, I have always wanted US foreign policy to live its truth. But it is more important what lurks beneath the lies. Trump’s problem is not his plain language — most never believed America anyway. It is that he has expressed American interests as imperialism, white supremacy, and resource theft without any hypocritical moderation, implying there is no end to American rapaciousness. This is worse than a sin; it is a mistake. It will eventually turn the whole world against us, including our closest allies …

One takeaway is that Trump is just a taker, there is nothing more complicated to it than that. He primarily seeks to take things without giving anything in return. Another takeaway is that he doesn’t have any guardrails except his own self-interest. There are no ethics or other principles that constrain how he thinks about the world. As a result, Trump’s rapaciousness becomes America’s rapaciousness.

Other countries are beginning to realize this. The result is that there is very little reason for any foreign nation to negotiate with the Trump administration in good faith — because there is no intention on his part of reciprocating. This means virtually all “deals” are performative and should not be considered as either meaningful or durable.

While some countries are obviously in better position to push back than others, the battle for “hearts and minds” is being lost.

Geopolitics

Most of the talk about Venezuela has been in regard to oil and the potential for regime change. What has not been widely emphasized is the relationship between Venezuela and China and what the implications might be.

Shannon Brandao ($) provides some background:

For years, Nicolás Maduro treated his relationship with Beijing as a shield. He broadcast phone calls with Xi Jinping, posed with Chinese envoys, and boasted of an “all-weather” partnership meant to signal that Venezuela sat safely inside China’s protective orbit.

Then, in the early hours of 3 January, U.S. forces seized him anyway.

The timing was striking. Just hours earlier, Maduro had met China’s special envoy, Qiu Xiaoqi, to review more than 600 bilateral agreements. Chinese officials were reportedly still in the country when the operation unfolded.

While China of course condemned the move, it did not intervene. As a result, the message sent across the world is that even long-term partners of China should not expect support if the US comes after them. As Brandao states, “the limits of Chinese protection are no longer abstract”.

As Brandao also reveals, “For years, Beijing propped up Nicolás Maduro’s regime, channeling tens of billions of dollars into loans, infrastructure, and energy projects in exchange for discounted oil and political alignment in the Western Hemisphere.”

Combining these developments with recent threats against Iran, and it begins to look more like an effort from the Trump administration to assert its authority over China by way of disrupting its cheap oil supply than any kind of designs on Venezuela per se. This also begs the question of how hard the Trump administration is really trying to reach a sustainable trade deal with China.

On the other hand, it’s not exactly like China has been playing really nice in the sandbox either. The FT ($) reports:

Emboldened by its success in neutralising US tariffs, Beijing plans to reinforce its dominance of global manufacturing despite persistent deflation at home and rising tensions with other trading partners.

For Beijing, the tariff war is the clearest evidence yet that President Xi Jinping’s strategy of investing heavily in high-tech production and industrial self-reliance is paying off, despite deflation at home and complaints from abroad about Chinese trade surpluses.

The report concludes, “China is doubling down on its export-led growth model”.

So, as investors patiently wait for a China trade deal to signify an “all clear” for markets, the evidence instead points to the two sides becoming more emboldened and more aggressive. Some of this is positioning and some is posturing, but it is also how geopolitical tensions escalate into much more serious events.

Japan

One of the interesting puzzles in the investment world is the seeming paradox of persistently rising long-term yields in Japan coincident with a weakening in its exchange rate. As Matt Klein ($) writes, “As of now, however, there is a more benign explanation: Japan may have finally exited its post-bubble stagnation”:

The return of modest inflation alongside persistently faster wage and income growth should align with higher interest rates than those that prevailed when the economy experienced essentially no growth in yen terms between 1997 and 2019. Moreover, if the recent growth in nominal incomes is sustained, Japanese government borrowing costs would still be lower, relative to expected revenue increases, than in much of the past few decades. (That helps explains why the yen has not appreciated recently despite the apparent convergence of nominal yields with the U.S. and other G10 economies.) Far from indicating trouble, Japanese bond prices are implying that Japan has converged, in at least one important way, with the rest of the rich world.

By this telling, Japan isn’t running off the rails at all but rather is just normalizing after a long economic malaise. The rise in longer-term yields is less a fear of runaway inflation and/or monetary debasement than it is a reset to more normal, modestly positive inflation expectations.

This narrative contrasts pretty sharply with that of Russell Napier who has been arguing that as Japanese bond yields rise, it comes progressively closer to triggering a repatriation of Japanese capital that will fundamentally reshape global capital markets.

Klein’s narrative also contrasts with that of Bob Elliott ($):

The classic signals of a building currency crisis is a combination of a falling exchange rate, rising yields, weak growth and a central bank that is squeezed between the choices of maintaining currency stability and supporting domestic economic conditions, particularly for economies which have limited foreign currency debt.

The most likely outcome is Japan remains stuck in an undesirable loop of weakening bond prices, weakening FX, soft economic conditions and inflation which is a bit higher than desirable. Teetering on the edge until a catalyst brings the trade-offs into sharper relief.

I suspect the truth is some combination of these. The big risk, and likely eventuality, is the scenario Napier describes. As a result, investors need to be prepared for its consequences. However, Klein’s explanation is valid and certainly buys some time for Japanese authorities. As long as there is a plausible, positive narrative to tell, there will be less pressure to act imminently. This suggests the “reshaping of global capital markets” could take some time. In the meantime, Elliott’s characterization provides a useful dashboard for tracking progress in one direction or another.

Investment landscape

With the DOJ’s probe into the Federal Reserve this week, the subject of guardrails has been a popular topic. Namely, what processes and institutions are in place that can constrain the worst tendencies of the Trump administration? While this is an important issue, it is really just a subset of a bigger issue: What are the limitations of any presidential administration?

One of those limitations is economic reality. Economic actors, i.e., CEOs and corporate leaders, have a primary responsibility to ensure their company’s economic success, regardless of what the president or anyone else says. They invest if there is a compelling case of making a solid return and don’t invest if there isn’t. To this point, the FT ($) made very clear the limitations of the Trump administration to increase private investment in Venezuela’s oil industry:

US oil companies want “serious guarantees” from Washington before they make big investments in Venezuela as President Donald Trump urges them to back his bid to reshape energy markets.

“No one wants to go in there when a random fucking tweet can change the entire foreign policy of the country,” said one private equity investor who specialises in energy.

There is also the economic reality of how companies make money. In the case of credit cards, issuers charge rates on the basis of credit risk and marketing (customer acquisition) costs. If one of the variables is fixed, such as the rate cap the Trump administration is imposing, companies figure out how much they need to cut back credit in order to still be adequately profitable. The net result is less credit availability. Jamie Dimon said as much on his conference call.

There are many other examples, and several this week even, but they all boil down to the same basic idea: Presidential administrations cannot prescribe outcomes.

Two things happen when they persist in trying. One is that people increasingly link proclamations to failed outcomes and simply stop listening altogether. This is the “boy who cried wolf” phenomenon.

Another, related result is that repeated failure to achieve desired outcomes erodes credibility, and credibility is necessary to maintain authority. With the Trump administration’s policy nous already suspect and with dim prospects for midterms, the administration’s perceived power is rapidly diminishing. Last week I said, “The thing to watch for will be a very public loss in confidence of crisis-battling prowess”. This is happening.

On one hand, loss of power establishes a guardrail of its own; an administration with little authority has less capacity to run too far off the rails.

On the other hand, loss of power also greatly reduces what an administration can do in the event of an emergency. I believe this is the bigger risk right now. What if things turn south and not only does the Trump administration lack viable policy ideas to stem the tide, but also lacks the authority to carry out basic crisis-fighting activities? That would be a problem.

Implications

It is true that markets have been extremely forgiving in looking past indications of risk. However, it would be wrong to infer that the relative calm is an accurate assessment of actual risk.

As much as anything, market complacency appears to be mostly a function of the conditioned response to public policy efforts to quell volatility. As such, complacency is a big bet on sustained policy efficacy.

Increasingly, that looks to be a bad bet. Not only does the universe of constructive policy options continue to shrink, but investors and voters are both becoming increasingly suspicious of the capacity of public officials to improve conditions. That is a very fragile state. It won’t take much of an impetus to tip the scales.

Note

Sources marked with ($) are restricted by a paywall or in some other way. Sources not marked are not restricted and therefore widely accessible.

Disclosures

This commentary is designed to provide information which may be useful to investors in general and should not be taken as investment advice. It has been prepared without regard to any individual’s or organization's particular financial circumstances. As a result, any action you may take as a result of information contained on this commentary is ultimately your own responsibility. Areté will not accept liability for any loss or damage, including without limitation to any loss of profit, which may arise directly or indirectly from use of or reliance on such information. 

Some statements may be forward-looking. Forward-looking statements and other views expressed herein are as of the date such information was originally posted. Actual future results or occurrences may differ significantly from those anticipated in any forward-looking statements, and there is no guarantee that any predictions will come to pass. The views expressed herein are subject to change at any time, due to numerous market and other factors. Areté disclaims any obligation to update publicly or revise any forward-looking statements or views expressed herein.

This information is neither an offer to sell nor a solicitation of any offer to buy any securities. Past performance is not a guarantee of future results. Areté is not responsible for any third-party content that may be accessed through this commentary.

This material may not be reproduced in whole or in part without the express written permission of Areté Asset Management.

Writing the Outlook piece over the holidays and thinking about strategy for the upcoming year has left me in a reflective mood. In terms of portfolio strategy, as I said in the Outlook, “I view the new year with both trepidation and excitement.”

I said “excitement” because a lot of different pieces are coming together in a scenario whereby there are likely to be significant opportunities for active management. Big changes in the market are increasingly likely AND very few investors are positioned for it. I said “trepidation” because as the actions by the Trump administration to remove the president of Venezuela over the weekend have already revealed, there is also pervasive opportunity for government overreach.

All of this means there are likely to be significant opportunities for investment, but also significant risks to be mitigated and avoided. As a result, I anticipate needing to spend more time on portfolio management work which means I also need to be more economical with the time I put into producing Observations.

Hopefully this will not cause any major changes to Observations, and I don’t think it will. That said, I do plan to experiment with a less rigid publication schedule, slightly less content on occasion, and the use of AI (artificial intelligence) tools to increase efficiency — and to help tease out deeper analysis.

As always, if you have any comments or just want to follow up on something in more detail, let me know at drobertson@areteam.com.

Dave

Market observations

Almost Daily Grant’s, Monday, January 6, 2026

https://www.grantspub.com/resources/commentary.cfm

retail investors are carrying an increasingly heavy load as the bull market stretches into its fourth year. Citing data from Citadel Securities, The Wall Street Journal relayed last week that the cohort accounted for 22% of domestic equity turnover in October, the highest share on record outside the February 2021 meme stonk revolution. That figure remained at or above 20% for the bulk of 2025, compared to a 10% baseline seen during the two years prior to the pandemic and about 15% during the 2022 selloff.

“They are now a price setter – a dominant force in the market,” Scott Rubner, Citadel’s head of equity and derivatives trading strategy, told the Journal. “It’s not a passing trend.”

We’re all aware of the occasional presence of the retail hordes and the numbers once again confirm not just their presence, but their increasing influence in setting prices. Interestingly, retail behavior has morphed over the last few years. Once an illustration of fickleness and momentum chasing, retail investors today are more likely to be the ones buying the dip. That puts them in pole position to be the new bagholders when things turn south.

One of the less appreciated features of the investment environment over the last couple of decades has been the weakening trend in economic growth. The graph below from John Hussman shows just how dramatic the slowdown has been:

Part of this has been due to population decline and part due to weakening productivity growth. Given the expansiveness of the downward trend though, it’s hard not to wonder, “So, what exactly has tech been doing for ya?”

While growth above two percent is still decent and there are policy levers that can be pulled to improve it, this evidence should help to set expectations more modestly. Part of those expectations should be skepticism about painlessly managing the excessive load of public debt.

Economy

U.S. Wages Still Rising Briskly, Employment Holding Up, and Inflation Still Sticky (Probably) ($)

https://theovershoot.co/p/us-wages-still-rising-briskly-employment

More generally, the rise in unemployment since March 2025 has coincided with a rise in the share of people saying that they are actively looking for a job, rather than a decline in the proportion of people who are gainfully employed. The share of Americans aged 25-54 with a job was 80.6% in November, up slightly from March 2025, when the “prime age” employment-population ratio was 80.4%.

