Many of life’s failures are people who did not realize how close they were to success when they gave up – Thomas A. Edison
We’re starting to see outright panic in the global economy. For the past 15 years, wherever the underlying economy started to fracture, we would get rallies that signaled the opposite of economic trends. For this reason, I stopped using equity market returns as leading indicators.
The S&P500 has given up a little ground but the rallies in Europe and China have more than made up for this setback. Both regions are on the verge of deep decline – China is already there – but a well-timed short-squeeze acts as a shot of adrenaline on a faltering pulse.
Beyond equity markets, a rally in copper tells us the global economy is still in expansion mode. The drop in the value of the dollar adds credibility to the idea that the economies of Western Europe and China are actually viable. Bravo! Well played! Only now the world needs a miracle to reverse negative economic trends as the US focus turns increasingly inward.
Europe
I want to stand as close to the edge as I can without going over. Out on the edge you see all the kinds of things you can’t see from the center – Kurt Vonnegut
Germany is suffering from deflation and an absence of growth. GDP has gone nowhere in five years; the population is aging and their industries are uncompetitive. Friedrich Merz, the incoming Chancellor, has agreed to deny the will of the electorate and has pushed a €500 billion spending plan through the old parliament to invest in infrastructure and defense. It’s desperation similar to Mario Draghi’s “whatever it takes” message in 2012.
Germany is going to re-militarize very rapidly ostensibly in response to questions about the US’s commitment to NATO. €100 billion will go to climate initiatives to secure the backing of the Greens. The rest is going to civilian infrastructure. The critical point is that the vote removed the “debt brake” in the German Constitution which allows for potentially unlimited spending if needed in the future.
We can see from the chart below that the German government is afraid of deflation as their consumer price index drifts back into negative territory following the energy spike between 2021 and 2023. I suspect they are also afraid of losing relevancy in the global economy unless they reverse this economic malaise.
If nothing else, the credit expansion should help reverse this slow, seemingly inexorable slide in their economy, but is it healthy economic growth? I view military spending as a cost center, not a profit center because it doesn’t create a multiplier effect like other types of investment.
Furthermore, will this spending package be enough to counter the negative effects of US tariffs and the loss of market share for automobiles in China? Is Germany at risk technologically because their dearth of electricity generation limits their ability to harness the potential of artificial intelligence? AI requires vast amounts of stable electric supply, something that green energy can’t provide.
Ultimately, I see this spending package as a desperation move at the 11th hour.
China
Fraud really thrives in moments of great social change and transition. We’re in the midst of a technological revolution. That gives con artists huge opportunities. People lose their frame of reference for what can and cannot be real – Maria Konnikova
China represents fraud at the most extreme level. The CCP has expunged Confucian virtues from society over the past 80 years and the result is that you can’t trust anything that comes from the Middle Kingdom. This most recent rally in Chinese equities is just such a fraud.
If we use BYD as an example, the company looks reasonably priced and modestly attractive if BYD can export its inexpensive electric vehicles around the world. But a report out of Hong Kong explains how BYD is getting nearly 90% of its financing from its supply chain by extending payment terms out to an average of 275 days versus 38 days on their accounts receivable.
Even more amazing, they’re able to command this channel power in a highly fragmented Chinese EV market where suppliers have alternative vendor options. I suspect the CCP is directing suppliers to offer such sweet terms. For comparison, Tesla Shanghai settles accounts within 90 days.
BYD has over 8,000 suppliers which means they are forcing an enormous amount of hardship through their supply chain. Any weakness in the Chinese market or failure to succeed in exporting their cars abroad and this company is headed for a crash along with its supply chain.
And speaking of falling apart, BYD announced that they will be rolling out their technology to recharge batteries in as little as five minutes. Wow! If you’re going to lie, make it subtle, not a whopper that destroys all remaining credibility.
Anyone with an elementary understanding of electricity and physics knows that global electric grids are unable to supply such charging speeds without major upgrades. Not only will they need a giant fire hose to run the electric cable, they need extensive cooling systems in the hose, at the contact point, and most importantly, in the car’s battery. Otherwise, the car’s battery will simply overheat and explode. BYD’s batteries are relatively inexpensive with minimal cooling channels.
The stock reacted positively to the announcement and while it’s not technically fraud because under the right circumstances, such a charging system is conceivable, it’s neither practical nor attainable with BYD’s current fleet of cars and existing battery capacity. The fact that they made this announcement tells us that they have no regard for equity investors.
Unfortunately, this little vignette about BYD can be applied to everything controlled by the CCP. They have built the Chinese economy on deceit to their own people and to their trading partners. I don’t know how long this rally will continue but I know how it’s going to end…
Unless…
A sudden bold and unexpected question doth many times surprise a man and lay him open – Francis Bacon
There is growing evidence that Xi Jinping has been effectively deposed and replaced with a group of retired CCP leaders, possibly including Hu Jintao and Wei Jiabao, both of whom were pro-market leaders. If true, it could take some of the pressure off Taiwan and make China more attractive to its trade partners.
