We’re off to a pretty good start for the year in our portfolios despite the negative returns in the broader market. Our goal is to realize as many gains as we can throughout the year as opportunity permits because the second half of the year promises to be even more volatile.
As I mentioned in our previous newsletter, 2026 is going to be a year of profound change in the US and the world; our expectations are proving accurate. We’re seeing the rapid declines in Western Europe and China that we expected as decades of financial decisions were made without consideration of economic repercussions. The US is moving from a consumption-based economy to an economy that balances domestic production with consumption.
The Greeks used the term “metanoia” to describe a reorientation or fundamental transformation of outlook. For the first 125 years of our great nation – 1776 to 1901, our economic focus was on growing and protecting the investments of fellow Americans – protection against the predatory inclinations of Europe. From 1901 through 2025 – another 125 years – we opened our system to Europe such that our economy was ultimately dominated by financial interests, giving up our dearly built industrial assets in the process.
Today, our industrial might has been hollowed out, we’re over-indebted at all levels of government, business, and individual balance sheets with no alternative but to return to our economic roots. The time is right for the return to the American System.
American System
The American System was created by Alexander Hamilton and championed by Henry Clay during the first half of the 1800’s. The system rests on the core principles of self-sufficiency, regional industrial specialization, high tariffs to favor domestic producers, internal logistical improvements to foster commerce, and a national bank to ensure a stable money supply. It was a system that held financial interests in check as well as influence from foreign governments.
The system effectively ended when President William McKinley was assassinated in 1901 in a train station in Buffalo, NY. His murder opened the door for the creation of the Federal Reserve and the increasing power of financial interests over domestic commercial interests. We can see from the chart below of US Gross Domestic Product minus Total Federal Debt that the benefits of debt-fueled economic growth ended in 2008 and has collapsed since that year.
Alexander Hamilton, the creator of the American System once wrote: “Men often oppose a thing merely because they have had no agency in planning it, or because it may have been planned by those whom they dislike.” Therein lies the problem; half the country dislikes the lead agent driving the change to the American System – the President. Furthermore, much of Congress is still beholden to the old system. Despite these challenges, the old system of financializing the economy peaked in 2006 and has been in a state of decline since that year. The champions of the system have kept it functioning by rapidly expanding government debt at all levels much like a dying patient on life support. Yet we’ve hit the limit of life support because expanding debt while the private economy dies is the reason for rising consumer inflation. This is the brutal lesson of the Covid years.
Notice how the rate of change of the graph started to turn higher around 2004, again around 2009, and once again in 2020. This indicates how the old system has been failing for the past 25 years. Since 2020, the rate of change has started to approach the vertical plane. Coincidence? The old system has been failing for 25 years but kept alive by entrenched political interests of both sides.
The shift to the American System is going to happen regardless of the political backdrop for the simple reason that China and Western Europe have effectively destroyed themselves. The smart play is to avoid the investments that favor the old system and focus on the beneficiaries of the new system.
Index Funds
With the stock market in a mega-bull market for the past 35 years, investing in index funds has been a winning strategy but I believe the win streak is over for the simple reason that they hold big positions in the past winners. This is an odd point to make because investing in winners is why we’re in the stock market. Right?
The last five years of stock market performance has been driven by the hype of artificial intelligence creating another investment boom similar to the internet in 2000 but it’s not the same. AI isn’t profitable for end-users; the internet was instantly profitable for end-users. End-users are not willing to pay for the AI services offered by ChatGPT, Microsoft, Google, Anthropic, or anyone else. There is no way these companies are going to break-even on money invested to date, even as they pour more money into keeping the bubble inflated.
The biggest AI company in the indexes is Nvidia, a company that produced the right graphics chips at the right time. Orders exploded higher and the company became the most valuable company in the world at nearly $5 trillion. It was magnificent but it’s a bubble that will ultimately pop because their customers aren’t turning those chips into profits – just losses.