In fact, the share of Americans aged 25-54 with a job has been remarkably stable since hitting its multi-decade high of just under 81% in early 2023.

As the discussion around rate cuts becomes even more politicized than it normally is, Matt Klein brings some good old-fashioned analysis and common sense to the table.

Right in the middle of the debate is the tradeoff between inflation and employment. Recently, the Fed’s concerns about inflation have moderated while its concerns about weakening employment have grown.

As Klein points out, however, the headline numbers of modest increases in the unemployment rate are deceptive. Those increases have “coincided with a rise in the share of people saying that they are actively looking for a job, rather than a decline in the proportion of people who are gainfully employed”. In short, people aren’t losing jobs, there are just more people looking.

This is good news for the economy and helps mitigate some of the doom. Unfortunately, there is also countervailing evidence which complicates the analysis. Withholding taxes, which are an excellent real-time indicator of wage growth, have been trending down pretty sharply the last few months. In addition, Adam Josephson ($) reports retailers are also observing growing weakness in consumer behavior:

Kroger a month ago said that middle-income customers are feeling increased pressure, following in the footsteps of what lower-income households have experienced over the past several quarters. Albertsons said much the same this morning and added that even high-income customers are “becoming more conscious of price and value, reflecting a broader shift toward cautious discretionary spending.”

In aggregate, this points to a more nuanced view on employment. No, employment is not falling apart. However, greater volatility and uncertainty are increasing the overall sense of precarity. As a result, American consumers appear to be doing something they have rarely done in the past: Becoming more cautious and conservative with their spending.

Politics

Historically, Americans have had a fairly positive view towards wealth. In general, it was considered the rightful product of effort, skill, and merit. Conversely, poverty was generally considered the product of laziness and ineptitude. While there have always been a wide range of views on the subject, the US has always had a stronger association between wealth and merit than other developed countries.

Until recently, however. Matt Stoller ($) observes the political views towards wealth have been undergoing a major transformation:

Over the last 15 years, Americans have started to believe that most great fortunes are extractive by nature. Tech titans used to make cool stuff, but you can only replace the iPhone with something virtually identical so many times before you lose your innovation brand. And with the rise of surveillance pricing and junk fees, people have come to believe that oligarchs don’t work for their money, they simply extract.

For one, the status of significant wealth, a goal that many Americans used to revere, is now reviled. What used to be seen as a sign of merit is now seen as an indication of moral decay.

This transformation creates problems for both political parties, each of which has “aristocratic” constituencies that have disproportionate influence on party policies. As these views increasingly come to be seen as out of date and out of touch, there will be openings for more populist approaches. Something to watch for in the coming years.

Public policy I

According to Mike Green ($), the increasing degree of political dissatisfaction is largely due to an economic and public policy “machine” that is calibrated to concentrate wealth rather than redistribute it:

But because success compounds, capitalism naturally concentrates resources in a manner that is caustic to opportunity for future participants—our children, both born and unborn. To keep the game going, it requires a degree of redistribution from winners to BOTH losers (social insurance) and new players (opportunity).

The Trap: We have flipped that redistribution requirement into a concentration impulse. Instead of recycling wealth to fund new players, we are extracting wealth to protect old winners.

This analysis reveals an interesting paradox: While capitalism is useful for creating wealth, it’s tendency is to concentrate wealth which is antithetical to a smoothly running democracy. In order to maintain the system, an ongoing effort must be made by public officials to redistribute the wealth in order to ensure social cohesion and economic opportunity. Unfortunately, public policy in the US has become progressively less able to do so over the years.

The silver lining is “The economy isn’t broken because of bad luck.” It is broken because of conscious decisions to move the economic settings from “Stabilize” to “Extract” by abandoning productive capitalism for monopoly extraction”. The good news is different policy decisions can be made. Although signs from the budget bill last summer were not promising, that’s the thing to keep an eye on. It’s mainly up to Congress to change the policy settings.

Public policy II

With public policy being such a crucial element for diagnosing our economic and financial ills, it’s worth learning more about its history in order to gain some perspective. Eric Hobsbawm did exactly that with his expansive historical narrative of the 20th century in “The Age of Extremes”. Here are a few select quotes:

However, scientists were more directly politicized by their well-founded belief that laymen, including politicians, had no idea of the extraordinary potential that modern science, properly used, put at the disposal of human society.

It [Hobsbawm’s history of the 20th century] can tell us how little we know, and how extraordinarily poor has been the understanding of men and women who took the major public decisions in the century …

[Hobsbawm attributes the lack of a clear policy agenda to manage through global disorder partly to the complexity of world crises, but also significantly to] the apparent failure of all programmes [i.e., public policy], old and new, for managing the affairs of the human race.

The most obvious and glaring takeaway from these comments is the utter failure of public policy to improve the human condition. An important reason for that failure was the “extraordinarily poor understanding” public leaders had of the major issues. There is a silver lining in that science has “extraordinary potential,” but it comes with the caveat that it must be “properly used” and the reality that extremely few politicians are scientists.

This historical background casts a very skeptical light on the potential for public policy to solve today’s problems and/or to improve living conditions for most people. As a result, expectations should be kept extremely modest.

That said, it also provides a glimmer of hope for the future. Terrific science and technology do exist. It’s just that in order to realize their vast potential, we need to find leaders who understand it well enough to put it to “proper use”. That’s the key.

Investment landscape

Why the melt-up is still on ($)

https://www.ft.com/content/cb840ba1-7e4b-4c6c-9e15-e72becfc6d3a

Still, with all the potential downsides taken into consideration, the mood in the opening days of 2026 remains “OK doomer”. Wall Street thinks we are heading into a great year. Deutsche Bank is pencilling in 17 per cent gains in the benchmark S&P 500 index from current levels by the end of 2026, taking it up to 8,000. Several other influential banks are clustered around the 7,500 area, from 6,845 now.

Analysts and investors alike say they are not complacent about the risks staring them in the face, and claim they are focusing on quality and diversification, as if they usually buy any old rubbish in only one sector. But if we can get through 2025 in one piece, we can get through anything. Setbacks are close to certain this year, some potentially hefty. But few expect them to stick. Buying the dip is popular for a reason.

This piece by the FT’s Katie Martin is less notable for its profound insight than its capture of the current investment zeitgeist. According to the current wave of positive sentiment, any kind of skepticism or negative forecast is viewed as more of a psychological affliction than a credible investment outlook.

Nonetheless, investors are increasingly taking note of the disconnect between fundamentals and performance. “How is it that we’ve had tariffs and geopolitics are bleak and the French government has failed twice and markets are at record highs?” is a question Karen Ward of JPMorgan Asset Management says she gets asked all the time. Client investors seem to be a lot more skittish about the dissonance than their advisors are.

In most cases it’s not that advisors and managers aren’t aware of the fundamental shortcomings, it’s just that they have learned “you fight the crisis-battling prowess of the Fed and the US government at your peril”. Indeed, the career risk for investment managers of potentially missing out on gains is almost always greater than the concern about losses.

This is the key point: Advisors and managers are making a critical assumption on both the capacity and willingness of the “crisis-battling prowess of the Fed and the US government”. This is the lesson they have learned/been conditioned by over the last fifteen-plus years.

Increasingly, that assumption appears to be reaching its limits. This suggests the Trump administration will be working extra hard this year to maintain the perception even as the likelihood of failure increases. The thing to watch for will be a very public loss in confidence of crisis-battling prowess.

Portfolio strategy

I have discussed the trend towards “real” assets versus “paper” several times. This is captured by the tradeoff between commodities and stocks and is often associated with inflation. These arguments often involve a degree of abstraction that makes them hard to embrace though. Fortunately, Mike Green ($) provides a discussion of cryptocurrencies that serves as both a useful, and more understandable analogy.

The bitcoin “Store of Value” trade has fundamentally broken in two. Unlike gold, which is mined with energy, but then remains “gold” regardless of how much mining energy is expended, bitcoin requires continual energy expenditure to maintain the bitcoin network.

In the “Post-Capitalist” era of zero interest rates and surplus energy, we believed we could solve financial problems with code. We ignored the Second Law of Thermodynamics: entropy. Maintaining a digital ledger requires a constant injection of ordered energy.

The difference this time is that bitcoin miners are no longer using “surplus” energy (debates about renewable sources have notably disappeared), and are now bidding against Microsoft and Amazon for “Machine Food” (electricity). This is not a “dip”; it is a squeeze. The marginal miner is underwater, burning treasury (selling bitcoin) to keep the lights on, hoping for a bailout that isn’t coming. While bitcoin survived previous drawdowns because “true believer” miners had no competing use for their power connections, today AI datacenters pay 3-4x the revenue per kilowatt as bitcoin mining — and the miners are switching:

As Green reveals, the big problem with bitcoin is that it was based on the false assumption of “zero interest rates and surplus energy”. Those conditions, predictably, turned out to be transient rather than durable. In a world of normalized interest rates and competition with AI datacenters for energy, the economics of bitcoin completely unravels, which is what has been happening recently.

This illustration provides a useful guide for all paper assets. Stocks, for example, have been largely predicated on the assumptions of zero interest rates, surplus energy, cheap Chinese labor, and free trade. None of those was ever going to be a permanent fixture and now all of them are breaking down.

Green uses the case against bitcoin to make the case for gold, which is very fair, but the general argument also holds for all paper assets. Once the temporary surpluses are over, real assets matter. This is likely to be a key investment theme for many years to come.

Implications

With optimism all around in the new year and retail increasingly becoming “a dominant force” in the market, the easy trade is to go with the flow.

As I’ve pointed out several times, however, public policy is being increasingly constrained by economic and political realities. For longer-term investors, this means the ugly reckoning in markets keeps getting closer.

What signposts should investors be on the alert for? At it turns out, we got one on Wednesday. Robert Armstrong ($) reported on Thursday:

Good morning. Donald Trump proposed two staggeringly bad industrial policies yesterday. First, he suggested that in order to encourage more investment in military equipment, he would ban dividends or share repurchases (and executive salaries above $5mn) at defence contractors until the companies built “NEW and MODERN Production Plants”. Next, to address the housing affordability problem, he said he was “immediately taking steps to ban large institutional investors from buying more single-family homes”.

Both ideas are self-defeating, and for roughly the same reason. You won’t encourage investment or productivity in an industry by making it illegal for investors in that industry to earn certain forms of return. And you won’t increase the supply of houses — the only sustainable way to support housing affordability — by forbidding institutions from investing in it. In both cases, the effect will be the opposite of the intended one.

This episode reveals several important insights for investors. One is that Trump is feeling enough political pressure to feel compelled to “do something”. These were not items on the pre-existing agenda; they are reactions. Another is that neither of the policy prescriptions are constructive; in fact, they are counterproductive. As such, Trump is his own worst enemy. The more he feels compelled to act, the worse he makes the situation. I suspect voters and investors are beginning to figure this out.

That said, investors should also be on the lookout for signposts from abroad. An inquiry to ChatGPT produced the following assessment:

Governments—starting with the most stressed—will increasingly protect sovereign funding and strategic autonomy even if it hurts private risk assets. That’s the shift to financial repression.

In other words, look first to countries that are the most stressed — like Japan and France. When they start making moves to protect government interests at the expense of private risk assets, the game will be on. This will affect global investment flows and dramatically reset risk assessments everywhere. It’s coming.

Note

Sources marked with ($) are restricted by a paywall or in some other way. Sources not marked are not restricted and therefore widely accessible.

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There are a lot of different reasons to provide an outlook so I’ll be upfront with mine. Mainly, it forces me to think through issues clearly and completely. I also find the exercise of going through and comparing current views to documented views from last year to be useful for identifying changes and mistakes. As such, it is also useful for rethinking and updating mental models and frameworks. Finally, it creates a nice opportunity to highlight signposts from which to evaluate progress during the year.

