WEALTH MANAGEMENT QUARTERLY – Q2-2024

“By almost any measure, the 2020 recession began with sharp declines in economic activity, employment, and equity prices that rivaled or exceeded the initial declines of the Great Depression…The 2020 contraction might turn out to be the sharpest, but also the shortest, in modern times and perhaps of all time in the United States.”

While increased government spending is common and non-inflationary during recessions, the stimulus has not slowed since the economy re-opened.  As a result, inflation has become a market pest for consumers and companies alike.  Using Federal Fiscal years, in 2022, 2023, and 2024, deficit spending has been 5.4%, 6.3%, and 5.6% against a long-term average of 3.4%.  Financial markets keep looking for a cooling in inflation, but for that to happen, either the private market economy needs to contract or public spending needs to slow.  Our projections are that inflation will become a more secular problem. Currently, the U.S. government is continuing to run deficits at levels commonly associated with recessions and war, which leads us to the second horse.

Q: What is the second horse investors should consider?

The second horse is the red horse of “War.” He takes peace from the earth and brings bloodshed.  We see the red horse most directly in the conflicts in Ukraine and Israel. On the war financing front, the U.S. just approved $95.3 billion for Ukraine, Israel, and Taiwan for long-range missiles, the Iron Dome, and underwater defenses.  To put the numbers into perspective, the U.S. defense budget in 2023 was $916 billion. The recent bill therefore represents a 10.4% increase in U.S. defense spending.  By comparison, Russia had the world’s third largest defense budget at $109 billion, so the U.S. just created the fourth largest defense budget in the world with a single bill.

There are other potential flashpoints and hot zones like Niger which are not getting much press but could be important.  Niger just ended military cooperation with the U.S. amidst a coup there.  The U.S. has had about 1,000 people stationed in the country on anti-terrorism efforts. The concerns with Niger and terrorism are that the country is responsible for about 5% of global uranium production.

Beyond traditional military spending, markets are also focused on the importance of artificial intelligence (“A.I.”) semiconductor chips.  To illustrate our changing world, Nvidia chips are now being used as collateral for multi-billion dollar loans.  Given their importance to defense, in 2023, the U.S. limited the sale of high-end chips to China but China is building out its own capacity.

Incidentally Alan Turing, who is considered the founding father of A.I., led the effort to break the Nazi’s Enigma Code during World War II.  The “Turing Test” constitutes one of the primary measures of artificial intelligence.  Given the nature of modern warfare, our readers may want to watch the movie The Imitation Game which is based on Alan Turing’s life.

Economically, war spending inflation has historically ushered in the third horse that markets must occasionally face.

Q: What is the third horse?

The third horse is a black horse of “Famine.”  Its rider holds a pair of scales for wheat and barely, basic foodstuffs of the ancient world. He calls out, “two pounds of wheat for a day’s wages, and six pounds of barely for a day’s wages, and do not damage the oil and the wine.” If we make the economic adjustments, it suggests that in times of famine the price increases for key commodities may approach 10x.

The quote from the third horseman teaches investors that commodities generally do well in war times.  As a result, I suspect this decade will bring  a bull market for commodities and commodity trading strategies. Beyond just the possibility of war related food production disruptions, there have been large farmer protests occurring in the E.U. related to certain policies there. Meanwhile, in the U.S., there is also a debate related to new rules.  For example, the USDA is spending $19 million more due to complaints related to the costs associated with the new RFID animal tagging rules which were passed in April.  The updated tagging rules follow on the heels of other new regulations related to animal health.

Beyond agriculture, modern warfare is also heavily informational.  It also involves more complex economics given supply chains structures, so I think investors can think far beyond just buying defense stocks.  For example, I think cybertechnology, biotech, semiconductors, technology, artificial intelligence, agriculture, infrastructure, and infrastructure safety are all solidly part of defense spending. War inflation also pressures interest rates higher, so big expensive wars can be very negative for long-term bond and fiat currency holders. I think war concerns are driving part of the demand for bitcoin, gold, and silver.

Unfortunately, the U.N. estimates 10% of the world’s population lives on the edge of starvation.  Higher agricultural prices would impact these 735 million people the most.  War and famine in time bring us to the fourth horseman.

Q: Who is the fourth horseman?

The fourth horse is the pale horse of “Death” and Hades was following close behind him.  They were given power over a fourth of the earth to kill by sword, famine and plague, and by  wild beasts.

Economically, we can see global defense spending increasing, so death by sword is likely to increase  We have already discussed direct human diseases like Covid, but I think the more dangerous diseases for the global population are those associated with agricultural crops. Crop failures would likely bring famine to much of the world.

Plagues, like Malaria which still kills over 600,000 people per year in Africa, generally involve unclean water and mosquitos.  Consequently, The Bill & Melinda Gates Foundation has been involved in mosquito research and funding and Malaria efforts for decades. Genetically modified mosquitos are being used in research efforts around the world, including in the U.S. in states like Florida and Texas.  Regarding death by wild beasts, I think paying attention to animal health stories like the bird flu, swine flu, and crossover risk to humans are also important stories of which investors should be aware.

Finally, as it relates to the fourth horse, much of the death late in the decade will just come from natural demographics and causes.  I believe this will result in a bubble then a crash in later life stage healthcare.  The crash then will be followed by a strong recovery and shift in focus to nutrition, preventative, and early stage healthcare by the early 2030s. Demographers like Neil Howe have documented that The Fourth Turning demographics give the country a U shaped population.  We have lots of older boomers (age 60-78) the earliest of which are now 78, relatively few Gen Xers (44-59), then we have a lot more Millennials (age 28-43) and Gen-Zers. The boomer demographic is really going to pressure Medicare and Medicaid expenses and stress government budgets for the foreseeable future. Millennials, however, are going to prefer that healthcare dollars go to toward health and wellnesses programs for younger people.

Q: Allen, any final thoughts for investors on Wealth and The Four Horsemen?

I believe I can best summarize our conversation by leaving you with a few closing thoughts directly from Barton Biggs. In 2008, he wrote the following:

“The trigger event could be a massive terrorist or nuclear attack that disrupts the economy for months and maybe for years. A power failure that lasted not a day but a month would paralyze a modern economy. Or it could be a plague, a massive SARS epidemic in which hundreds of millions die, or an electronic explosion that cascades into a complete breakdown of the world’s accounting systems.  Whatever happens, it most likely will be an event that is both unexpected and we will not have prepared for….What can you do? In the simplest terms, the conclusions are to diversify your fortune both as to asset class and location…equities (global) are the place to be in the long run because of their proven and virtually unique ability to increase purchasing power of capital, …[but] another, much smaller part of your diversification strategy should be to have a farm or ranch (or commodities) somewhere off the beaten track…Even in America and Europe there could be moments of riot and rebellion when law and order temporarily completely breaks down…I repeat that history suggests the rich almost always are too complacent, because they cherish the illusion that when things start to go bad, they will have time to extricate themselves and their wealth. It never works that way. Events move much faster than anyone expects.”

Most interestingly, Biggs closes his book with a quote from Confucius, “Study the past if you would divine the future.”

Sincerely,
Allen R. Gillespie