Winter is coming

It’s Labour Day weekend in North America, which marks the end of summer and the beginning of the fall season. In Vancouver it is suddenly much cooler and we had the first rain in many weeks, which was somehow fitting. It also led me to reflect a bit on the sad state of the world and the direction that financial markets are headed.

The Fourth Turning

I am a believer in the Fourth Turning theory, that basically predicts that the world is heading into a major crisis over the next decade or so. This theory focuses specifically on the US, but because the world is so interconnected its impact will be felt everywhere. Everything seems to be coming together now, a perfect storm is brewing that I believe will lead to civil war in the US and potentially to a global war. In this article I will focus on why I believe things are moving in the wrong direction and on the worst possible outcome. However, I will also discuss how you can best prepare in case things really go wrong.

A Perfect Storm

What does this perfect storm consist of? It’s a number of things that all come together at the current moment. Polarization is worse than ever, the left and right in the US simply have no common ground left anymore. At the same time the world is divided over Ukraine, with most of the Western world condemning Putin, but with a large part of Asia continuing to do business with Russia. This will lead to huge energy problems in specifically Europe over the next couple of months, but this will also affect North America. Next to that the worldwide food supply is endangered if not enough grain can be shipped from Ukraine to Africa and the Middle East.

On top of that the world’s Central Banks pretend to be in control, but in reality they have lost control years ago by printing unlimited money. Suddenly double-digit inflation also appeared in the Western world. It will only make the growing divide between the rich and the poor even bigger. Trust in governments and institutions is at an all time low, in the US only 20% of the population still believes the government can be trusted to do the right thing. Finally the climate crisis is going from bad to worse in many parts of the world, leading to potentially widespread famine and hundreds of millions of refugees during this decade. How this will end nobody knows, but I am much more worried about the next couple of years than I was earlier this year.

How to prepare yourself?

The question is what you can do to prepare yourself for the fall out of all these problems. The book The Fourth Turning gives some good advice on this. The book advises for example to forge strong bonds in your community, be in good shape and to make sure you have a good reputation. But you also need to be financially prepared.

Assuming you still have a nest egg, where should you invest it? Honestly, there is no easy answer to this. I think diversification is key, but what should you diversify in? A few months ago I thought the stock market had seen its lowest point, but I am not so sure anymore. I believe the recession will be much worse than we are led to believe. Soon we will see widespread labour unrest because people can’t live a normal life anymore, so they simply need to get higher wages. Companies that already have much higher costs for raw materials can’t pay those wages, so profits will fall sharply and businesses may simply not survive. And that doesn’t even take higher energy prices into account.

At the same time the FED keeps on increasing interest rates, which will lead to even more problems for companies because it makes it more expensive to borrow. But it also leads to issues for governments because they will have to refinance their huge debts at higher rates. The question is how long that game can last. 

My point is that based on all of this the valuation of many companies might still be way too high. If people start to realize how big a recession could be and how it will affect every single company, don’t be surprised if stock markets can go down at least 50% from here, which would put the Dow Jones roughly at its value a decade ago. And if the world really starts to fall apart it could even go down a lot more than that.

The last Fourth Turning started in 1929…

Going back to the Fourth Turning theory, the last time a Fourth Turning started was in the fall of 1929. At that point we had seen a decade of huge growth in stock prices, not dissimilar from what we have seen in stock markets since 2009 (in the 1920s the Dow Jones index went up about 8 times, since 2009 it went up about 6 times). After Black Monday the Dow Jones kept on falling for 3(!) years, eventually ending down 89%. It took 25 years for the Dow Jones to get back to its 1929 levels. Although most people can’t imagine it, history tends to repeat itself. That doesn’t mean we’ll see such a large drop in company valuations, but you have to keep in mind that it’s certainly a non-zero possibility. 

What to invest in?

In times of crisis it’s important to have at least some liquidity, so keep part of your assets in cash. Yes, you will lose 10% or more per year because of inflation, but at least you have cash if you need it. And it gives you the opportunity to buy back into the market at much lower prices in case it crashes. Commodities like gold and silver have generally done well in times of high inflation and crisis, but it seems that’s not happening this time around yet. If you would have bought gold in 1929 and would have held it until the market stopped falling 3 years later you would actually have made a 30% return. Not long after that the government forced investors to sell their gold to the government thought, but that’s a different story.

If you have a longer time horizon (2-3 years) Bitcoin should be a good bet, long term my very bullish predictions have not changed. However, Bitcoin is extremely volatile and it may have not seen its lowest point yet. There is still a lot of leverage left in the Bitcoin market that could get flushed out. Long term it should outperform most asset classes though, so if you hold enough cash you could consider putting some of the rest of your assets into Bitcoin. As I discussed in a recent blog post, I am also a huge believer in voluntary carbon credits, so that is something you should look into, especially because it is a hedge against climate change. 

In terms of stocks I would stay away from index funds, but invest only in specific sectors that you believe might outperform the market. Energy stocks could be one sector to look at, but it’s hard to say what will happen when governments step into the market and set prices. Anything related to climate change will likely do well, so look at renewable energy related stocks or companies active in carbon reduction. Artificial Intelligence will be a game changer whether the world falls apart or not, so that’s something that I would include in a portfolio as well. And of course crypto related stocks, not just miners or exchanges, but also crypto Wall Street firms like Galaxy Digital.

Also make sure you diversify geographically. Having only investments in North America and Europe may not be the best strategy. I think Southeast Asia will be the least affected by effects of the Fourth Turning and may even benefit from it. So investing in companies or real estate there seems like a good idea.

Conclusion

Things are not looking good at all. But hopefully I am completely wrong and the FED will start lowering interest rates again soon and continue with quantitative easing. Then the stock market might stabilize or even go up again. But if you want to be prepared it may be a good idea to keep at least part of your portfolio in other instruments. The worst that could happen is that you miss out on some upside, but at least you are well protected if things don’t go as well as most people still seem to believe. 

Disclaimer: As always, these are my personal opinions and not meant as investment advice.