As a reminder, virtually everything discussed here has been reported in previous editions of Observations; it is not meant to break a lot of new ground. Rather, it is more of a compendium designed to pull together several interrelated threads into a cohesive outlook. It is longer than usual so if you can’t see the piece in its entirety, please access it online or by way of the Substack app.

As always, this is for information purposes only; it is not investment advice.

If you ever want to follow up on anything just let me know at drobertson@areteam.com.

So with that, let’s dig in.

Investment philosophy

For starters, and in order to provide some context, it is important to understand what I try to accomplish with investing. My orientation is very much to long-term investment. Think saving for retirement over a horizon spanning years and decades rather than days and weeks. While much of what I do can inform shorter-term trading as well, that is not the focus of decision making. This stands out as a very different orientation than most of what you find on Wall Street or social media.

I work from two major assumptions. One is that things change. Because things change, it requires an active effort to maintain an advantageous investment position. “Set it can forget it” can work if you are lucky, but it is not a robust strategy. Sometimes stocks are attractive, and sometimes they are not. Same for bonds. Investment success over time depends on rigorous, ongoing research and analysis to make those determinations. It is not an inalienable right.

It is also important to consider multiple perspectives. Differing viewpoints and perspectives provide important context for understanding and interpreting various phenomena. Investing with a long-term orientation, for example, means it is important to incorporate perspectives from disciplines that span longer periods of time such as history, politics, and geopolitics. It is also important for equity analysts to understand fixed income markets and vice versa. The more perspectives one considers, the more complete the understanding, the more robust the decision-making.

The best and easiest way to consider multiple perspectives is to read a lot. I focus on content providers who I find to be insightful and who are also independent thinkers. The list includes people like Russell Napier, Ben Hunt, Peter Zeihan, John Hussman, Michael Howell, and Michael Pettis, among others. In addition, I find the Substacks of Mike Green, Russell Clark, and Paulo Macro to be consistently insightful.

Investment process

Mainly, I am trying to inform an asset allocation that stacks up favorably against a traditional 60/40 (stocks/bonds) portfolio.

In doing so, I employ a three-pronged process that involves a formal valuation model (of stocks, bonds, and bills), a consideration of uncorrelated asset classes, and an analysis of narratives (for more detail see the 2023 edition).

Review of 2025

Before jumping into the outlook for the upcoming year, I will briefly review some of the major lessons from 2025. Since negative surprises tend to be the most instructive, I will start there.

The single biggest deviation from my expectations in 2025 was the degree to which markets shrugged off major threats and disruptions. The announcement of “Liberation Day” tariffs in early April rightly jolted the market. After a few days and some modifications by the Trump administration, however, markets completely brushed off the threat. By the end of the year, volatility in both stocks and bonds were at extreme lows. The risk was still there, but markets didn’t care.

Another negative surprise was the absence of any notable liquidity problems. The Fed did work down its balance sheet as expected but the most important change was the increasing intervention of the Treasury under Scott Bessent. After rounding criticizing Janet Yellen’s increased purchase of Treasury bills in order to reduce supply pressure from longer-term bonds, Bessent not only continued the program, but expanded it. He also significantly increased the Treasury buyback program which had the effect of suppressing rate volatility.

Finally, I was surprised by the strength and duration of the AI (artificial intelligence) rally. Partly because so many elements of the narrative have been so flimsy and partly because the narrative has changed several times, I thought the fervor would subside. I was wrong, at least in regard to 2025.

That said, there were also strong confirmations of my outlook during the year. In general, the primacy of politics and geopolitics absolutely played out. The chaos and disruption of the Trump administration was absolutely expected. Both of these phenomena confirmed the continuing pressure on major economies with excessive debt, poor demographics, and rapidly diminishing tolerance for the old economic and political order.

That pressure continues to constrain the universe of viable political options. It doesn’t so much predict what governments will do as to identify what they absolutely cannot do — and that list keeps growing. These constraints were most clearly manifested in the outstanding performance of gold during the year.

Probably the biggest lesson to takeaway from 2025 is the reality that the investing public is still enamored with financial assets and still overwhelmingly complacent in response to major disruptions. Whether this is pure greed (i.e., trying to reap the gains while they are there to be had), naivete, obliviousness, desperation, or some combination thereof, doesn’t especially matter. What does matter is investors still want to believe asset prices keep going up.

There is a very good chance those beliefs get seriously tested this year.

Investment landscape

As in most cases, understanding where we are today depends crucially on how we got here and why. In the investment landscape, those questions can be answered to a large degree by the massive growth in global trade in the 1990s and 2000s that occurred under the neoliberal political and economic order. The model was successful, but arguably too successful. It led to the massive imbalances that are haunting the global economy today. Nearly everyone wants change, but it is oh so hard to change old ways, especially when vested interests have acquired a great deal of political power.

In the US especially, this history has resulted in excessive public debt. The combination of China’s excess production, the dollar’s global reserve status, and a refusal to accept higher unemployment in the US, have caused debt to explode. Aging demographics makes solving the problem even more challenging.

In addition, public policy has also contributed to the country’s political and economic woes by way of undercutting the economic value of labor. In a recent Substack, Mike Green illustrated exactly how and why workers have suffered over the years:

If you look at a chart of the Labor Share of GDP, it doesn’t just drift downward. It breaks at three specific moments in history, each tied to a policy decision that seemed reasonable at the time.

Each of these major public policy decisions led to unintended consequences which hurt labor and helped capital. In the earlier years, the costs weren’t so noticeable. Today they are manifesting in widespread concerns about affordability that severely constrain home ownership and household formation. It’s worth reading the whole piece to get a a good perspective on just how counterproductive public policy has been — and therefore what it will take to fix things.

What it does as much as anything is to reveal exactly how lopsided policy has been in favor of capital at the expense of labor. This poses a both a big economic risk as well as a big political risk.

These are the key factors shaping the contours of the investment landscape.

Importantly, these factors don’t so much describe what the US (or any other) government is likely to do or what is likely to happen as outline the obstacles facing global economies and the operational limitations of public authorities. As a result, alert analysts can significantly improve their odds by applying the process of elimination.

The economic obstacles are comprised primarily of progressively rising interest expense on government debt and a progressive shift higher in the proportion of retirees supported by working people. In the US, much tighter immigration enforcement under the Trump administration is also constraining growth by reducing the supply of labor.

Since the fiscal austerity and redefinition of the social contract required to address these challenges are politically unpalatable, the economic obstacles have also led to political obstacles. Various governments have responded in different ways but none have yet tried to seriously address the underlying problems. As a result, those problems fester, and as I wrote in the 11/8/24 Observations, “Voters are dissatisfied everywhere. Problems have been kicked down the road by politicians for too long.”

Despite increasing levels of voter dissatisfaction, however, two other trends have helped to further forestall a re-writing of the social contract. First, China’s effort to manage its exchange rate below fair value beginning in 1994 has led to “a major distortion to US interest rates, gearing levels and asset prices” according to Russell Napier. This has created the appearance of prosperity in the US and consequently also subdued more aggressive calls for reform.

Second, as I also noted last year, the proliferation of passive investing turbo-charged the appreciation of financial assets by corralling flows of money and allocating them according to mechanical, non-fundamental rules. These dynamics have also helped to inflate asset values and subdue calls for reform.

Two developments occurred during the year that pulled forward the date of a major reckoning. One is that political sentiment has morphed from general dissatisfaction to a more proactive phase that involves a re-imagination of political strategy. Exhibit A is Zohran Mamdani winning the mayoral race in New York City. That could not have happened if voters had continued to align with traditional political parties. I expect the political landscape to undergo a major overhaul the next few years and for some really surprising changes to emerge from it. I also expect political forces to become considerably more effective in lobbying for better living conditions.

The second development is an increasing demand for capital. Whether the capital is to rebuild critical infrastructure, reshore important industries, arm for military conflict, or build out technology infrastructure like AI (artificial intelligence), tons of new capital will need to be deployed. Doing so will completely change the global financial dynamics from capital surplus to capital deficit and therefore also completely change the investment playbook from low interest rates to higher interest rates. After all, capital goes where it is treated best and more attractive rates will become the competitive advantage necessary to secure finance. This will be a bad environment for financial assets.

One takeaway is that investors should be leery of overly optimistic assessments of government economic plans for all but the shortest of time horizons. Governments are behind the eight ball and have little more than chutzpah and narrative to sell to their constituents at this point, though those efforts can buy time. Long-term investors should be able to identify the shortcomings in government initiatives and plan for their failure and the major changes that are coming. This will be a process and is unlikely to happen all at once. Along the way, there will many pitfalls to avoid, but also opportunities to exploit.

Another takeaway is the widespread resistance by governments to meaningfully address fiscal and economic problems to date means the problems will continue to grow worse by the day. That means when things finally do break, there is a greater chance of a major dislocation.

Implications and outlook: Macroeconomic

Politics

The primacy of politics and public policy was a key theme last year and remains so this year. Another ongoing theme is that of disruption. Late in 2024, John Ikenberry of Princeton University ($) claimed, “Trump is poised to contest ‘almost every element of the liberal international order — trade, alliances, migration, multilateralism, solidarity between democracies, human rights’.” He was right, in spades.

That said, knowing this proved to be of little benefit for investing in 2025. While “Liberation Day” tariffs did create a ruckus in the market for a few days, the Trump administration relented, postponed the tariffs, and fairly quickly was forgiven by the market. By the end of the year, volatility of both stocks and bonds was exceptionally low.

A key question for 2026 is how much longer can the investment environment remain so unperturbed? How much longer will investors continue to believe that policymakers can bend markets to their will?

A great deal of insight to the answer can be found in a simple observation: One of the great mysteries of the first year of the Trump administration has been the dissonance between its stated goals and campaign aims, and the effects of its policies.

For instance, lower inflation was stated as a clear goal but prices have continued to rise. While oil prices are lower, tariffs increased prices for consumers. In addition, healthcare costs are going up materially for many Americans explicitly because the Trump administration would not renew healthcare insurance subsidies. Indeed, the Trump administration’s efforts were so counterproductive as to facilitate the emergence of “affordability” as the key political hot button during the year.

In addition, the Trump campaign reveled in its appeal to working class voters and small business owners, but again, took almost every opportunity to make things worse for them. The signature legislation of the budget bill massively favored tax cuts for the wealthy but tax increases for lower income earners. Tariffs created massive uncertainty for everyone, but more so for individuals and small businesses. Conversely, big companies and/or wealthy individuals regularly got relief when it was requested.

Because of the large number and variety of instances in which stated goals failed to comport with actual outcomes, it behooves us to search for possible explanations. The best I have come up with is that Trump is rapacious by nature. He has no desire, or arguably ability, to make sacrifices. He always wants to have his cake and eat it too.

As a result, he says a lot of stuff but at the end of the day, he is only willing to do what provides the most benefit and least cost to him. This is why he says one thing, often persuasively, but then does another. This is why he has made liberal use of executive orders but basically shut down legislative action, why he backed off on tariffs in April, and why he has mainly acquiesced in trade negotiations with China.

Another way to think about this tendency is as a preference for immediate consumption versus longer-term investment. Investment requires short-term sacrifice — and that’s not what Trump does. This explains why he talks populist (because of the short-term benefit of political popularity), but acts as USA Inc., by which the largest companies, and Trump himself, benefit disproportionately. It explains why the oft-stated desire to industrialize is highly unlikely to succeed. It also suggests that when push comes to shove in the Trump administration, capital almost always wins out over labor.

While this helps to define “intent” going into the new year, it vastly raises the stakes on “ability”. This will be the question governing the landscape in 2026: To what extent will the Trump administration be able to achieve its desired goals?

One of the tools the Trump administration will undoubtedly use is its social media narrative machine. While one could argue that machine was a critical factor in Trump’s electoral success, one could also argue it was mainly a product of the times. In other words, when circumstances have devolved such that virtually no practical economic or political reforms will be sufficient to correct problems without significant pain, then the most attractive political option is to tell stories. In short, to lie.

The nature of the lies is important though. Virtually every administration lies — exaggerating potential benefits, de-emphasizing side-effects, underestimating costs, etc. Voters are accustomed to these lies, however, and can calibrate accordingly.

