2026 is going to be a year that is analyzed for decades as people try to understand all the factors that seemed to converge in a short time. I’ve been covering many of these factors for years in this missive and in the 2nd Derivative section of our website. https://geovestadvisors.com/the-second-derivative/
The conditions are in place for weakness in the stock market but I don’t expect weakness. Instead, I expect a rotation into US domestic re-industrialization stocks and the beneficiaries of de-regulation. The only real question is when will the market conclude AI is a bust?
Markets
I’m not alone in expecting an impactful year; many people are calling for a market crash or a decline in the value of the US dollar, among other market possibilities. I don’t expect a stock market decline to happen in the near term although we’re always vigilant. Instead, I expect more of the same back and forth between risky assets and defensive assets that we’ve experienced for years.
Rising stocks represent global industrial policy around the world – rising equity values to maintain confidence and consumption. China’s economy is disintegrating even as Chinese stocks march higher. It’s the same with Western Europe.
We have two primary indicators to tell us when the current Bull market is over – copper and the US dollar. When copper declines and the dollar spikes, it will mean that the powers that control the markets have lost that control. Copper is currently spiking higher while the US dollar remains in a stable trading range. Here’s a chart of copper.
The price of copper is elevated because investors expect that the need to increase electricity generation to power artificial intelligence will result in a dramatic expansion of our national electric grid. The problem with this investment thesis is that AI hasn’t yet proven its worth – more on that later.
For now, we expect equity markets to continue higher despite troubling evidence of financial problems bubbling to the surface.
US Economy
Charles Dickens wrote: “It was the best of times; it was the worst of times.” He was referring to the differences between London and Paris during the French Revolution but the quote could easily apply to the middle class in the US.
Some clever analyst came up with the description of “K” economy where the top and bottom of the K do well while the middle (middle class) continues to get squeezed. It’s been a good description for the past 16 years.
The mid-term election is set for November 3rd, and both sides are fighting for the direction of our country – and the world. No expense will be spared to secure victory – by both sides. One side wants a strong economy while the other wants a weak economy to stoke voter anger. The Federal Reserve claims non-partisanship but it’s a façade; they are deep in the fight.
US interest rate policy is killing the housing market where we can already see signs of stress in formerly hot markets such as Florida. Expect this stress to continue because the Fed is going to slow-walk rate cuts for as long as possible, even though the rest of the world is rapidly cutting rates.
On the flip side, the White House announced a $1.5 trillion defense budget, ostensibly to outspend and bankrupt China, much like Reagan did to the Soviets in the 1980’s. This spending, along with continued spending on AI should help maintain GDP expansion through the year. Our large position of defense stocks is benefitting from this decision.
The problem is that defense spending has only a modest impact on the middle-class while high interest rates have a big impact on home values, which represent the bulk of middle-class wealth. All things considered, AI has a negative impact on middle-class electricity bills and employment.
The first wildcard is de-regulation which is rapidly reducing onerous costs on small-business. The second wildcard is rising healthcare costs predominantly from the Affordable Care Act. The White House has promised to reduce payouts to healthcare insurance companies and pharmaceutical companies. The market has noticed.
I don’t expect an official recession in 2026 but I do expect a binary expansion where some industries do well while others, like healthcare insurance and housing, do poorly. Household stress will continue to grow.
We have already entered a negative credit cycle. Historically, private credit securities were purchased by insurance companies, large pension funds and wealthy individuals with the means to study the financials of small companies and organizations. Today, financial analysts have been replaced by algorhythms that provide cursory analysis and rely on understanding the portfolio effect of including each security and not whether the borrower has the capacity to pay.
The bankruptcy filing of First Brands, an automotive supply company, represents the start of a jailbreak. Many of these companies re-financed their debt at ultra-low rates in 2021 and are now facing maturities and much higher rates in 2026. JP Morgan’s earnings miss on higher credit costs suggests things are getting worse.
Geopolitics
The profound change I alluded to at the beginning of this missive are in the geopolitical landscape of the planet. Before the end of 2026, I expect major economic declines in China, France, Germany, and the UK – and perhaps political change. All four nations are on the verge of becoming irrelevant.
I have documented the problems in China as well as any western analyst over the past 20 years. Much of what I anticipated has come to pass but the worst is still in front of us.
Western Europe is suffering from decades of moral and economic decay that has left them devoid of an economy’s most important asset – people. Collectively, the EU treated people as commodities, thinking they could simply import foreigners with different values and culture and continue as before. Assimilation has been a disaster and now all three have rising budget deficits, excess debt, high-cost energy, and poor economic prospects.
