Opportunities in Europe as it re-organises: America is actively withdrawing

I see that changes in the world order will lead to a re-organisation of the global financial system. I want to explore how I see Europe as a new rising centre for political institutions, and how that leads to greater opportunities for financial markets and public markets investing. I also want to explain what the state of American dominance is at, why institutions matter, and what the trends are following from their current actions on the international stage. The third section will look at the secular trends and investing theses that I see arising from these broad movements. I also want to get into substantive reasoning for positioning and opportunities. 

In this report, I will briefly cover some theoretical concepts, but will not be exhaustive. I assume that the reader is one that follows current affairs reasonably well and can thus understand these frameworks. I also want to flag that while somewhat academic, the point is not to show how these theories dominate in a straightforward fashion. Rather, I aim to use these ideas and frameworks to analyse the assumptions that have long been held on global financial markets. 

The first driving force is that American actions as they are will lead to less economic dominance. But before I continue, let's lay out the assumptions that I will undermine. First, financial markets are in general dependent on the host economy and other political-economic institutions. In other words, we cannot take business to be some independent economic activity from the global order. Take how interest rates and macro movements are clearly influenced by the decision-making of central banks. These central banks, be it in India or New Zealand, are also beholden to their own internal domestic pressures. For example, with their own economic agendas, consideration for how rate changes might affect their own currencies, and their own goals be it stability or economic growth. The main point is that clearly we already accept that factors in the global financial system are not apolitical, but rather clearly political. The next thing to point out is that the economic assumptions for how markets work and global trade is organised is also taken for granted to a neoliberal tune. What does this mean? It means that many economic assumptions have been taken for granted with far-reaching impact. Take the idea that GDP is used as a measure of economic strength. But many can point out that GDP, even adjusted for purchasing power parity and on a per-capita basis, only measures what transactions there are. There are still the issues of cases where transactions occur but are not measured, where prices are not indicative of value, and where there are other strategic concerns that are not valued by the market. The main point of this is to on one hand move away from a fetishization of the market as some mechanism that values things clearly. The other point is to illustrate how markets themselves are clearly affected by other concerns, be they cultural, political, or domestic. When I say strategic, consider how ownership of a firm in a supply chain might be more valuable on account of longevity over a similarly priced firm that is downstream of said supply chain. Clearly there are differences here that will translate to different valuations, we hope. 

All of the above is building up to make a case that markets can change, and in fact do change on the basis of several institutional underpinnings. As we see with global monetary history, decisions such as moving away from the gold standard have clear and direct implications. In other cases, we can see how the status of the reserve dollar of the world moved away from the British pound to the American dollar. Now here I point out very clearly that I believe that the global order is obviously changing. Where it goes, I am unsure. But I believe that the order is clearly changing, and so that many other assumptions that come from it must change too. This is all the more important when considering our portfolios and investments. 

What then is changing? It appears that the Americans are withdrawing from the current rules-based global order. This seems undeniable, but somehow might be a pervasive sentiment. There are several psychological biases to combat right now. This might outright denial. One might believe that America can move back into the global order, but I believe this is false. Take the gutting of the state department, which incurs clear losses and opportunity cost on information gathering. Take also the capture of the supreme court which has led to a weakening of the judiciary in favour of the executive. This is a clear case of institutional capture and breakdown. To say otherwise appears, to me, to be mere denialism. The second stage of this is not just that America is facing internal decay, but actively causing damage to their position on the world stage. I find that denial might come from some historical amnesia or thought that what has happened in the past will surely follow. That seems to just take for granted what exactly led to American dominance and hegemony in the first place. American dominance has emerged in the post world war era precisely because of the willingness to underpin a rules-based world order and active participation in institutions such as the WTO and the UN. Now it seems that they have actively withdrawn from such institutions, then clearly these withdrawals are in effect. Another case is that Trump's withdrawal from cases such as the TPP and the threats of tariffs suggest a weakening of American leadership. Put simply, American leadership is seen increasingly as unattractive and adversarial. To believe otherwise is to ignore the choices that other countries and states would be incentivised to look towards. Even if America is still relatively strong on economic terms, states, such as those in ASEAN and beyond, could well be looking to other allies and sources of leadership to arrange their new security structures. Put simply, the needs would be a security guarantee as with nuclear deterrence and securing the sea lanes as America has done in the past. Perhaps new arrangements could work, as with Japan and Australia picking up more slack in Asia, and Europe coming together to contribute more in an independent manner. To do so would then lead to less direct American influence over such foundational aspects of the world order. Similarly, it leaves room for China to come over and devise a new security architecture. I won't say much on China but take these two axioms. First that no great power will allow their security to be outsourced to another state. It is undeniable that China is on track to be a great power, even if it will not completely dominate the entire world. Second, that the two states are having to grope in the dark to devise a new security architecture that may come with friction. The view here is that we don't even need to ascribe deep reasoning on part of the two states. Perhaps they are just trying to negotiate, but there will be friction inevitably as the two have their own goals. America for it does not want to willingly give up hegemony, and China for it wants to secure itself. Clearly there will be competition between the two as this restructuring occurs. 

