We’re entering a new economic cycle in the US. Thus, 2025 is likely to be ugly in the economy and the markets. The good news is that I’ve been writing to you about this for the past two years. We prepared ahead of time which is why our first quarter performance was good.
We are in a transitionary period. To use agricultural parlance, we are at the point where fields that formerly yielded crops from last season are being prepared for seed even as the remains of the old cycle are tilled under the earth. By this I mean that many companies that were successful in the old cycle, won’t be successful in the future, even as the next cycle’s winners are in an embryotic state. It’s why I believe the benefits of index funds are behind us; they are full of the old winners that are likely to languish in the future.
If you are interested in a deeper understanding of this transition period, please visit our website under the “2nd Derivative” banner. Here’s a link to the first installment of the series I wrote called “After the Harvest.” https://geovestadvisors.com/after-the-harvest-i/
There is also a bigger issue in front of us than the political divide in our nation and it directly impacts how the US will interact with the rest of the world. Simply put, the current financial system can no longer serves the needs of both the US and the World. For one to expand, the other must contract under the US dollar system. Here’s a link to a piece I wrote discussing this bifurcation of the global economy: https://geovestadvisors.com/at-the-crossroads/
Despite sharp rallies in both European and Chinese stocks over the past quarter, I expect the broader European economy and mainland Chinese economy to contract sharply over the next year. Both have experienced a collapse in their birth-rates and both face deep declines in their respective financial systems. Here are two pieces that discuss this dynamic in greater length. https://geovestadvisors.com/were-missing-the-obvious/ and https://geovestadvisors.com/after-the-harvest-ii/
I believe there is money to be made over the next couple of years despite it being a transitionary period. While most industries recalibrate operations, companies that supply auto parts, food, electricity, and arms for the defense industry are in their sweet spots. While we are likely to experience a negative credit cycle, US Treasury bonds should benefit from falling interest rates. In short, there is every reason to be optimistic if you are prepared.
US Economy
The election year stimulus is starting to run out which is why we are about to get a clean look at the underlying trends in the US economy. It doesn’t look favorable.
We have already heard from companies ranging from FedEx to Walmart to Dollar Tree to homebuilders. They are all telling us that the consumer is out of cash. This shouldn’t be surprising given that interest rates are too high for consumers and the US government has gone from a driver of economic activity to an anchor on economic growth. US debt has grown so fast over the previous four years that the new Administration has no choice but to tap on the brakes to prevent a collapse on the US government’s credit rating.
From January 2021 to today, US government debt has grown by $10 trillion; this growth rate is completely unsustainable. In four years, our total US government debt grew by an astonishing 38%. Not only that but it has gotten to the point where it now takes more and more new debt just to move the economic needle. In short, we are WAY past the point of diminishing marginal return on new debt.
I’ve covered the sharp increase in consumer inflation in past newsletters. Inflation is the DIRECT result of this new debt because it put money in people’s pockets that was never earned through labor. This being the case, the fastest way to cut consumer inflation is to stop the rapid growth in new US government debt. The good news is that the new Congress won’t allow the new Administration to grow debt at this rate. The result should be lower inflation followed by lower interest rates.
We can see from the chart below that new debt growth is the only driver of new GDP growth in the US because it’s taking so much more new debt to move the needle. It’s telling us that if we continue with the old economic plan, debt will have to grow much faster which suggests that consumer inflation will have to grow much faster.
The official term for the old economic plan was Modern Monetary Theory. It seems that economists guessed that they could contain inflation in this new digital age but they couldn’t. The experiment failed and made people’s lives worse; voters opted for a new direction.
Government economists seem to have forgotten that economics is about people; it’s not about spreadsheets, models, or distributions in a dataset. People change their minds and beliefs based on their changing circumstances. Ultimately, people want a better life for themselves and their children and the old system could no longer deliver.
Artificial Intelligence
Like the economic experiment with MMT, artificial intelligence is another part of the experiment where leaders hoped to force through a new technological cycle to help grow the economy, and ostensibly, take people out of the equation. It’s proving to be another failure as data centers are showing signs of excess capacity. It was too much investment in too short a time. It is like Y2K and the internet revolution except the web offered consumer’s utility from the beginning while presently AI benefits are negligible at best.