Germany, France, and Britain have all resisted a peace deal in Ukraine for a simple reason, they desperately need a distraction from their political mistakes. All three need Russia’s abundant natural resources to help reverse industrial decline; all three have VERY unpopular political leadership.
Russia doesn’t pose a threat to any of them because the war in Ukraine has depleted much of the old Soviet military arsenal. Russia lacks the logistics, navy, and air power to project power beyond its borders. The nation is effectively bankrupt.
Militarily, China doesn’t pose the threat most assume. The PLA Navy and Air Force are both for show, not for fighting adversaries such as the US or Japan. Most of their weapons are built on old Russian technology with a smattering of stolen western weapon designs thrown in.
The US military is the most well-organized, well-trained, best supplied, and best led on the planet. Actions over the past couple of years have proven that US weapons can get past the very best electronic defenses of both Russia and China with little difficulty.
The only real threat is thermonuclear war if our adversaries are pushed too far.
Artificial Intelligence
We continue to spend vast amounts of money on AI and still don’t have a true purpose that will allow companies to earn back the hundreds of billions of dollars already spent. It’s an example of “build it and they will come” popularized in the move “Field of Dreams.” Somewhere between 1% and 26% of firms who have implemented AI at scale have achieved measurable success, depending on which consultant you ask. This is a disaster.
The only tangible thing to show for the investment is higher electricity rates as shown below. AI requires TONS of electricity to power those expensive and short-lived Nvidia chips. They also require TONS of short-term memory. Making these investments even more expensive is the necessity to build electricity co-generation near these data centers because there is insufficient electric generating capacity to fuel AI. It’s a capital investment nightmare. I refer to AI as “arrogance improbable” to address both the lack of hubris by AI companies and the likelihood that these investments will prove worthless.
I’ve already written extensively about it. Here’s a link to a popular piece on our website: https://geovestadvisors.com/is-ai-a-trojan-horse/
In my opinion, AI will ultimately prove to be the hill that companies such as Microsoft, Amazon, Meta, and Google die on because investing in AI has transformed their business models from being highly profitable cash flow machines to capital-intensive and increasingly low margin businesses that can no longer buyback shares. Their expensive AI models have already been commoditized and the industry is already EXTREMELY competitive.
In addition, Nvidia and its competitors are bumping up against the limits of silicon chips. According to theoretical physicist Michio Kaku, the co-founder of String Theory, the circuits on silicon chips are so close together that they will soon experience “short circuits” when electrons start jumping from one circuit to another. Semiconductor chips are microscopic electric circuits imprinted on silicon wafers. Currently, these circuits are not much bigger than the size of an atom. Moore’s Law has crossed the finish line.
I don’t know when investors will embrace reality with AI; tech stocks may continue to rally because it is politically expedient. The people who invested in data center debt are already losing money and it’s going to get worse, not better. I am confident that the AI boom will turn to bust and when it does, it’s going to destroy a huge amount of national wealth.
The GeoVest Approach
We’re cautiously optimistic about 2026 but with our eyes open. The global economic expansion cycle is over and it’s not going to return. The problems in China are so deep and so pervasive that it’s unfixable. The only remaining question is whether the CCP will try to embroil the world in war before they fail. I don’t believe they can.
Western Europe is headed for a deep economic downturn and I don’t expect the European Union to survive as a political entity. They won’t be able to compete with the US and the emerging powers in Eastern Europe.
The US is on the cusp of becoming the sole superpower in the world. If we can stay out of European and Asian wars, our future looks exceedingly bright. But we are going to experience economic difficulty thanks to wayward AI investments and the need to re-industrialize. The Federal Reserve is going to cause a shock in financial assets; interest rates are too high and credit quality is too low. Our portfolios favor the highest quality assets we can find.
Paul Hurley continues to expand our presence on Linked-In where he is posting updates regularly. I’ve been adding to our analyses on our website www.geovestadvisors.com under the 2nd Derivative section of Insights. I post at least two insightful pieces a month. These represent a deeper dive than what I can cram into this newsletter. You’ll see that we are viewing the present climate opportunistically and without trepidation.
In the short run, gifted linguists can spin narratives that excite the imaginations of investors but ultimately, cash flow determines the value of stocks, bonds, and real estate. Our economy is built on private debt growth and that growth is about to turn negative as investors fear losses.
We are bullish on the US. The country is in a transition phase and transitions always include ugly rhetoric and noise. We remain focused on our nation’s innate competitive advantages and the fact that we are the most successful nation in existence at assimilating people from all over the world that want to be better. Thank you and it is our continued pleasure to serve you.
Philip M. Byrne, CFA