What makes the Trump administration pattern of misinformation so pernicious is that it creates misdirection about the beneficiaries. Workers and small businesspeople believe Trump speaks to them and understands them. Maybe he does. Regardless, he actually acts against their best interests. Indeed, the administration’s current economic program to “run it hot” benefits large public companies, financial firms, and the very wealthy at the expense of everyone else.

As a result, it should be expected that 2026 will be a year in which narrative volume will be cranked up even louder in an ongoing effort to emphasize perception over reality. The degree to which this effort succeeds will be a key determinant of the administration’s ability to accomplish objectives.

By most accounts the pool of political capital is past peak and is now dwindling. Trump’s approval ratings have continued to fall across a wide variety of voters and issues. As with any administration, its ability to accomplish things is a function of its approval ratings. For this reason, a number of commentators are already labeling Trump as a lame duck.

The off-year elections in November were telling on many levels. Across the board Republicans lost ground to Democrats in what was largely interpreted as a rebuke of the Trump administration’s policies. Importantly, younger voters who had largely turned the election for Trump the year before notably turned against him after actually observing and experiencing his policies.

Dissatisfaction has also spread to the political class. There have been increasing signs of conflict within the administration. Politicians like Marjorie Taylor Greene who had previously been a strong supporter began publicly lashing out at the administration. Other Republicans, especially those in purple states, are resigning, joining discharge petitions, and otherwise stepping away from the Trump circle.

The main signal in this activity is loss of power. Politicians don’t step out of line unless they fear their constituents more than the party leadership. With midterms coming up this year, the trend is likely to become even more evident and pervasive. All of this points to a diminished ability to achieve political ends.

It is important to also note, however, that political dissatisfaction extends more broadly than just the Trump administration. Voters aren’t happy with either Republicans or Democrats. Both parties are fractured and failing. Complaints about politicians failing to represent the interests of ordinary voters, being out of touch, and being too old to appreciate the challenges for younger people, are all complaints directed at politicians of both major parties.

In addition, because politicians are considerably older than the population in general, their mental models and norms mainly come from a different era. They disproportionately have ties to finance and big business, endorse extractive economic models, and exhibit gatekeeping tendencies. These all conflict with the political center of gravity of the population.

As a result, I also expect progress to accelerate toward a political regeneracy, i.e., re-orientation of political affiliations. Political sentiment is advancing from mere discontent to an increasing demand for remedial action. If the old political parties don’t want to change, or are unable to change, perhaps a new movement can take over.

Geopolitics

In many ways, the geopolitical environment is a reflection of the political landscape of the large global economies. The same factors that constrain policy options at home are also forcing countries to consider offloading their problems onto other countries. The US, China, Japan, and France are all examples of this.

The premier example of this kind of behavior is China. Constrained by weak consumer demand at home, it keeps trying to keep the economic engine running by exporting ever more products abroad. Even as the US increased tariffs to mitigate this threat, China’s export totals continued to increase — they just went to other countries.

The US has also taken a page out of the same policy book. Constrained by the rising cost of government programs such as entitlements and defense at home, as well as by rising interest costs, the Trump administration has tried to force what it considers burden sharing onto trade partners. Whether through commitments to higher defense spending, commitments to purchase US products and services, and/or commitments to invest in the US, the Trump administration is asking (and often coercing) other countries to help out.

In both cases, the deals are determined unilaterally and usually foisted upon weaker countries. As a result, the inherent tension in such relationships is hard to quantify. It doesn’t behoove smaller countries to openly defy more powerful ones when they make requests. Nonetheless, they cannot completely acquiesce for fear of betraying their own populations. This is why there has been little visible backlash to date.

However, to infer geopolitics doesn’t matter because there haven’t been a lot of fireworks to date is to completely miss the reality that geopolitical tensions are both guiding and constraining behaviors. For example, it was fear of what Gzero called an “unmanaged decoupling” with China that caused the greatest concern in regard to the “Liberation Day” tariffs. Indeed, it was only the recognition of real “economic and security risk” that caused the “two sides to better manage their growing tensions”. This conflict isn’t over by a long shot; it has just been recalibrated to avert an immediate flareup. That the two sides came so close to blows speaks volumes of the potential for disruption.

In addition, the US is causing former allies to consider the prospect not just of the US withholding security provisions, but also the prospect it could become an active opponent. China can provide capital to countries in need, but it often comes with a lot of problematic strings attached. Those caught in the middle can no longer just pick sides; they also have to consider the possibility that neither China nor the US will be there to help in a time of need.

This landscape is consistent with Ian Bremmer’s G-Zero thesis — that no single geopolitical power will dominate the global landscape. At very least, it creates more uncertainty. At worst, it opens up the possibility of hot conflict between major powers. This is not something that has been experienced in several generations and as a result, its probability is likely being underestimated.

In the short-term, there is a good chance the Trump administration will work hard to reach some kind of temporary agreement with China in order to keep peace at home. It’s frightening to consider what concessions might be made, but it’s unlikely Trump will suddenly and uncharacteristically take a tough stand based on principle.

Longer-term, however, the two big heavyweights of China and the US will continue their strategic conflict. We will continue to see evidence of the tensions in the forms of constant probing for weaknesses, challenging perimeters, and testing resolve. The nature and magnitude of the flareups will indicate the overall temperature of the engagement.

Meanwhile, Japan and France are rapidly approaching the limits of their excessive debts. Rising long-term rates and weakening currencies are sure signs. There is a good chance 2026 will be the year these countries will have to impose capital controls or some similar desperate measure in order to save their economies.

Such a possibility also creates enormous risk of spillover into other countries. A weakened Japan would look like prey to China and could force the US reveal its stance. A weakened France would seriously impair the European Union and make the region even more vulnerable to Russia’s aggressions. All the ingredients are there for major events to take place.

Economy

One of the consequences of excessive debt, rising interest costs, and a political class unwilling to make sacrifices, is that economic growth per se says virtually nothing about the health of the economy: It grows at a rate government determines it will grow at by way of the subsidy of deficit spending. It’s more accurate to think of it as a “trophy” economy — something to show off more than to actually create and build things.

One of the more interesting outcomes of Trump administration policies thus far is the unevenness of benefits. Wealthy people are doing extremely well and lower income people are struggling with affordability. Increasingly, a lot of people in the middle are also becoming vulnerable to financial precarity in what is often referred to as the “K” shaped economy.

The same kind of distribution applies to companies. Large companies are doing well (at the expense of labor) while small ones struggle with demand, credit, and uncertain policy. This graph from Paul Krugman illustrates the divide well:

Another interesting aspect of Trump administration policy orientation is that it is a study in countervailing trends. On one hand, the Trump administration has a well-rehearsed mantra for the economy next year: Lower taxes, lower interest rates and less regulation are going to provide a massive jolt to the economy.

While it is true each of these will provide some degree of benefit, it is also clear each comes with consequences that have a good chance of more than offsetting any benefit.

For example, the budget bill will provide for tax refunds for the wealthiest Americans but will increase taxes and reduce SNAP benefits for the poorest and increase health insurance costs for a wide variety of Americans. Since lower income families spend a higher proportion of their income, this will have a disproportionate effect on overall spending. Bob Elliott ($) provided a nice analysis that concluded the net effect was “Hardly the mix that would create a surge in demand to kick off the year.”

In addition, while lower interest rates can be stimulative all else being equal, all else is hardly equal. Inflation has been above target for nearly five years. Lowering rates in that context puts upward pressure on longer-term rates — and those rates are more meaningful for the types of borrowing that effect the economy — such as for mortgages. In addition, short-term rates provide income for savers. Whatever benefit wealthier Americans will receive from tax refunds will be at least be partially offset by lower interest income. Again, it’s not at all clear lower short-term rates will be beneficial on a net basis, and they could be quite harmful if they allow inflation to pick up again.

Finally, lower regulation could potentially be helpful if it were directed at real obstacles to doing business, but that is not what the Trump administration is targeting. Rather, the focus has been on reducing frictions for short-term borrowing (which aids financial engineering) and on facilitating corporate deals (which increases consolidation at the expense of consumer welfare).

Two other phenomena should be considered in the mix of policy-driven actions that can affect economic growth. One is that other Trump administration policies are harmful to growth. Tariffs raise prices to consumers. In addition, immigration policies are reducing the labor supply by quantities large enough to matter. Lower labor force growth means lower economic growth, all else equal. Both can lead to higher inflation.

In addition, the general predilection to engage in economic activity depends on confidence in the system. Since Trump fired the head of the Bureau of Labor Statistics over the summer, the prospect of eroding confidence in the quality of government data is quite high. This does not bode well for increased investment or growth.

In summary, one key theme about the economy going into 2026 is that it appears expectations are inflated. Public policy actions are not internally consistent and therefore should be expected to provide little, if any, benefit. Moreover, the economic headwinds created by policies in 2025 will continue to dribble into the new year. In regard to economic forecasts, it will be better to err on the low side.

Another key theme is that a close inspection of actual policy actions by the Trump administration reveals a strong preference for “capital” over “labor”. This is often confusing because the administration’s rhetoric often touts the causes of workers and small businesses. What it actually does, however, is usually adverse to those causes. Don’t be fooled.

So, the big question for 2026 is how long can the Trump administration continue to “run it hot” until serious consequences emerge? How long can workers, small businesses, and host of other constituents remain on board politically while their economic lives are being undercut by Trump administration policies? How long can the wealthiest Americans and largest companies carry the economy while everyone else suffers? It’s like the Trump administration is playing “chicken” with the economy. How long until something crashes?

Inflation

My view on the longer-term risk of inflation remains unchanged: “monetary inflation is a long-term policy and therefore is likely to be around for years”. Everything I said two years ago remains valid and can be reviewed in the 2024 Outlook piece.

One of the things that has changed during the interim is the clear aversion of governments to accept slower growth. As a result, the prosect for recession-induced deflation or disinflation is greatly diminished.

Another thing that has changed is the prospect of supply shortages. The onward march of National Capitalism threatens to impede global trade and increase the incidents of supply shortages. The trade conflict between China and the US has highlighted the importance of rare earth elements but that is only the opening salvo. Expect many more commodities to become issues of national security and therefore less easy and more expensive to procure.

Yet another supply shortage can be expected with labor. With demographics already limiting the growth of labor forces and with US immigration policy very intentionally reducing labor supply, all signs point to the need for higher compensation to provide the requisite incentive to ensure retention and meet hiring needs.

Net/net, given the decline in reported inflation in the back half of 2025, we are probably at or near the lows in inflation for the next several years.

Monetary policy

Monetary policy continued to be in focus for the cues it could provide on market direction. Looking forward into next year, the picture from monetary policy gets a lot fuzzier. Bob Elliott ($) summarizes one of the major changes: “The last few years have seen some of the most ideal monetary policy conditions for the majority of global economies and markets - plenty of cuts without weakening growth. But that dividend is largely behind us, with most policymakers set to hike rates on the margin”.

In addition, an interesting dissonance is developing. Per the FT ($), “Several central banks, including the ECB, have signalled they are nearly done cutting” which “leaves the Fed an outlier”. Given the “rate differential between the US and other countries is narrowing,” the US is becoming a progressively less attractive destination for capital. While lower short rates sound good for investors, they could have extremely harmful ramifications.

Another story that played out during the year was the Fed’s balance sheet. The Fed finished its Quantitative Tightening (QT) program and is now signaling modest growth in the balance to align with economic growth. That is the stated purpose. We will have to wait and see if it becomes tempted to goose the balance sheet at a rate greater than economic growth. There is certainly plenty of potential to quietly dial up liquidity if it wants to, but it also needs to be wary of re-igniting inflation.

One of the bigger developments during the year was the effort by Treasury to shift the proportion of new issuance to bills. This prevented increasing the supply of bonds at a time when demand has been falling and could have caused longer-term rates to spike. As it was, the heavier issuance of bills, combined with an increase in buybacks of issued bonds, kept longer-term rates in check and caused bond volatility to plummet.

Another interesting, but telling development was the composition of bank lending. Growth in commercial and industrial lending, i.e., lending into the real economy, grew at a rate of just 0.36% from the end of November 2024 through December 17, 2025. In contrast, Adam Josephson ($) documents just how much bank lending has gone to help out the financial sector:

To put into perspective what’s happening partly thanks to the Fed, banks’ repo lending is growing at ~25%; bank-affiliated primary dealers’ repo lending is growing at ~20% (and at a record high); margin debt provided by broker-dealers is growing at ~40% (and at a record high); and hedge funds’ borrowing is growing at ~30% (and at a record high). At the same time, GDP is growing at just 2%, which highlights how little this record-high financial leverage is doing for the real economy.

