Change, accelerating

The Weekender offers my perspective on market developments and their potential broader implications, written fortnightly on Friday afternoons. If you'd like this delivered to your inbox on Saturday mornings via Northern Trust, please sign up here.

Special edition

With apologies for disrupting our new fortnightly cadence of The Weekender with this abridged edition. But, as I’m travelling next week and given recent accelerated developments that connect with themes we’ve been discussing here, I wanted to quickly revisit a few of these and hopefully help get us thinking about what might come next.

Relevant themes include: Military Keynesianism, The Risk in Not Taking Risk (China/EU/UK), The New Regime (with dividends), Reframing from ‘Left verses Right’ to ‘Up versus Down’ and pricing Uncertainty.?

But let’s start with Keynes, who argued that military rearmament is not just a deterrent against armed conflict, it can also be a forced multiplier to drive productivity and GDP growth, something a few economists had predicted in regards to Europe, save my favorite (other than our own Carl Tannenbaum, of course): the stock market.

Military Keynesianism, a fiscal put?

We’ve had Draghi, Lagarde, the president of the EC and now the German Chancellor talk of doing ‘whatever it takes’ to get Europe back on track. UK Prime Minister Kier Starmer arguably set the tone last week pushing Defence to 2.5% of GDP, although he’s since been trumped by the sums that Friedrich Merz is proposing: €400bn for defence, with an additional €500bn over 10 years for infrastructure.

The Warfare State may begin to crowd out the Welfare State, adding another nail in the coffin of Eurocracy, improve European competitiveness and help drive a reappraisal of European growth ?– something the markets themselves have been quietly discounting for some time (the German Dax is now up 112% in USD since the launch of the AI bull-market in Oct 22, versus the SPX being up only 66% at time of writing). And this during a period of uncertainty in Germany, think war, Russian gas, China, immigration (that term – uncertainty – may now more aptly be applied to the US). But still, my sense is this change is largely ignored.

As Keynes reminds us, ‘the difficulty is not in the new idea but letting go of the old ones’. And many investors still think Europe is an economic basket case. So, while defence contractors will benefit, it’s largely priced in. It’s now time, perhaps, to consider the wider benefits, and/or second order effects of (Military) Keynesianism.

For example, is a fiscal put now emerging in Europe at a time the US is heading the opposite direction (DoGE) and the once-powerful fed put seems neutered by persistent inflation?

If so, we ask: are you positioned for that?

Motivating forces

There are few more galvanizing forces than the threat of armed conflict (or the removal of your security blanket). And interestingly, there is a playbook for what such threats can do for productivity and economic growth. Take the US in 1939 (we could use modern-day Russia too, but I would rather not). In 1939, defence spending in the US accounted for just 2% of America’s GDP, and its “minuscule” army was on a par with Belgium’s.

By 1945, US defence spending had risen to 41% of GDP, and the economic boost had helped lift America out of the Great Depression. Ford had built “the biggest factory the world had ever seen”, capable of producing a four-engine B-24 Liberator bomber every hour. And as we discussed previously, one Chrysler factory in Detroit produced more tanks than the entire Third Reich. Astonishing.

Now, might German automobiles, their supply chain (steel) and the Mittelstand generally, stand to benefit? As Northern Trust Asset Management’s Peter Wilk (himself a German) reminds me, Mercedes, for example, produce some of the best military trucks in the world. Porsche, now owned by Volkswagen, once designed its own tanks.

Might idle manufacturing capacity now find a new buyer? The UK MoD?

New regime

For some time we’ve challenged ourselves: will the tools and techniques that worked well for the last 30 or so years will continue to work for the next 30? Our general conclusions can be found here, but one question we posed with regard to diversification is: to think more about regional diversifiers and seemingly forgotten performance drivers, like dividends. Perhaps unsurprisingly, I’ve had a lot of interest in my employer's International?Quality Defensive Dividend ETF, a proxy which captures both of these concepts and if little else, offers diversification benefits on top of a handsome 6% dividend yield.

While talking regional diversification, might the corollary of a fragmented geo-politic/geo-economic be a fragmentation of their market proxies? Might money move from highly concentrated global indices towards more regional, even country specific ones? We see more thematic expressions of market exposures, but might we soon see more country specific ones as well?

Great news for pheasants, phoenixes, and the FTSE if we do.

Stop thinking 'left v right'. Start thinking 'up vs down'

I believe this reframing is a helpful lens to understand current US policy. This idea was captured best by Scott Bessant in comments earlier in the week. “We have a new trend. It's a focus on Main Street. Wall Street's done great. Wall Street can continue to do fine. But we have a focus on small business and the consumers. So we are going to rebalance the economy”. This may explain Bessant’s principal KPI being the 10Y, for it matters most to Main Street (think mortgage rates).

With help from the new 4Ds of deficit reduction: Doge, Deregulation and David Sachs (think stablecoin demand) it seems likely that old records will hold, rates won’t face an unprecedented fifth annual decline and the market narrative might shift towards domestically-focused stocks closer to the consumer, like manufacturing and construction.

Take homebuilders, which have been hammered (pun intended) by a combination of high rates, supply chain issues, and tariff concerns (think Canadian supply chains). Is all their bad news now in the front window??

Shrinkage

The headline that private equity assets shrank last year won’t surprise our readers. But it’s surprised some investors running liquid strategies. The lack of PE cash-distributions combined with on-going LP liquidity needs has seen several European managers face large redemptions despite tremendous performance. How devastating. While I’m hopeful the current PE vintages have been well considered and priced more rationally than the heady days of the early 20s, I’m less hopeful the spigots are about to be turned on for IPOs, suggesting another year of single digit DPIs is possible.

Such has prompted our focus on alternatives to said Alternatives like public market dividends.

Of course, lower rates could help the buyout community, but it’s possible that more value may transfer to those (largely) public assets that firms are going to buy. Many that, I suspect you might find, in small and mid-cap indices.

In such foreign lands as the UK, Japan and Germany. ?

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