Consistent with news out of China, nothing is clear but we know that Xi’s trusted lieutenants in the People’s Liberation Army have all been replaced or are under investigation. This includes the 3rd most powerful man in the PLA, He Weidong, Vice Chair of the Central Military Commission.
We also know that CK Hutchison Holdings, headquartered in Hong Kong, sold its Panama Port holdings along with other global port holdings to a consortium led by Blackrock without Xi’s approval. These ports are critical to Xi Jinping’s Belt & Road Initiative, which has been Xi’s signature geopolitical plan.
The rumors of Xi’s internal struggles have been around since August of 2024 but this transaction represents a huge validation of the rumors. Many believe the number 2 general in the PLA and Vice Chair of the CMC, Zhang Youxia, now controls the military. Without the military, Xi is merely the titular head of the CCP.
This is significant because if reformist leaders are back in charge, it could relieve some of the geopolitical risks posed by China. The sale by CK Hutchison could be a signal that China wants to realign with the West.
If true, it would still be too little, too late. China has broken every law of finance, economics, and accounting over the past three decades such that a deflationary decline is unavoidable.
Copper
Whoever is out of patience is out of possession of their soul – Francis Bacon
Copper is the commodity with a degree in economics. As an indicator, it has proven itself for a hundred years because any expansion of an industrial or technological economy requires copper inputs.
But the point I have been making for years is that a deflationary downturn in the markets is only possible once the interventionist policies of global central banks and governments have been broken. We’ll know it’s broken when they lose control of the price of copper and the value of the US dollar. For a refresher, I expect the price of copper to collapse and the price of the US dollar to spike when it’s time to escape the equity markets. Neither condition has been met.
Copper is currently heading towards new highs, giving the impression that the global economy is poised for new growth. Based on what? Are Trump’s tariffs good for the global economy? Are we really going to expand the electric grid to support AI?
The price movement in copper is inconsistent with the direction of the global economy. The price movement in European and Chinese stocks are inconsistent with the underlying direction of their economies. Something is going to give in 2025.
Blame Bernays
The conscious and intelligent manipulation of the organized habits and opinions of the masses is an important element in democratic society. Those who manipulate this unseen mechanism of society constitute an invisible government which is the true ruling power of our country – Edward Bernays
Edward Bernays (1891 – 1995) is known as the “father of public relations.” The nephew of Sigmund Freud, Bernays took social influencing to a higher level, introducing elements of academic rigor to the practice of shaping public perception.
During his career, he worked for the US government during both world wars in various aspects of psychological warfare, helped politicians shape their images, and helped companies create demand for their products. In short, he popularized the use of mass psychology for defining narratives.
I blame Bernays for the inconsistent signals in the markets we’re presently seeing. If I was tasked with keeping perceptions of the global economy positive, I would organize a strong bid under the price of copper and rallies in the stock markets of the weakest economies, namely China and Europe. In the US, I would work to prevent an inverted yield curve and to make sure that equity market declines remain muted.
Is this another conspiracy theory? Perhaps but we’ve witnessed too many conspiracy theories become proven over the past 15 years ranging from the Covid origin to President Biden’s mental acuity. One thing I know is that I’ve been witnessing similar patterns for 15 years.
The law of diminishing marginal return appears to be acting on Bernays-type interventions. The November election was a clear indication that people are looking past influencers. People can be persuaded but their perceptions are formed from more than just slick messaging – people eventually see the reality of their environment.
Returning to my primary indicators, copper and the dollar, neither is flashing a warning sign with copper flashing a contrary signal to the recession thesis. I don’t expect sharp declines in the markets until copper declines and the dollar blows through 112 on the upside.
It is unlike 2008 when the Fed, financial firms and market regulators were taken by surprise. A short-seller needs to get the fundamentals correct but also needs to figure out when the authorities are about to lose control. It’s going to happen eventually but not today. The hedge funds that bet aggressively against the market in late February are presently getting clobbered by both option premiums and this bounce off the bottom.
Conclusion
Successful investing is anticipating the anticipations of others – John Maynard Keynes
Like the original quote above where Edison opines that success requires the fortitude to stay on course just a little longer than the rest, profiting from a market downturn requires similar patience. The fundamental conditions are right; we’re headed for a global recession but the global banking system represents a powerful gatekeeper that learned from 2008.
Tariffs won’t be good for either China or Europe. In addition, the US consumer continues to weaken while domestic reindustrialization will be delayed until the Federal Reserve slashes interest rates. Interest rates are presently far too high for such a structurally weak economy.
Meanwhile we’ll continue to experience periodic “short squeezes” until the shorts are gone. Like everything in life, the law of diminishing marginal return has its part to play in today’s AI dominated robot trading. Like predatory animals in nature, they’ll go extinct once their prey has been consumed. Ultimately, they’ll turn on each other like a digital form of “King Rat.”
There are still reasonably priced companies trading in the markets that will benefit from lower interest rates and which are not popular with index funds and momentum traders. These are the companies that should make money when investors begin withdrawing from index funds. If you’re interested in learning more, visit us at https://geovestadvisors.com/ and contact Paul Hurley.
Philip M. Byrne, CFA