He follows up ($) by highlighting, “NDFI [non-depository financial institutions] loans are now two-thirds the size of C&I loans, whereas in 2019 C&I loans accounted for 24% of all loans and NDFI loans just 5.5%.”

The story this evidence tells is that monetary policy is increasingly being conducted by a partnership between the Fed and the Treasury and that in subtle, but important ways, the proclivity is to favor capital over labor. Lower short-term rates and lower volatility helps the financial sector by reducing the cost of capital. This happens at the expense of labor.

Interestingly, this has all appearances of being the wrong playbook for the times. In times of growing demand for capital, the challenge is to attract the necessary capital, not repel it. In a pro-labor, rising cost of capital world, Russell Clark ($) reminds us, “The time to get bearish is not when the Fed is TOO HAWKISH, the time to get bearish is when the Fed is TOO DOVISH.”

This will be a key item to monitor in the year ahead. US monetary policy appears to be on exactly the wrong setting. That could cause monstrous problems.

Interest rates

Last year’s take on rates still holds and will probably hold for several more years to come: “Longer-term, the most likely destination is still financial repression — which will involve keeping longer-term rates below that of inflation.”

Interestingly, over the course of the past year, both Japan and France moved much closer the point at which financial repression is likely to be implemented in some form. Capped long-term rates and capital controls are examples of the kinds of measures that could be deployed. If and when that does happen, it will almost certainly put pressure on markets that trade more freely. The game until then will be to watch long-term rates rise until policymakers are forced to react.

In regard to short-term rates, most major central banks have signaled the completion of their rate-cutting programs. Whether the Fed decides to keep cutting or not doesn’t materially change the global posture.

What could have a material impact is any notable change in interest rate volatility. While the Bessent Treasury has fairly aggressively managed rate volatility downward, fundamental pressures suggest volatility should be higher. Indeed, the end of global easing could facilitate higher volatility on its own. Regardless, if and when volatility does move higher, it will have the effect of tightening monetary conditions.

Culture/Social media/Technology

The AI (artificial intelligence) theme drove stocks in 2025 but that was less interesting than the narrative landscape which it embodied. This narrative landscape evolved from an administration that was extremely comfortably capturing attention with the stories it wanted to tell and that increasingly welcomed the technology leaders who facilitated the endeavor into government. The pictures of big tech leaders with front row seats at Trump’s inauguration spoke volumes about the tightening embrace of technology leadership and government power.

At very least, the courtship between government and technology has been a rocky one. With the spotlight directly shining on tech leaders like Elon Musk, the public couldn’t help but to see the kind of people they really are, “banally opportunistic profit seekers wholly unconcerned by the consequences of ripping apart the social fabric,” as I described last year.

The relationship between the Trump administration and Techno-oligarchs remains troublesome, but that should not overwhelm our perspective of the potential for technology to be applied for more socially useful purposes.

For one, the campaign of Zohran Mamdani in New York City made extensive use of social media not to insult, beat down, or denigrate, but to listen, give people a voice, and share positive messages. Social media was employed as a tool to capture people’s concerns rather than to irritate and enrage them. The contrast with old, out of touch politicians who don’t understand the problems of ordinary citizens was unmistakable as was the contrast with tech leaders who singularly endeavor to monetize their tools.

Regardless of Mamdani’s politics and whether he succeeds as mayor or not, he opened a new door as to how campaigns can be run and how social media can be used in a far more positive way. That’s a start.

Indeed, it’s not a big step at all to take a fresh look at all technology and how it is currently deployed. It doesn’t have to all be deployed for profit; it can also be used to produce social goods. Indeed, as Ben Hunt rightly notes, “having a government in the first place is to solve problems of the commons, to provide for the common defense, the common clean water supply, the common electricity supply, etc.” What more appropriate and deserving application of technology is there?

The good news then, is technology provides amazing potential when used properly and applied for the common good. This should provide no small amount of hope for the future.

The bad news is, until that indeterminate future, we can expect a full barrage of narrative wars. The Trump administration is between a rock and a hard place and leveraging its social media and narrative tools is one of the few resources it has. It will continue to use them aggressively.

Implications and outlook: Investments

Given the primary goal of my investment outlook is to inform and guide a strategic allocation, I will emphasize the absolute and relative attractiveness of major asset classes for long-term investors. As a result, the outlook for assets tends not to change a lot from year to year. That said, I will also share thoughts about shorter term outlooks where appropriate.

Stocks

The main thing to consider in regard to (US) stocks is the long-term outlook remains extremely negative on the basis of extremely high valuations. This means future returns (i.e., over a ten year period) will be low and by my measures significantly negative.

In the short-term, sentiment is still quite positive and public policy looks set to “run it hot”. As a result, the momentum going into the year is likely to be positive.

It is important to remember, however, there have been several different factors providing tailwinds for the stock market and all of them show signs of fading or reversing in the new year.

For starters, the proliferation of passive continued apace, but in doing so simply reduced the amount of active share left to supplant. When passive inflows fail to keep pace, the bids of price-sensitive buyers will be considerably lower. In addition, corporate buybacks are expected to fall as cash flow is required for reinvestment in businesses. The carry trade is drying up as rate differentials erode and retail purchases have little room to go but down after another blockbuster year. As if to add insult to injury, PauloMacro ($) reminds us “that Year 2 ‘midterm’ years can be rough for US markets”.

Two other factors are also likely to cause problems for US stocks. One is a general problem: As the global demand for capital rises to exceed supply, the cost of capital will rise to clear the market. This will be detrimental to all financial assets. That said, companies and industries that are less sensitive to the cost of capital can outperform.

The second is a US-specific problem. The Trump administration’s hostility to most of the rest of the world vastly increases the risk those countries will seek to reduce already oversized allocations to US assets as well as to reduce exposure to the US dollar. Neither of these will be good for US financial assets, but do suggest opportunities in international markets.

In sum, US stocks have had a good run that has been blessed by good luck on a number of fronts. Increasingly, it looks like that luck is about to run out. Of course, there will always be opportunities, but the next few years look like tough sledding.

Bonds

Once again bond yields rose and fell over the course of the year, but generally trended down. This performance was especially notable in the context of two other phenomena. One, although short-term rates were cut three times late in the year, long-term rates were stuck in a range and barely moved. Two, the modest decline in Treasury yields over the course of the year happened while Japanese bond yields surged continually upward.

These oddities illustrate the degree to which US Treasury bond yields became a battlefield between fundamental reality and policy ambitions. On one side, fundamentals continued to point to higher yields as an indication of increasing demand for capital globally. In the US, shrinking demand for duration has been exacerbated by increasing supply of debt to finance deficits.

On the other side, Treasury Secretary Scott Bessent has made lower long-term rates a part of his economic agenda. As a result, he has finagled bond yields lower through a variety of interventions in issuance schedules and regulation. As noted in the December 12 edition of Observations: “This pattern suggests that while markets do believe policy can engineer artificially suppressed rates for some time, it can’t do so forever. The current numbers suggest the 10-year yield ought to be closer to 6% than 4%.”

This creates an awkward situation for investors. Do you bet against the Treasury Secretary and wait for fundamentals to assert themselves or do you trust that Bessent can continue to get his way? Unfortunately, investors are left with a very political decision.

Cash

Once again, Treasury bills, i.e., cash, are less attractive than at the beginning of last year, but are still an important investment option in the standard asset allocation mix right now.

With most other assets still extremely unattractive, cash still provides a large degree of safety. While it still provides a yield greater than the inflation rate, the margin has narrowed. Regardless, cash still provides important option value to buy other assets at a discount should asset prices fall. You never have enough when that starts to happen.

Gold

Gold had a terrific year in 2025 — and its strong performance also served as important confirmation of the assessment of the landscape I laid out the last few years. Bottom line, as large economies run out of options to manage their excessive debts, their fiat currencies become riskier and that creates a dearth of safe assets. The world is beginning to realize it doesn’t own nearly enough gold.

Longer-term, gold is still in the early innings. As a result, long-term investors should maintain positions or look to add. While central banks have started this process, gold is still hugely under-owned in most investment portfolios.

Shorter-term, the task of adding gold has become trickier because of the big fluctuations in price. Big upswings attract performance chasing flows which amplify swings in both directions. While this creates trading opportunities, longer-term investors can mitigate the risk by averaging in. Despite the big move this year and the volatility late in the year, there are still several milestones to be reached that can lead to step-function increases in price. These are the kinds of major moves you don’t want to miss.

Commodities

I still like the longer-term case for commodities, as I noted last year and detailed in the 9/6/24 Observations. The case mainly boils down to the relative demand for real things as opposed to paper claims on things. Alyosha ($) described this well:

The real auction is selling paper assets, mostly currencies, but broad and competitive deaccessioning fixed income like China dumping our Treasuries and the BRICs exchanging paper for gold. This will ultimately cause a showdown between stocks and tangibles because stocks are paper.

This year, the story got clearer as a number of commodities started to move. While many folks have pointed to oil as disconfirming evidence, oil has also been subjected to a number of other unusual influences, not least of which has been Saudi Arabia unleashing its excess capacity into a well supplied market.

Bottom line: The relationship between commodities and stocks is turning. Don’t let the low oil price fool you.

International stocks

For several years, international markets hugely underperformed the S&P 500 despite boasting much more attractive valuations. That turned around this year.

Most obviously, the Trump administration’s hostility to most foreign countries started both a reallocation of assets away from the US and a repatriation of money to the domestic markets of foreign investors. Since many of those decisions take time to fully implement, there is good reason to expect a lot more of this to happen over the next several years.

In addition, a number of emerging markets actually have fairly attractive demographic and fiscal profiles. As a result, there is a good chance many of these will get re-rated as being much more attractive investment destinations than they have been in the past.

Alternative investments

Investments such as real estate, private equity, and venture capital have long been pitched to advisors and retail clients as diversifying investments. They do add a few slices to the allocation pie charts and help create the impression of diversification. Bottom line though, these are all highly correlated to equity markets.

Most of the stories in 2025 revolved around private credit. As that particular segment has grown, so too have concerns about credit quality in a realm of opacity. These concerns will continue to hang over markets through the new year.

The paradox for all of these vehicles is that they typically invest in smaller companies that tend to be more vulnerable to competition and the economic cycle and yet their business models tend to benefit from capital-friendly policies like low interest rates. As a result, making a call on alternative investments involves offsetting the incoming tide of higher capital costs against the Trump administration’s tendency to favor capital. My bet is that the rising tide of capital costs will begin to overwhelm efforts to resist it this year.

Investment summary

In summary, just a few major forces are responsible for shaping a disproportionate share of the investment environment. One is rising capital costs. Another is the emerging rise of labor over capital. A third is the starting point of already-high debts and deficits. Given the challenges, this is not where you want to start from.

As a result, the Trump administration walked into an uphill battle. Unfortunately, it did not come well-prepared for such a battle. There has been little policy direction and it certainly has not been cohesive. There has been a political agenda but little effort at governance. In short, the administration has done exceptionally little in terms of policy to solve the pre-existing problems it inherited.

What it has done instead is try to control the narrative. Ben Hunt thinks this is only going to get worse. He believes the Trump administration is going to amp up its narrative machine to DEFCON 1:

They’re going to need the stick. They’re going to need to tell us that national survival is at stake, that our enemies will triumph if we don’t make the ‘necessary sacrifices’ to win this ‘AI arms race’.

To date, the consequences of the Trump administration’s dereliction of responsibility have been cushioned by a reasonably strong stock market. Looking forward into 2026, however, most of the tailwinds supporting the stock market are likely to subside or reverse.

Indeed, Russell Clark sees these conditions and ponders ($) whether it is time to short? It’s a good question. The answer boils down to timing.

