The Shaking of the Foundations

THIS IS NOT INVESTMENT ADVICE. INVESTING IS RISKY AND OFTEN PAINFUL. DO YOUR OWN RESEARCH.

This week, I observed three powerful forces interacting:

1. Regime change

2. Artificial intelligence

3. Unsustainable debt

Each is disruptive on its own. Together, they form a cocktail strong enough to give investors a headache. A well-constructed portfolio should account for all three.

Regime Change

Markets initially tanked on Friday after the White House tweeted about imposing massive tariffs on Europe—punishment for Europe’s refusal to comply with U.S. demands. That new Audi or bottle of Champagne you were eyeing just got 50% more expensive.

But the specifics matter less than the broader pattern: erratic, bullying, maximalist policies that are reversed only after their negative consequences become evident. The White House doesn’t appear to know its limits, so it tests them.

We’ve seen this before: Gaza was supposed to become a Riviera, peace in Ukraine would take 24 hours, tariff-induced currency strength would tame inflation, the Fed’s independence was to be overridden, China would foot the bill. Wall Street has coined a term: TACO—Trump Always Chickens Out. Policies often don’t stick, but the erratic approach leaves its mark, particularly on Sovereign Wealth Funds and Pension Funds, which invest hundreds of billions in U.S. assets.

This kind of policymaking repels that capital—generally bearish for U.S. assets, though the effect will vary depending on the asset class.

Artificial Intelligence

You’ve heard the bearish case on stocks: valuations are high, fiscal policy is erratic (see above), foreigners are cautious, and bond yields are rising. These are all valid concerns. The stock market fell by nearly 20% in April before bouncing back to flat on the year. Why? Maybe AI.

Earnings in Q1 were much stronger than expected. Forecasts for the rest of the year remain weak—but those forecasts may be wrong. AI is starting to reshape the corporate landscape more quickly than many expected.

Yes, the Magnificent 7 companies are seeing big AI-driven gains. But beyond them, every large company with an IT budget is beginning to cut costs by replacing people with AI. The Mag 7 are already replacing up to 30% of their programmers. This will likely lead to higher unemployment among software engineers and product managers.

Fortune 500 companies spend 5–20% of revenue on IT. Replacing even part of that with AI yields significant margin expansion. Some investors are rotating into foreign stocks, betting that the U.S. is overvalued. But that may be the wrong bet. The U.S. has more flexible labor arrangements and may adapt to AI more quickly than others. Could we see a weaker dollar and a rising NASDAQ? Possibly. Maybe tech surges while everything else struggles.

The Debt Knot

Bonds matter—a lot. But aside from bond traders, most people hate discussing them. Government bonds are just loans from investors to cover deficits—what governments spend beyond what they collect in taxes.

Right now, many countries are running dangerously large deficits. In the U.S., the House just passed a budget with a projected 6% deficit this year, on track to grow to 7–8% in coming years. The U.S. is not alone: the UK, Italy, France, Brazil, Japan, and others are all running unsustainable fiscal paths.

In the U.S., the debt explosion was initially justified—Covid froze the economy, and stimulus prevented a depression. (It also turns out the mRNA vaccines worked much better than expected, so perhaps not all that spending was necessary.) Covid is long over. The debt is not. And the only way to deal with it is to spend less and raise taxes—or inflate it away.

Instead, the White House is maintaining elevated spending levels, arguing that growth will fix the deficit. That idea has been tried before in many countries. It never works.

Here, too, the TACO template applies. These policies will persist until they trigger a crisis. That crisis will likely come in the form of higher yields. So far, the economy has held up—even with yields at multi-decade highs. Yes, the housing market is hurting. But U.S. growth isn’t primarily driven by private-sector borrowing anymore.

If growth continues, it will surprise many—and the Fed may not cut rates at all. Foreign investors may begin to avoid U.S. bonds, which could push 10-year Treasury yields well above 5%. The stock market may not react immediately. Right now, expectations are already low. The real risk to stocks comes when investors start to feel optimistic again.

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