2023 so far has been characterized by volatility, both up and down. Markets have managed to remain positive in aggregate. Some of the reasons for this volatility are well known, starting with the domestic economic environment. The much-anticipated recession, still said to be imminent, has not materialized despite two years of prognosticators’ predictions. Unemployment is remarkably low, and wages have been increasing across income levels. Inflation continues, albeit at a moderated 4% annual pace, which is still above the Fed’s ideal target, and this in turn adds uncertainty to markets that are having difficulty determining how many and how large additional Federal Reserve rate hikes to price into their models. Generally though, a more robust and still growing economy with greatly attenuated inflation is in principle modestly bullish for stocks.
Then there is the geopolitical environment. Ian Bremmer, founder of the Eurasia Group, believes that a rogue-state Russia is by far the greatest geopolitical risk currently facing the world. It is impossible to argue his point. In a recent podcast, Bremmer points to a recent incident where a Russian fighter jet mistakenly fired on a British aircraft, and all that prevented the deaths of 17 British service men and women was the malfunction of the Russian missile. Bremmer uses this example to point out that as long as the Russian invasion of Ukraine endures, we are a hair’s breadth away from an incident that would provoke a shooting war between NATO and Russia, adding along the way that Russia has more nuclear weapons than any nation on Earth.
The second major geopolitical risk is the ongoing deterioration of the relationship between the United States and China—the world’s two largest economies. This deterioration is meaningful in terms of its threat to economic growth, as it impacts not only trade, but also innovation and productivity. In the United States, the bipartisan clamoring to “get tough on China,” and in China, increasing authoritarianism and the regime’s desire to be the key regional superpower in Southeast Asia, have led to an atmosphere of distrust and uncertainty, and subsequently to both punitively motivated and risk-hedging steps towards economic decoupling. We view this as dangerous through the framing of the Thucydides trap: historically, when nations have moved to separate themselves from one another economically, and taken active steps to throttle the development of a rival, it has often led to open war.
Relative to the desired outcomes of economic growth and stability, Green Alpha Investments would much prefer to see stabilization in the US-China relationship, and even active collaboration in areas where the two nations are in agreement, such as the need to address the climate crisis and to find ways to spur economic growth amid declines in working age populations. In that environment, areas where there is disagreement can be addressed far more constructively. Barring such a de-escalation, escalating tensions present risks for investors.
Given all the above, it should not be surprising that investors globally are sitting on near record levels of cash. That the markets have risen at all in 2023 should, if anything, be the surprise. So, why is that?
Despite these very significant risk overhangs, there are many positive developments, particularly in the United States, which is growing its economy rapidly relative to other developed nations and has also managed to do a better job taming inflation than most of its peers. Most notably, the growth in the U.S. economy revolves around significant new construction to support the build out of new, large-scale manufacturing. A significant share of this production boom is in:
- semiconductor manufacturing,
- manufacturing for renewable energy,
- batteries for energy storage and electric vehicles, and
- increased domestic production of electric vehicles themselves.
All this is creating well-paying jobs and driving economic growth. We can’t help but note that all these bullish trends are occurring within areas we have always defined as key Next EconomyTM sectors and industries.
We continue to believe that this dynamic will continue: most economic growth will be derived from innovations that are economically competitive and that simultaneously solve problems, helping to de-risk the world. This is the underlying thesis of Green Alpha’s Next EconomicsTM, and, as complicated and nuanced as things are, we believe the current geopolitical and economic environment is providing elegant validation of that thesis.
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