Economically, time is running out. There is no immediately obvious forcing factor, but there are a lot of candidates and that could change quickly. Politically, things are even more tenuous. G. Elliott Morris ($) writes:

One study of public opinion toward wars suggests that presidents can shape opinions early on in a crisis, but the information tends to catch up with them. Trump, in other words, can only bullshit for so long.

It seems he has reached his limit.

So, how is this likely to resolve? I suspect it will come down to a Common Knowledge moment like the Biden presidential debate — when everybody suddenly knows that everybody knows that the suspicions are confirmed. With Trump it will be the realization there is no plan to improve the economy or to solve the country’s problems or even to keep the stock market afloat — and that he has just been bullshitting. If and when the authority of the Trump administration cracks, so too will its ability to control the narrative.

While it is always dangerous to predict timing, I am increasingly believing there will be some kind of reckoning this year. The political losses in the off-year elections illuminated vulnerabilities in the Trump administration and midterm races this year are likely to turn the political heat up even higher.

In the meantime, I view the new year with both trepidation and excitement. I am worried about how disruptive a major market dislocation could be and fear the degree to which government interventions can upend the best of investment ideas. At the same time, I see an investing public that is amazingly complacent and with remarkably few investors positioned for a downturn. I think things are about to get very interesting.

Implications and outlook: Investment advisory

I would be remiss in describing implications of the investment landscape if I did not also discuss implications for everyday investors.

First, as I alluded to above, the outlook for stocks and balanced 60/40 (stock/bond) portfolios is terrible. It’s one thing to invest long-term and ride through the ups and downs. It’s a different thing to be overexposed to risk at a historic extreme of market excess. Make sure your level of risk is appropriate. What you don’t do can hurt you.

Second, by virtue of the extended run up in stock prices, it has become extremely difficult for investors to get good, thoughtful, and useful investment commentary. Instead, the financial media landscape has become littered with cheerleaders, followers, performance chasers, and risk takers. This strongly biases the types of information and advice that most investors have easy access to. It’s usually not helpful.

I founded my company, Areté Asset Management, to do something better. I am much more interested in uncovering investment reality than in telling stories. I also try to present my findings in a way that is understandable and helpful. My goal with Observations and Areté always is to give investors a fair chance at getting ahead. I hope I have done that.

Regardless, good luck and best wishes for a successful 2026!

Note

Sources marked with ($) are restricted by a paywall or in some other way. Sources not marked are not restricted and therefore widely accessible.

Disclosures

This commentary is designed to provide information which may be useful to investors in general and should not be taken as investment advice. It has been prepared without regard to any individual’s or organization's partar financial circumstances. As a result, any action you may take as a result of information contained on this commentary is ultimately your own responsibility. Areté will not accept liability for any loss or damage, including without limitation to any loss of profit, which may arise directly or indirectly from use of or reliance on such information. 

Some statements may be forward-looking. Forward-looking statements and other views expressed herein are as of the date such information was originally posted. Actual future results or occurrences may differ significantly from those anticipated in any forward-looking statements, and there is no guarantee that any predictions will come to pass. The views expressed herein are subject to change at any time, due to numerous market and other factors. Areté disclaims any obligation to update publicly or revise any forward-looking statements or views expressed herein.

This information is neither an offer to sell nor a solicitation of any offer to buy any securities. Past performance is not a guarantee of future results. Areté is not responsible for any third-party content that may be accessed through this commentary.

This material may not be reproduced in whole or in part without the express written permission of Areté Asset Management.

As always, if you want to follow up on anything in more detail, just let me know at drobertson@areteam.com.

Market observations

The CPI (Consumer Price Index) came out considerably light of expectations on Thursday. According to Kevin Hassett, Director of the National Economic Council for the Trump administration and a lead contender to be the next chair of the Federal Reserve, it was an “absolute blockbuster report”. According to most market watchers, the numbers were suspiciously low. The market didn’t assign much importance to the reported numbers either; The two-year yield barely moved.

Combined with the market reversal after the Fed cut last week, this is a potentially ominous development. If the market stops listening to policymakers for direction, the ability of policymakers to influence markets will decline substantially.

“BOJ is Said to Start Selling ETF Holdings as Soon as January” proclaimed ($) the Bloomberg heading (h/t The Daily Shot). This could create a really interesting set up for 2026. What will the net effect be of Japanese savings being repatriated versus the ongoing selling by the BOJ?

Normally, when there is an overhang of selling it depresses prices. In this case, however, there is also pent up demand for Japanese securities by Japanese investors who have historically invested their money elsewhere. This will be a very interesting tension to monitor next year.

Economy

The FT’s Unhedged ($) newsletter did a nice job summarizing the economic data this week. While the headline unemployment number ticked up, that was mainly the result of government job losses. Private job growth trended up. Retail sales had some puts and takes but was up about two percent in real terms. Overall, Unhedged nudged its economic assessment up from “meh” to “fine”.

Adam Josephson ($) had a lot more to say about the retail environment, especially in regard to Home Depot and Lowe’s. He called their traffic trends “striking” and indicative of both the “K-shaped economy and discretionary spending”.

For Home Depot, “From 2Q21 onward—a span of 18 quarters—its traffic fell in every quarter but one, with an average decline of 3.1%.” For Lowe’s, “its traffic has declined in every quarter from 2Q21 on.” Josephson concludes, “While traffic declines were logical to expect following the COVID surge, such declines four years later are more surprising, and indicative of many Americans’ unwillingness/inability to spend money on repairing and remodeling their homes.”

He didn’t have to search very far for the cause of such weak results from the improvement retailers:

the Fed has cut interest rates by 150 basis points since September 2024, yet 30-year mortgage rates are essentially unchanged since then at 6.2%. And 10-year UST yields are 35-40 basis points higher than they were when the Fed started cutting.

Despite the less than stellar assessment of current economic conditions, investors still appear to be bulled up on expectations for next year. Bob Elliott ($) dissects that outlook:

A first half household stimulus driven boom is one of the key centerpieces of many bulls takes for the first half of ‘26. But the numbers just don’t add up. Most refund checks are going to higher income households and any marginal spending is likely to be offset by the squeeze on lower income households from ACA and SNAP cuts. Hardly the mix that would create a surge in demand to kick off the year.

In sum, it’s not at all unusual for Wall Street to be excited about the prospects for the upcoming year. With a wide gap between the challenges consumers are experiencing and the high expectations of investors, however, those expectations are at unusually high risk.

Politics

For most of the year, we have seen a White House aggressively pursuing an agenda. Over the last month or two, however, several glitches in the Trump administration’s efforts have appeared and its momentum has slowed considerably. The Epstein files issue has been an important impetus, but several other factors also converged.

One of those factors has been intense dissatisfaction in the House of Representatives. Representatives have been all but ignored by the White House unless it wants something, and then they get bullied into whatever that something is.

As Joe Perticone ($) reports for The Bulwark, acts of defiance are beginning to appear. Most notably, a number of Representatives have engaged in “aggressive procedural rules-gaming” in order to “circumvent House leadership through the use of discharge petitions”. In what Perticone describes as a big “middle finger” to Speaker Mike Johnson, he details:

The increasing frequency of these end-runs around leadership is a forceful demonstration of just how sick and tired rank-and-file Democrats and Republicans are of trying to work in a chamber run by an obsequious speaker who sees his role as doing the bidding of a power-hungry White House.

The use of discharge petitions is essentially a last ditch effort to get around the House Republican leadership’s refusal to put certain issues to a vote. While only two petitions have collected the 218 signatures required to force a vote (the Epstein files bill and a bill to restore collective bargaining rights for federal workers), Capitol Hill staffers “are predicting that more discharge petitions will make it to the floor in the coming months”.

In another story of political turmoil, G. Elliott Morris writes

The vibes are, to be blunt, shit. Harvard’s IOP [Institute of Politics] finds just 13% of young adults say the country is headed in the right direction, and 43% report they’re “struggling” or just “getting by” financially. In the GenForward data, nearly 9 in 10 say they’re concerned about food prices and health care costs, and a meaningful share report acute housing anxiety.

He sums up, “The average young person is extremely economically and politically anxious”.

Morris also highlights that young people are more likely to switch parties. He notes that “roughly 60% of young people hold unfavorable views of both major political parties” and believe voters need more political party choices.

Taken together, these two observations suggest politics next year will be fraught with turmoil and uncertainty. While I doubt we will reach the kind of political regeneracy I have discussed many times, I also suspect there will continue to be a number of unusual happenings that further undermine the incumbent political parties.

The thing about young people is their influence grows with time. As a result, the baseline expectation should be for a lot more change to the existing political system.

Monetary policy I

Now that the Fed’s Quantitative Tightening (QT) program has ended, all eyes are turning to what happens next with the Fed’s balance sheet. The FT’s Unhedged team ($) jumped right in to the discussion:

Many people, including Wang and Constâncio, think of RMPs [reserve management purchases] as a neutral and technical operation, categorically different from quantitative easing (QE), in which the Fed buys long-term government securities. QE was not only targeted at a different part of the yield curve, it was explicitly designed as an additional form of stimulus, for when rates were already near their lower bound.

Others disagree, arguing that the real function of RMPs is the same as QEs: preventing the collapse of a financial system, and indeed an economy, built on very high leverage and correspondingly high asset prices.

There are valid reasons for believing in the “neutral and technical” interpretation of RMPs. Liquidity is seasonally tight at year-end, early in the new year, and into tax season in April. There is a case to be made for smoothing that path.

However, it is also hard to escape the experience that there is almost always some short-term reason to ease up on monetary conditions. As the FT’s Robin Wigglesworth points out, the bias towards easing also has its own costs:

It kinda looks like the Fed, by flooding the system with money, has inadvertently allowed the repo market [a key short-term borrowing market] to balloon to an unhealthy size…

it probably isn’t healthy to have this level of dependence on short-term leverage . . . dependent on central banks running permanently huge balance sheets that have to balloon every time a crisis hits, and prov[ing] very hard to shrink again without causing mayhem.

Good point. Unhedged summarizes:

I’m sure the Fed leadership believes RMPs are a technical operation. But the purpose of a system is not defined by the beliefs of the people in charge of it; it is defined by what it does. And I’m not sure I believe there is a big functional distinction between preventing volatility in the money markets with purchases of short-term government debt and propping up the values of leveraged assets like stocks or houses with purchases of long-term government debt.

This highlights one of the big challenges for the Fed going into the new year. As confidence in the Fed to control inflation continues to wane, anything other than a “bright line” between easing and not easing will fail to change the public’s perception. At some point, the Fed will need to make a stand or risk losing a lot of its credibility in one fell swoop.

Relatedly, the Fed has inadvertently painted itself in a corner with its “communication strategy”. While it goes to great lengths in every FOMC (Federal Open Market Committee) meeting to convey that everything it does is in service to the American people, what results from its actions rarely actually does make things better for the American people. Instead it always seems to be a case of “heads I win, tails you lose” for owners of financial assets. On that note …

Monetary policy II

Adam Josephson ($) also recently posted on the Fed’s RMPs and what it means for investors. He is unequivocal in his assessment:

Cutting interest rates by ~6.5% and expanding its already-large balance sheet (equal to 22% of nominal GDP as of 2Q25, compared to just 6% in late 2007) by buying T-bills will be most beneficial to the Treasury Department and the financial sector, which has been a consistent theme post-Great Financial Crisis (GFC).

To put into perspective what’s happening partly thanks to the Fed, banks’ repo lending is growing at ~25%; bank-affiliated primary dealers’ repo lending is growing at ~20% (and at a record high); margin debt provided by broker-dealers is growing at ~40% (and at a record high); and hedge funds’ borrowing is growing at ~30% (and at a record high). At the same time, GDP is growing at just 2%, which highlights how little this record-high financial leverage is doing for the real economy.

In short, the Fed’s actions are reducing the cost and uncertainty of financing in the repo market, “thereby incentivizing more speculation on the part of hedge funds while making banks’ and broker-dealers’ financing of that speculation an even more compelling proposition”. This comes at the expense of credit availability for the real economy.

This paradox is likely to take center stage next year. On one hand, Trump campaigned on making things better for working people (i.e., labor). On the other hand, almost everything the Trump administration actually does favors owners of financial assets (i.e., capital).