In general I then view that America, if it continues, and even if it stops now, is in too deep a spiral of relative decline for its own domestic institutions. That leads to clear effects on the world stage. Simply put, there is too much opportunity cost and immediate penalties which are applied. A lack of faith and mistrust by allies thus leads to new arrangements being made. What are these arrangements? It is the relative growth in usage of the Yuan as a competitor to the dollar as a reserve currency. It is the re-alignment of economic trade areas between states. It is a relative weakening of American military might and access across the globe. It is also the relative re-arrangements of political institutions and strength to make guarantees. I see the latter most obviously occurring in Europe as the Russian, and to some degree Chinese, centres of power are still active. 

What does this mean? I will substantiate the European aspect here. Simply, I think the European union has already proven that there is scaffolding for political organisation to occur. It is something that can be improved upon. This means that there could be greater co-ordination, which can lead to greater military guarantees being made in the face of authoritarian states. The rules-based order might then in part be guaranteed by an European locus of power. How would military power align? It comes from their re-armament programs, which seems even more salient in the face of the Russian-Ukraine war. Political will can also follow after negotiations, and while messy, is still possible. This does not suggest that it would be easy, but the impetus for change is clear to me. So is the way out, which is to demand greater re-organisation, greater legitimacy, and greater co-operation to meet the challenges of the current day. 

Take that a pull back in American guarantees will lead to a need for a new architecture in Europe. In other words, that the bargain and arrangement in the past is fast fading. Take also that Russian aggression is clear and undeniable. Thus a need has arisen for new solutions from the European perspective. This is also clearly possible due to past arrangements. Take that integration in the EU has been steadily improving, albeit at slow paces. There is also leadership from the French state that could continue, which might be bolstered by German re-organisation. While the French are hamstrung by high debt levels, they have clear motivation and will. Similarly, Germany would need to get into greater fiscal expenditures rather than being a parasite on the spending of other states. This might occur sooner rather than later. Last, Britain also clearly sees the threat and could be moving to balance European moves by supporting EU strength as their security guarantees increasingly fade from the Americans. Technologically, there is clear strength. There is also institutional apparatus for such a change to occur. While difficult, I find this more possible than not.

In turn, this can lead to greater diversification of economic ties from third-party states, such as those in Africa, South America, and South-East Asia. Such ties would lead to a new locus of gravity towards Europe as security ties and economic arrangements are made. 

What does this mean for investments among public markets? 

I think that we can follow an intuition where good investments come from capital flows. Capital flows are then influenced by institutional structure and the attractiveness of a place economically. Economic attractiveness is ultimately affected by said institutional strength as well. 

First, I think there are many more opportunities in Europe as it re-arms and organises itself. Maybe not just in defence, but among the whole gamut of sectors and firms. Most notably, more technology firms and other consumer firms could be open. I also somewhat look to Japan in a more selective manner on the same grounds. The point being that the Japanese are also ready to take a more active role, ever since the agenda from Shinzo Abe has been developed, in the face of China. Key in Japan would be infrastructure, financial, and consumer cyclical sectors. Key in Europe would be defence and technology sectors.

Second, I also think that there are opportunities amid South East Asia, and to some extent South America, as governance is cleaned up. This means firms which are selectively tied to dominant interests. It also means firms in what few sectors we can trust to be more institutionally secure. While more selective, there are opportunities that could be undervalued here. Think again of technology firms, and consumer-oriented or manufacturing firms. 

Third, that we can still follow markets for American-led technology dominance, but only in a pragmatic sense. This follows from the idea that American firms still dominate, and likely will for a fair amount of time. We could try to short some aspects but that demands much more effort to time and investigate. Meanwhile, I would not want to bet against markets on solvency and irrationality grounds. Thus, we can look for reasons to pare down an American stake in the coming years, all the while opportunistically looking at taking advantage of capital flows so long as they continue. This is especially true for the existing technology wave into AI. What might lead to a pullback? I am unsure as of now, but would be working to develop ideas on what possible catalysts there might be. Perhaps the clearest would be a rate-hike which leads to unsustainable capex and subsequent drawdowns on the cash allocated towards such technology firms. This would also be more obvious if there are no clear monetisation or revenue pathways when that occurs. As of now, I do view that AI development is not clearly going to develop in clear ways, neither would licensing agreements develop in obvious ways. In other words, that automation is not clearly skill-complementary, and even if so it is not doing so in a well-considered manner. What seems more likely is AI used in a very narrow and siloed manner, but that requires percolation of its use just as digital technology took a while to percolate into other industries. Take how digital efforts lagged the introduction of the technology bubble in the 2000s. Outside of many major firms, there was economic growth and returns harnessed by ordinary real-economy firms over a long period of time. In that sense, there is no clear return except for in general broad-based ways. The winners would be select technology firms that captured specific narrow slices of the pie of personal computing. In this analogy, it suggests that continued holdings in specific technology leaders, as with Microsoft and Google. I would explore coupling this with holdings in select adjacent technology firms that follow from crony-capitalist or hyper-narrow narratives, as AMD and Palantir have shown.