In short, AI doesn’t offer broad applications that are desired in the market, at least not yet. Nvidia’s graphic chips, which drive AI, need a ton of electricity and water for cooling. AI models require enormous amounts of data and time to train these models. It is expensive to produce a model yet China’s Deepseek has shown it is easy to pirate.
If the applications that draw on this power don’t offer consumer and corporate utility, why incur the expense? ChatGPT uses 10X more electricity than a normal Google search. Google’s new Gemini model uses 25X as much electricity as a normal Google search. Data centers presently use around 3% of US electric output and are forecasted to use 8% by 2030. Meeting this demand will require an enormous amount of new electric capacity which can’t be supplied by wind or solar because Green sources are too expensive and too variable.
Sure, you can build data centers in the desert but where will you get the water needed to cool them? The market is starting to figure this out which is why the Magnificent Seven stocks all seem to have topped out in 2024.
Nvidia’s new Blackwell chip is believed to have a TDP, or thermal design power, of 1000 watts. That’s a lot of electricity and while I believe the chip will allow for some amazing applications, I don’t see enough broad application to warrant Nvidia’s stock price. In fact, I suspect it will ultimately be used in niche applications that will take time to develop.
Nvidia is a great company but so too was Cisco Systems in the year 2000. I suspect the winners in AI going forward will be the companies that find ways to harness the amazing possibilities the systems offer but not necessarily the companies that provide the systems.
Bond Market
I am very, very excited about the prospects in the bond market even as I fear that a lot of money is going to be lost in a negative credit cycle later this year. I expect interest rates to decline as the economy weakens which should make US Treasury bonds more valuable.
With the US Congress unwilling to keep increasing government debt and the new Administration actively working to cut government expenses, the table is set for a very sharp rally in long term bonds. Unlike 2021, the US government has already maxed out its credit card which means the only avenue left to support a weakening US economy is to slash interest rates aggressively.
The world is already in the grips of deflation. Both Germany and China are experiencing declining consumer prices. With China, its deflation is getting worse despite the People’s Bank of China injecting 20% new money in 2023! That’s money printing.
The Swiss Central Bank has already cut interest rates to 0.25%. This suggests that investors are flocking to Switzerland for safety. Switzerland is a small country, so they can be easily over-run by those seeking capital protection.
In addition, the Swiss Central Bank tries to keep the Swiss franc largely in parity with the European euro for trade reasons. Germany is considered the safest large economy in Europe and their overnight rate is 2.27%. You would think an arbitrage trade is possible where investors borrow in Swiss francs near 0% and buy German bonds above 2% but it’s not happening.
Here’s a chart of the Swiss National Bank’s overnight rate. Note that the chairman of the bank has already promised 0% rates if warranted. A rise in the Swiss franc versus the European euro would trigger 0% rates – or even negative rates.
Deflation is late to the US due to the aforementioned government spending but it will hit later this year. The Federal Reserve has kept interest rates too high for too long and that suggests that they will be forced to get aggressive cutting rates later this year.
The GeoVest Approach
I’m excited about the prospects for our clients and for GeoVest as a firm. Personally, I did my worrying years ago when it became clear that we would be entering a period of transition. For good or for ill, it kept getting delayed, first by Covid, then by extraordinary growth in government debt.
Paul Hurley has already expanded our presence on Linked-In and X(Twitter) where we are posting updates daily. As noted earlier, I’ve been adding to our analyses on our website www.geovestadvisors.com under the 2nd Derivative section of Insights. If you want to understand this economic transition without politics, it’s a great place to start.
Most of all, I’m excited about prospects for growth in the US. Investing in a “wealth-effect” environment was never sustainable but investing in a “comparative advantage” environment is not only sustainable, it can build on itself. We just need to manage through this “transition period” which we are prepared to do.
The key is to avoid wealth-effect investments and focus on utility. Companies that do things that allow our economy to heal itself and grow will be in demand. This includes companies that learn to selectively use AI to develop sustainable competitive advantages. Thank you and it is our continued pleasure to serve you.
Philip M. Byrne, CFA
