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Watching Threads Fray

“We have seen much, comprehended much.

States were falling, countries passed away.

Chimeras of the human mind besieged us

And made people perish or sink into slavery.”

Milosz, 1986

My mind hurts. Two wars, rapidly falling bond markets, and an overvalued stock market make me edgy. I remind myself to breathe and think carefully before taking action.

We have reached the point where monetary tightening and geopolitical risk are beginning to fray the delicate threads that hold the economy and markets together. Tech stocks have shed 9% from their highs. Bonds have lost about 5% this year, with yields rising about 100 basis points. Oil is up about 20% in recent months. Gold is soaring.

The global economy is not collapsing but it is slowing. Wars in places that have often seen bloodletting—-Ukraine and Israel—risk sparking direct confrontations between major powers. That hasn’t happened yet but it is clear Russia, China, and Iran are on one side, and the US and its allies are on the other.

A poll taken last week shows bi-partisan American support for Ukraine and Israel. President Biden asking for $106 billion of emergency funding, adds another piece to a $33 trillion debt pile that the market is struggling to digest. Higher oil prices feed into inflation and make the Fed’s job harder, delaying any adjustment in monetary policy. Fear of a wider war is likely what led to money leaving the stock market and going into the bond market Friday. 

A doom-loop scenario is not hard to imagine, but not the most likely outcome. The way it works is this. Investors fret over the US fiscal balance, driving interest rates higher at a time when a series of emergency defense spending measures are needed to help contain two wars. The Treasury needs to issue yet more debt to cover the higher debt service. Higher interest rates crush the economy and the Fed prints. More likely is that inflation falls, the Fed eases and asset markets rally, but that is not imminent.

On top of this, we are in an informational haze. It isn’t just social media. The New York Times was appropriately pilloried for regurgitating Hamas propaganda about an alleged hospital strike that turned out to be caused by Hamas itself, not Israel. If you want perspective on how damaging this can be, I recommend the film Mr. Jones, which details how New York Times reporter Walter Duranty won a Pulitzer while diminishing the brutality of Stalin’s forced starvation of Ukraine, known as the Holodomor. The reporter who ultimately revealed the truth was later murdered by Kremlin henchmen.  

Here are facts to help anchor us all. 

In terms of geopolitics, most hot conflicts remain regional and burn out. Post-Soviet Russia has been creating chaos in many countries (Ukraine, Georgia, Montenegro, US, Syria, Niger) and the global economy has more or less chugged along. Hamas has attacked Israel too many times to count, though the most recent incident was far more lethal. Yet, Israel and the West continue to prosper. Of course, the exceptions to this rule are cataclysmic, like World War 1. A Serbian fanatic assassinated the presumptive heir of a country, Austro-Hungary, that no longer exists, and before long Europe was a vast killing field.

The biggest winner of Hamas’s attack so far might be Putin. Stalin’s heir is likely delighted the US needs to go back to Congress for more money at a time of financial vulnerability. Putin is praying Trump comes back to power. Zelenskyy, on the other hand, must be very worried. That 194 Republicans voted for feckless Jim Jordan, an election denier who wants to cut off military aid to Ukraine, is one of the things that makes my head hurt. This is the party of Reagan and Lincoln?

The odds are pretty good that these conflicts recede. But war is fundamentally unpredictable. I am quite defensive now, as subscribers can see with my asset allocation.

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