Time to prepare our portfolios for war?

Is it time to panic? How to navigate further.

New speculations arise daily on how things can escalate in the Middle East and other conflicting areas, how the US is not prepared for war, and whether we are about to see Doom’s Day or not.

Let’s explore how much we should worry.

Background

Leading financial gurus are sharing concerns about World War III.

  • Ray Dalio (article), Jamie Dimon (article), Paul Tudor Jones (video), and others think this is the most dangerous time in our generation.

  • There are 3 major conflicts, Ukraine and Russia, Israel and Hamas, China and Taiwan.

  • Luckily, the leading powers (the US and China) are not directly involved, but that might change.

  • Rising concerns about external governments seeing the US president as weak, which might escalate conflicts further before the elections —> e.g. China invading Taiwan.

  • The US is in the worst fiscal position since WWII and not in a shape to finance a worldwide conflict.

Ray Dalio

Ray Dalio, founder of Bridgewater Associates, one of the world's largest hedge funds, is known for pioneering the "All Weather" investment strategy. A risk-parity approach designed to perform well across any economic conditions.

Additionally, his book "Principles" dives into his unique philosophy on life and work, and it become one of the most popular books in the finance industry.

Ray Dalio wrote a detailed article about this situation.

  • Dalio expands on his book: Principles for Dealing with the Changing World Order, for which he made a great summary in this video.

  • In the video, he explains how the power shifts from the leading empire to the rising one, and how did this happen in the last cycles (Dutch, British, US)

  • Dalio is worried this escalating war in Gaza will lead to new conflicts both between countries and within countries (e.g., repulsive violence against Jewish and Muslim populations in many countries).

  • This could further fuel the internal conflicts driven by already existing debt/money/economic problems, and divided US government (article).

  • As Dalio says: “Fortunately, the progression toward a world war between the biggest powers (the US and China) has not yet crossed the irreversible line from being containable (which it is now) to becoming a brutal war between the biggest powers and their allies.” but if that happens and the US enters in direct conflict with China, this will likely end up with a World scale conflict.

Paul Tudor Jones

Paul Tudor Jones is a legendary hedge fund manager who became famous after he successfully predicted and profited from the 1987 stock market crash.

Jones is known for his macroeconomic insights, accurate market predictions, and as a dedicated philanthropist.

In his interview, Jones says that we live in the most threatening geo-political environment of our time.

  • 4 nuclear-armed powers: China, Russia, and North Korea are led by “sociopaths with zero accountability and responsibility”. Iran is led by someone “who thinks God is talking to him”.

  • The US is in the worst fiscal position since WWII: 122% debt to GDP (s) and interest cost rising. Higher interest rates > higher funding cost > higher debt issuance > further bond liquidation > higher rates > untenable fiscal situation.

  • He further elaborates on the debt situation. The interest bill will exceed the defense bill in a few years, and the FED is losing control because the debt is getting too high, which can force further rate hikes and a recession in 2024.

  • From the political point of view, PTJ mentions that the two people responsible for this fiscal situation (Trump and Biden) are the two candidates for the next election and that neither of them should be the next president.

  • The way out could spark further internal conflicts as it’s needed to cut spending (healthcare, social security) and simultaneously raise taxes.

Jamie Dimon, CEO of JP Morgan: “The war in Ukraine compounded by last week’s attacks on Israel may have far-reaching impacts on energy and food markets, global trade and geopolitical relationships. This may be the most dangerous time the world has seen in decades.”

Is it time to panic?

The US as the leading country faces debt and fiscal problems, but China as well (real estate, banking).

The US is struggling with internal conflicts (removal of House Speaker, possible Government shutdown, election year, rising consumers’ debt), and external countries can see this as a weakness and use it to tip the scales.

This has an impact on the Middle East conflict, but also on Taiwan. If China is to invade Taiwan, they’ll most likely do it in the next 12-18 months. Such an act could trigger direct conflict with the US that Ray Dalio warns us about.

I hope not. China has its own economic problems which hopefully reduce attempts to further destabilize the economy with an open conflict.

Also, China still has an intertwined economic relationship with the US, and it seems unlikely that either country will engage in direct war until they separate further.

Similar fears were here many times before - dot-com, 9/11, 2008, Covid, …

Here is an article from 2014 when Russia invaded Ukraine to annex Crimea.

To a question: “What of the potential threat of World War III or a return to the Cold War?”

Warren Buffet responded:

“If you tell me all of that's going to happen, I will still be buying the stock. You're going to invest your money in something over time. The one thing you can be quite sure of is if we went into some very major war, the value of money would go down - that's happened in virtually every war that I'm aware of. The last thing you'd want to do is hold money during a war.”

Also, September 11 saw a drawdown of 11.6% on the S&P 500 but it took just 31 days for stocks to recover. The Russia-Ukraine war saw the benchmark index tumbled as much as 6.8% but it took just 23 days to recover the losses. (s)

For me, this means:

Diversify. Earlier this year, Warren sold his stake in TSMC (after a few months) because of the potential war with China (s). He also bought more Japanese companies to spread the geopolitical risk. The key is to reduce the exposure to a single market or asset class.

Crypto can act as a hedge against geopolitical conflicts as long as the project is not tied to a single market/regulator. Bitcoin is beating gold in the assumption that with Bitcoin I can at least make a purchase, with gold hardly plus holding a certificate of ownership vs. real gold is different.

Search for value. Defense stocks, oil and energy companies, and heavy industry that can convert to defense stock, these all will profit from conflict. But rather than speculating, I focus on searching for value in companies that have positive cash flow even in bad times.

Play it safe. Minimize the risk rather than chasing higher returns.

And as always, don’t panic. See the chart below from the World War II era and how the DJIA reacted to the news. The impact of the war was far lesser than the one from the stock market crash in 1929 when it took 25 years to reach the 1929 highs again (s).

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