While the Trump administration would probably like to have it both ways, it can’t. If it sticks with capital over labor, it will almost certainly suffer even greater political pushback. If it pivots and favors labor over capital, it will almost certainly lose financial support. What will it decide to do? Or will events make the decision for it?

Geopolitics

Tucked away in a little corner of the FT ($) last week was the sobering report that “Lithuania has declared a state of emergency after hundreds of smuggler balloons from neighbouring Belarus forced the repeated closure of its airports in recent weeks and threatened national security.” The report went on to explain, “The balloons are the latest hybrid attacks,” and that “Vilnius airport has been closed for 60 hours in recent weeks, affecting more than 350 flights and 50,000 passengers.”

Now, it may be easy to gloss over what happens in Lithuania as not exactly earth-shattering, but then again, that innocuousness makes it the perfect place for Russia to probe the boundaries of NATO. Especially in the context of a wide array of other hybrid attacks, this should be taken seriously.

Such threats are all the more troubling now that role of the US as provider of European security is in question. Indeed, things are far worse than that.

As Gzero reports:

In an unprecedented move last week, Denmark labeled its ally the United States as a potential security risk. A report by the Danish Defense Intelligence Service argued Washington is using its economic and military power to “assert its will,” creating new security risks for Europe and for Greenland, Denmark’s semi-autonomous territory.

Not only has US under the Trump administration taken a less friendly stance towards Europe, it has become hostile to the point of threatening aggression in the case of Greenland. No country receiving such threats can take them lightly. This is all the more troubling and disruptive given the foundational role of the US in NATO.

While these are just two data points, they are two more added to a rapidly growing collection of geopolitical frictions. It’s fair to expect more of the same next year.

Investment landscape I

At the beginning of the year, I suggested bond volatility could rise due to rising needs for debt issuance, too-high inflation, geopolitical tensions, and a host of other factors. Bond volatility did shoot through the roof with the announcement of "Liberation Day” tariffs in April, but since then has been on a slow and steady downward trajectory. In regard to the the recent lull, the Economist ($) noted, “it is odd just how orderly interest rates on long-duration bonds have been”.

Given that oddity, the magazine offered a possible explanation: “the Treasury has become a big buyer of its own bonds”.

Under Janet Yellen, the Treasury began to consider a “buy-back” programme, whereby it would regularly offer to acquire older, illiquid issues of its debt, the kind that can be difficult to offload at reasonable prices in a panic.

The Treasury launched such a scheme last year. Scott Bessent, the current treasury secretary, has since drastically expanded it. On his watch the Treasury has bought almost $180bn-worth of bonds so far this year, up from $84bn last year. In general, it has been retiring long-dated debt—20-year or 30-year issuance—and replacing it with shorter-dated bills.

In other words, the Treasury repurchase program was initially intended to smooth out some technical liquidity issues. However, that program became repurposed and turbocharged. Now it is being used proactively to artificially suppress interest rate volatility.

This has three important implications. First, interest rate volatility is now just one more domain whereby public policy is forcefully imposing its presence so as to manipulate “data” to look appealing. Whether it is high stock prices to indicate economic success, low oil prices to indicate low inflation or low interest rate volatility to indicate financial stability, the overall effort is the same: Focus more on creating a perception than on fixing underlying conditions. Regardless, the increasing tolerance for such policy intervention in the US given its free-market history is remarkable.

Second, the actions to subdue interest rate volatility are coming almost exclusively from the Treasury, not the Fed. This marks a significant transition from the GFC when the Fed was “the only game in town”. Now, as the Economist notes, investors are learning a new lesson, “Don’t fight the Treasury [i.e., not just the Fed], either.”

Finally, like so many “market-based” indicators of the past, once public policy started targeting them, their information content faded considerably. In short, they provide bad signals. The key here, though, is to appreciate the transient nature of signal distortion. Public policy can distort market signals for some period of time, but cannot do so indefinitely. The duration of such distortion is a function of resources and determination. The risk is that when one or both of those drivers fails, the signal can change rapidly.

Investment landscape II

As is often the case with anything that undergoes too much scrutiny, one can get lost in the weeds. In the case of monetary policy, Matt Klein ($) takes a step back and provides some healthy perspective:

Federal Reserve officials are more optimistic about the growth outlook, less worried about unemployment, and just as worried about inflation as they were six months ago. Yet the median official now expects that short term interest rates “under appropriate monetary policy” will be lower than what was expected in June through at least 2027.

The more plausible explanation is that a small but growing cadre of Fed officials have been reinforcing the pressure from administration officials for larger and faster reductions in interest rates.

At very least, Klein highlights what by all rights appears to be logical inconsistency in the Fed’s forecasts. As he rightly points out, however, there is another explanation: Politics. As the political composition of the Fed has changed, so too has its assessment of the landscape. Hmmmm.

For those who remember or have studied the devastating inflation of the 1970s, this will ring bells. Arthur Burns, who was saddled with the ignominious legacy lamented afterwards of the surprising and powerful effect of politics on the setting of monetary policy.

Interestingly, Ken Griffin, who almost certainly has more than a passing knowledge of monetary policy and its history, recently warned, “The most important move the president and the incoming Fed chairman can make . . . is to create distance between the White House and the Fed,” as reported by the FT ($) in regard to Kevin Hassett’s prospects as Fed chair.

This is one of the wealthiest and most important people in all of finance telling the White House, for all the world to hear, to back off on the idea of a purely political appointee. It will be very interesting to see if some powerful people like Griffin have the ability to impose constraints on the Trump White House.

Implications

One of the characteristics of the investment landscape since the GFC has been the dominance of public policy. For years after the GFC, the Fed kept rates anchored around zero in order to push investors further out on the risk curve. After Covid, stimulative fiscal policy ensured that the economic machinery kept running.

To a large extent, the losers in each of those regimes, were active managers. With policy set to give nearly every investor a participation prize, there was little opportunity for stock pickers and other active managers to stand out. Nor was there much opportunity for inexperienced and intemperate investors to lose tons of money. Over the years, many of the pro investors closed down their operations and/or converted to family offices.

That may be changing. As Marc Rubenstein points out (in the free version of his note):

The thing about markets is that nothing is permanent and, recently, the opportunity to extract returns from within the financial sector has re-emerged. Whisper it quietly but away from the distortion of the Magnificent Seven, banks have been outperforming even technology. In Europe, bank stocks are up almost 60% this year, versus tech which is up only 3%. In the US, banks are up 29% against the Nasdaq up 20%. Indeed, the best performing megacap stock in the S&P 500 this year is a financial. And – meat and drink to hedge funds – the worst performing stock? Also a financial.

While it is still true that policy dictates a great deal of market action, it is becoming less true that policy dictates investment outcomes. Increasingly, the resilience of a business model (or conversely one’s fragility) and the ability to navigate uncertainty, are re-emerging as distinguishing attributes in the investment landscape. This kind of differentiated performance opportunity marks a significant change in the investment landscape and therefore also presents a significant risk to investors who have been contented to just follow along with index funds.

Note

Sources marked with ($) are restricted by a paywall or in some other way. Sources not marked are not restricted and therefore widely accessible.

Disclosures

This commentary is designed to provide information which may be useful to investors in general and should not be taken as investment advice. It has been prepared without regard to any individual’s or organization's particular financial circumstances. As a result, any action you may take as a result of information contained on this commentary is ultimately your own responsibility. Areté will not accept liability for any loss or damage, including without limitation to any loss of profit, which may arise directly or indirectly from use of or reliance on such information. 

Some statements may be forward-looking. Forward-looking statements and other views expressed herein are as of the date such information was originally posted. Actual future results or occurrences may differ significantly from those anticipated in any forward-looking statements, and there is no guarantee that any predictions will come to pass. The views expressed herein are subject to change at any time, due to numerous market and other factors. Areté disclaims any obligation to update publicly or revise any forward-looking statements or views expressed herein.

This information is neither an offer to sell nor a solicitation of any offer to buy any securities. Past performance is not a guarantee of future results. Areté is not responsible for any third-party content that may be accessed through this commentary.

This material may not be reproduced in whole or in part without the express written permission of Areté Asset Management.

As always, if you want to follow up on anything in more detail, just let me know at drobertson@areteam.com.

Market observations

With gold’s glistening performance this year, a popular narrative has formed that the price has risen too far too fast. John Authers ($) added some useful insight to the discussion. As his graph shows, gold is merely acting as a proxy for government interest expense — and all the consequences that come with it. By this telling, gold is just saying the market doesn’t expect the government to get control of its interest costs any time soon. That doesn’t sound so extreme.

Miscellaneous observations

Record Numbers of Younger Women Want to Leave the U.S.

https://news.gallup.com/poll/697382/record-numbers-younger-women-leave.aspx

In 2025, 40% of women aged 15 to 44 say they would move abroad permanently if they had the opportunity. The current figure is four times higher than the 10% who shared this desire in 2014, when it was generally in line with other age and gender groups.

This number jumped out at me when I read it in John Mauldin’s newsletter. I could understand 10% or maybe even 20% as being a fairly normal baseline number, but 40%? That’s extremely high. My first inclination was to check the source to see if it was credible. It was.

I have plenty of opinions about why this may be so, but I won’t bore you with those. I’ll simply say, if I were the human resources manager for the US workforce and I saw this type of flight risk, I would panic. Not only does this represent a dismal state of affairs for younger adult women in the country, but an enormous risk of losing a large chunk of the native talent pool.

Politics and public policy I

Almost Daily Grant’s (December 8, 2025) reports that bank lending standards are about to ease:

U.S. regulators are set to add a dollop of gasoline to today’s bull-market conflagration. Late last week, the Office of the Comptroller of the Currency and Federal Deposit Insurance Corp. jointly announced the rollback of post-2008 strictures on bank lending to higher-risk borrowers (i.e., private equity backed firms and fast-growing technology companies operating at a loss or negligible profitability), which typically capped such funding at six times the borrower’s annual earnings. Instead, the agencies “expect banks to manage. . . exposures consistent with general practices for safe and sound lending.”

By itself, this measure isn’t likely to have a huge impact but it does signify a broader effort by the Trump administration to reduce regulations. Efforts are also underway to reduce capital requirements, to fine-tune funding markets, and for the Fed to start increasing reserves again, among others.

The main point is investors can expect to see an ongoing rollback of regulations intended to ease financial and business conditions. Whether the relaxation of oversight will have the intended effect or not will be one of the key issues to monitor in the new year.

Monetary policy

Speaking of rollbacks, the Fed rolled back its short-term interest rate by a quarter percent as the market expected. The bigger news, in my opinion, was the decision to start buying Treasury bills at the rate of $40B per month through April of next year and then taper down to a lower rate on an ongoing basis.

This was not unexpected either as funding markets clearly started running into problems in October and November as the Fed’s balance sheet continued to decline. In addition, with heavier funding needs at the end of the year, early in the new year, and into tax season, this is a sensible decision. Monday, December 15, in particular, is expected to be demanding of liquidity as corporate tax payments are due. So this comes just in the nick of time.

The thing to watch will be the ongoing pace and level of reserve additions. With the Fed’s balance sheet at approximately the level it wants relative to the economy, it will have to grow along with the economy in order to prevent the monetary plumbing from clogging up. Whether the Fed paces its reserve growth commensurate with economic growth, or whether it uses the situation as a pretense to jack up liquidity remains to be seen.

This is not the same effort as Quantitative Easing (QE), but it’s hard to have too much faith in a Fed that has failed miserably before and is only becoming less independent.

Geopolitics

A couple of weeks ago, Jonathan V. Last at the Bulwark ($) ruminated over various geopolitical scenarios, namely how US allies are coping with an unpredictable Trump administration. While most allies have considered the consequences of various levels of US engagement, Last introduced a new one: “What if America switched sides?”

After the harsh lesson of Ukraine, Last concludes that to America’s former allies, the US is not just an “unreliable defender”, but now they must consider “that America may take the side of the aggressor”. He continues: “And if we switched sides in Europe, what is the principle that would prevent us from switching sides in China? If anything, switching sides would be easier in the Pacific.” Here’s looking at you, Japan.

This development not only increases the challenge for US allies of the past, it changes the entire calculus:

How could you possibly make plans for your long-term security that depend on a country where one of the two political parties—and something like half the citizens—will be opposed to defending you?