Investors have already started to figure this out which is why the stock has been flat over the past seven months even as Microsoft, which owns 40% of ChatGPT has fallen 26% over that time. Since the Mag7 stocks of Nvidia, Microsoft, Google, Tesla, Meta, Amazon, and Apple dominate index funds, index funds will perform as well as these names.
ChatGPT and Anthropic are the repository of all the losses which are not public, the Mag7 companies have been forced to fund the massive investments in AI out of their operating cash flow to maintain the bubble. In the recent past, these companies were able to buyback their own stock with their earnings but that’s in the past.
AI investments are going to collapse sometime in the future but not yet. There is still enough wishful thinking and clever PR to keep them elevated but time is not their friend. Unless AI companies miraculously find paying customers before long, the investment in this bottomless pit of capital destruction will stop.
When this happens, index funds are going to experience a major decline in value, even as individual companies outside the AI mania should continue to grow in value. The era of “easy investing” is over.
Iran
The war in Iran is about more than just eliminating Iran’s nuclear weapons program; it’s also a war on Western banking systems. According to the Guardian, a UK newspaper, roughly 40% of the world’s illicit money is laundered by London banks. Iran is a big player in global weapons shipments and in drug trafficking. It is believed that German, Swiss, and French banks are also involved.
This might explain NATO’s reluctance to help re-open the Strait of Hormuz which is curious because European governments are under extreme pressure from citizens due to fuel shortages. It’s destroying Europe’s economies due to high prices and fuel rationing. So why won’t they help clear the Strait of Hormuz?
Without terrorist activity, Lloyd’s of London, which insures the world’s oil tanker traffic through the Strait of Hormuz, will be forced to cut prices and that would destroy revenue entering London’s banks. It represents an existential crisis for the men and women in Armani suits.
The same can be said for China which is also dependent on oil that passes through the Strait of Hormuz. They call themselves a superpower but their vaunted navy can’t stand up to the US Navy. China’s economy is already in decline and this may destroy it.
The ultimate prize for the US military is a small island, 15 miles off Iran, called Kharg Island. It’s the export terminal for 90% of Iran’s oil shipments abroad, and the main source of Iran’s foreign currency to fund imports. If the US Marines can successfully take this island, the US will control 50% of Iran’s government revenue. It will allow the US to de-fund much of the terrorist activity sponsored by Iran in the Middle East.
It will take another week for the USS Boxer to join the USS Tripoli, both amphibious assault ships – small aircraft carriers full of Marines, aircraft, and landing ships. Once off the coast of Kharg Island, these ships and the other specialized ships in the flotilla will be able to capture the islands inside the Persian Gulf that allow Iran to be a nuisance to the global economy.
The GeoVest Approach
The US is transitioning to a domestically-focused economy even as Western Europe and China remain inches from sharp decline and political unrest. AI was supposed to be the economic life-raft that preserves the old system but despite extraordinary investment in chips and datacenters, there is no evidence that AI will prove to be anything more than an upgraded tracking system. Datacenter investments are already being cancelled.
The global economy had been weakening before our action against Iran and rising oil prices and shortages will hasten this downturn. Despite this oncoming storm, we expect the equity markets to remain in the current range until later this year when the volatility will increase as all of the “black swans” converge at once.
I have been writing extensively on what’s happening and why – things that don’t end up in the media but which are vital for understanding. Here’s a link to the Second Derivative section of our website. https://geovestadvisors.com/the-second-derivative/
We’ve made money for clients because we look ahead, not behind. Cycles have started and ended over the span of human existence. Wealth gets created and destroyed because people think in linear terms, not cyclical terms. We are amidst of one of those cyclical changes where the influence of Western Europe and China are going to decline in a short time.
If you remain invested in the old cycle’s assets, you’re going to lose money but if you avoid yesterday’s winners, you’ve already won half the battle. Index funds exemplified old cycle thinking. We’ve reached the end of the financialization of the US economy; future winner’s will combine competitive advantage in products and services that rebuild the US domestic economy.
We remain 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