The obvious answer is: You can’t.

These ruminations are not idle thought. The publication this week of the National Security Strategy makes very clear the Trump administration is taking a giant leap away from the historical trajectory of foreign affairs. Most obviously, the language towards Europe is pretty hostile.

Bill Kristol’s ($) interview with Bob Kagan, a commentator on American foreign policy, puts the situation in perspective:

But it’s the permanence and reliability of the [post-1945] system that has been such a great force for peace.

We have not had to fight for any treaty ally. It is the reliability of the commitment that is the source of stability. And right now, we are absolutely anything but reliable.

Kagan makes a fair point: Having an established “system” did promote peace. That said, the “permanence and reliability” of many of the post-war institutions is just cheerier language for having become ossified and no longer fit for purpose. While the Trump administration does have grounds for seeking to redefine those institutions and relationships, its aggressive approach threatens to do so at the cost of stability.

It’s hard to imagine the leaders on the other side of this aren’t taking notice. Kagan considers:

It is clear that Putin’s building up a military that is not only about Ukraine, but also about Europe.

I wonder whether Putin in particular—but maybe also Xi—thinks this is the time to make the move before the Americans have recovered their understanding of what needs to be done.

Good question. From the other side of the table, it would be hard to not view the West in general as suffering from some combination of weakness, indecisiveness, and unpreparedness. Exactly the kinds of things predators look for.

Technology I

There are stories about artificial intelligence (AI) floating around every day and most of them are almost completely devoid of information content. That sad state of affairs made this dense interview with Paul Kedrosky (by Paul Krugman) all the more enjoyable. I’d highly recommend listening to the whole thing, but I’ll discuss two of the bigger takeaways.

First, Kedrosky illustrates what a huge issue depreciation is for data center semiconductors. Interestingly, there are two primary applications but they vary substantially in their demands. Training models are intensive but responding to requests is not:

You have to think about it in the context of the workload, what’s actually happening inside the data center, and it can loosely be split in two ways: there’s the training aspect of what goes on, so where I’m training new models or enhancements to old models using giant amounts, at least 10 to 20,000 GPUs inside of one of these data centers; and then the other chunk of the activity inside the data center is inference, which is responding to requests I might make when I write some nonsensical question to a chat AI, like Claude or whatever. So those are the things that loosely split in terms of the two things going on inside the data centers. Chips are underlying both of those. But from the standpoint of the wear and tear on the chip, those are very different activities. The analogy I often make is, let’s take training as an example, if I take training and I’m using that for a job, I’m running the chip flat out 24 hours a day, seven days a week, which requires an immense amount of cooling, incurs a lot of thermal stress (heat-stress), and then inference: I’m running it more episodically, maybe more in the day, less at night. People aren’t making as many requests at night, so the load changes fairly dramatically.

So the analogy I make is, imagine both the chips were used for 50 hours for training and 50 hours for inference. Now imagine a car in the same circumstance. I raced a car for 50 hours in two 24 hour races, or I took it every Sunday to church for an entire year, roughly 50 hours, let’s say it’s a half hour there and back. Which car would I like to own?

So, for intensive exercises like training, chips only have a useful life of two or three years. That means large, regular flows of capital to keep the training machine running. For requests, however, chip use is far more relaxed and therefore the useful lives are longer.

What this means is the front-end activity of training is capital intensive. The back-end use case of responding to requests is not. The dynamics are made to order for a massive boom-bust cycle.

Technology II

Just as the supply and demand dynamics are conducive to a boom-bust cycle, so too is the financing landscape. Kedrosky explains:

we’re in that point where there’s a financial flywheel now, where increasingly the financing of these data centers is in a place where it’s somewhat divorced from what goes on inside the data center, because we’ve created a financing template for how to finance data centers, where you have these SPV, these special purpose vehicles into which a third party contributes capital and the tech company contributes technology. And out the other side magically pops these securities that have great income and yield characteristics that are hugely attractive to investors. They look at it as almost like a synthetic security, where I understand it’s the SPV, the data center that’s producing this.

But on the other side of this is Meta and Google and they’re a prime credit. They’re a really strong credit. So they’re going to keep paying on this. I don’t really care what goes on inside the data center, because I have a lot of confidence in the counterparty in this. We know where all of this kind of thing leads when you have these financing flywheels driven by securitization and high yields and people not caring what goes on inside the actual structure itself: it leads to a lot more construction and eventually over-building.

If this doesn’t send shudders from the GFC, it should. Then, mortgage-backed securities and other agglomerations of credit were the synthetic securities that had “great income and yield characteristics”. Today it’s data center financing. Then, it was a belief that house prices would never go down. Now, it’s a belief that the big tech companies are “a really strong credit. So they’re going to keep paying on this.”

This dynamic does two things that will create future problems. One is that “there’s a perverse incentive in the system to make bad loans.” Another is that the easy financing “creates the impression of much more demand than there is.”

It’s always hard to say exactly when the gig is up, but it is good to know when that is the almost inevitable outcome. Then, one’s level participation only depends on how lucky one feels.

Investment landscape I

One of the great, if extremely understated tensions, in the investment landscape is the credibility of Scott Bessent as Treasury Secretary. As was the case in the first Trump administration, Trump has relied on having a few steady hands around to right the ship when he acts too unpredictably or aggressively. That was the case with Liberation Day tariffs in April and Bessent proved his ability to calm market nerves.

Since then, however, Bessent has become more vocal and more overtly partisan. For example, on Monday, Robert Armstrong ($) highlighted the following tweet:

This messaging stands out for a number of reasons, none of which are good. For one, it is clearly partisan with the MAGA hat. Partisanship was also clearly evident in this graph:

This raises another issue. Investors know there are a lot of factors that affect bond yields that are outside of any administration’s authority. Claiming otherwise is to strain credulity. This is not a good look for someone who markets are depending on to keep an even keel and who has already tested the market’s patience several times.

Normally these types of indiscretions would be overlooked by an investing public more interested in topics more likely to move markets. Given Bessent’s critical role in maintaining credibility for the Trump administration’s economic efforts, and his disproportionate influence in the White House, observers are paying close attention.

All of this begs the question as to what Bessent is trying to accomplish with such an apparently inane communication. Perhaps this is him acting out in response to the recent rise in long bond yields despite continued cuts in short-term rates …

Investment landscape II

John Authers ($) posted a good analysis of the paradox of falling short-term rates and rising long-term rates:

Then, they must establish whether the administration plan to re-energize the housing market with more rate cuts is even workable. The central bank controls short-term rates, but not the longer-term ones that drive the mortgage market. That has been rammed home over the past year, and particularly during the rise in bond yields over the last few months. Mortgage rates have risen since the Fed resumed cutting in September:

This is not at all usual. There’s no direct link in real time between the two, but in general the times when the Fed decides to cut will also be those of low inflation and low growth, when yields will likely fall. In recent history, it’s unprecedented for a cutting cycle as aggressive as this one has been to overlap with rising 10-year yields:

Since Bessent set out a goal last year of reasonably low long-term rates, it is understandable why he might be touchy that his objective is being threatened even with the benefit of lower short-term rates. This suggests that lower rates, which are a foundational tenet of the Trump administration’s economic plan, are not working as intended.

For investors, there is an even bigger reason to be worried. As the graph below from The Daily Shot indicates, the 10-year forward 10-year rate normally moves fairly closely with the 10-year rate. The 10-year rate dipped below the forward rate after the tech bust in 2000 and after the GFC when monetary policy kept rates and is doing so again now.

This pattern suggests that while markets do believe policy can engineer artificially suppressed rates for some time, it can’t do so forever. The current numbers suggest the 10-year yield ought to be closer to 6% than 4%. Neither Scott Bessent nor the investing public will be happy if that comes to fruition.

Investment landscape II

With long rates continuing to climb in Japan and its currency continuing to flag, it’s natural to consider the potential impact on the yen carry trade. This has been an on-again, off-again affair so it’s a good time to think through where things stand.

On one side, Bob Elliott ($) argues, “The Yen Carry Trade Is Dead”. In an important sense, the trade was a product of the times:

At the time in the mid-00s the rest of the world was booming and Japan continued its depression. As a result it had become fashionable to borrow in low yielding yen to buy damn near anything. The result was that not only were the financing costs on the yen much lower, but the yen also fell vs. most assets. It was the carry trade heyday.

However, times have changed and by the way, the yen carry trade was always an incredibly risky proposition:

But there is no yen carry trade of any size that matters these days. Every risk manager learned from the 07-08 experience that naked currency positions are an idiotic way to finance a risky asset book.

Interestingly, Alyosha ($) comes at it from a very different perspective. He recognizes that the central banks of the US and Japan are moving rates in opposite directions …

That implies a 50 bps swing in the cost of and return on the yen carry…a funding swap of unknown size but estimated to be between $5 and $20 trillion depending on the methodology one chooses to measure it. What is generally accepted is that leverage in some cases is as low as 5% or 10%. Some pundits think a 50 bps negative shift in base rates will wipe out as much as 1 or 2 years of implied carry returns. Local Japanese investors hold over $1 trillion in US Treasuries and $650 billion in US equities and Bitcoin…. let that sink in.

So, which is it? I turned to ChapGPT to help reconcile the difference and it provided some useful perspective. A lot of the difference comes down to the definition of the carry trade. Elliott defines it pretty narrowly as a leveraged speculative short-yen/long carried assets position. Those trades are mostly gone — for exactly the reasons he stated.

However, that narrow focus on aggressive trading misses the impact of a broader array of activities such as “corporate funding, FX-swaps, hedging, balance-sheet financing and other uses of yen funding”. In this broader sense, there is still “an enormous pool of yen-based liability / funding outstanding (possibly ~$10–15 T of notional)”.

This massive pool matters — for exactly the reasons Alyosha stated. As rates in the US and Japan converge, the threshold for the reversal of those flows rapidly approaches. Money flowing out of the US and into Japan will matter a lot to both countries.

Implications

I am constantly amazed by the degree to which short little catchphrases seem to constitute sage economic theory — and elicit substantial political support. “Lower taxes”, “Less regulation”, and “Lower interest rates” are the kinds of blurbs that are frequently passed around as self-evident fixes for whatever ails the economy. I expect we’ll be bombarded with these next year.

While there is some element of truth in each of these, they are dangerously over-simplified. Less is not always more. There are very good reasons why we have taxes, regulation, and interest rates. Whether less is better or not depends on the starting point. The appropriate level of each depends substantially on existing conditions. In short, there is no short answer, and yet a lot of people believe there is.

As a result, while there is a fair amount of optimism built in for next year, it is also predicated on the ability of public policy, through lower taxes, less regulation and lower interest rates, to create positive market outcomes. The thing to watch for is if public policy measures fail to have the desired effect. If and when investors discover public policy is not omnipotent in delivering desirable market results, things could get pretty ugly.

On Wednesday afternoon, the Fed delivered on its rate cut and stocks went up. After the close, Oracle reported disappointing results and stocks went down. The Daily Shot captured the sequence in the graph below. Perhaps this is a premonition for the investment landscape next year?

Note

Sources marked with ($) are restricted by a paywall or in some other way. Sources not marked are not restricted and therefore widely accessible.

Disclosures

This commentary is designed to provide information which may be useful to investors in general and should not be taken as investment advice. It has been prepared without regard to any individual’s or organization's particular financial circumstances. As a result, any action you may take as a result of information contained on this commentary is ultimately your own responsibility. Areté will not accept liability for any loss or damage, including without limitation to any loss of profit, which may arise directly or indirectly from use of or reliance on such information. 

Some statements may be forward-looking. Forward-looking statements and other views expressed herein are as of the date such information was originally posted. Actual future results or occurrences may differ significantly from those anticipated in any forward-looking statements, and there is no guarantee that any predictions will come to pass. The views expressed herein are subject to change at any time, due to numerous market and other factors. Areté disclaims any obligation to update publicly or revise any forward-looking statements or views expressed herein.

This information is neither an offer to sell nor a solicitation of any offer to buy any securities. Past performance is not a guarantee of future results. Areté is not responsible for any third-party content that may be accessed through this commentary.

This material may not be reproduced in whole or in part without the express written permission of Areté Asset Management.