Stocks and Geopolitical Conflict

The speaker discusses the S&P 500 amidst geopolitical conflict, highlighting three key factors for investing in stocks: the labor market, inflation, and geopolitical conflict. While geopolitical conflict is unpredictable, it can have significant long-term market implications. The rising price of oil in a late business cycle environment is identified as a precursor to the end of the business cycle. This late business cycle environment is indicated by a specific chart that incorporates the S&P 500, unemployment rate, US inflation rate, and US interest rates normalized by M2 money supply. Historically, all prior late business cycle environments concluded with a recession in the United States, often coinciding with a spike in oil prices. While oil price increases are generally bullish in an early business cycle, they are not in a late one, as they exacerbate inflation, especially when coupled with a weakening labor market, effectively "checkmating" the Federal Reserve. The current situation presents multiple challenges: a rising unemployment rate, likely rising inflation, a partial government shutdown, and ongoing geopolitical conflict in the Middle East. Although markets can climb "a wall of worry" for extended periods, the speaker senses market exhaustion from constant deadlines and shifting narratives. The traditional reliance on trade-back rallies following concessions or tariffs might start to fail as the year progresses. Predicting the stock market is challenging due to its cyclical nature, similar to Bitcoin's. While Bitcoin tends to top in the fourth quarter post-halving years and bottom about a year later, the stock market also exhibits a cyclical pattern, often bottoming approximately every four years. However, identifying market tops is considerably harder. Past examples illustrate this difficulty: 2018 saw a high in early 2018, followed by a sweep of that high before a larger drop in Q4. Before the financial crisis, a significant drop in 2007 (around 12%) was followed by a rally to a new all-time high before the major recession. The dot-com era also showed a similar pattern of a high, a rally, and then a sweep of the high before an inevitable recession. The speaker emphasizes that market topping is typically a process that unfolds over time, whereas market bottoming is a rapid event. This is exemplified by Bitcoin's top in January 2025 (on the new administration taking office), which was followed by a sweep of the high and then a collapse, indicating a drawn-out topping process. Similarly, the stock market's topping process can also extend over a long period, potentially involving multiple sweeps of prior highs. The speaker's personal strategy is not to actively trade these movements but to focus on international funds, energy stocks, and manufacturing stocks, which have performed well. The rise in the ISM (Institute for Supply Management) index, often misconstrued as bullish for crypto, was actually beneficial for manufacturing stocks, not speculative "frothy assets." Markets do not move in a straight line, and a long-term thesis can exist without perfectly predicting every short-term fluctuation. Currently, the speaker believes the stock market's high is either already in, or there will be a sweep of the high before a drop. This assessment is supported by several metrics, including the S&P 500 divided by gold. This ratio has only broken down from current levels a few times historically, notably in 1973 and 2008, both instances corresponding to market tops. This suggests that the local high for the stock market is likely in for a while, with any further upside potentially being a temporary "sweep of the high." Another supporting fractal is the S&P 500 divided by the money supply (M2). This fractal, observed in the 1990s and again leading up to the 2000s, suggests a potential rally back up to sweep highs before an eventual unwind and drop to sweep lows from April 2025. While a sweep of the prior all-time high is possible, it should not be mistaken for an end to a potential midterm bear market, as such sweeps have occurred before previous market downturns (e.g., 2000, 2008, 2018). It would be simpler, in the speaker's opinion, if the market merely marked a top, as it did when breaking down against gold in 1973 and 2008, without a subsequent sweep of the prior high. In those instances, both the stock market and gold initially dropped, but gold recovered to all-time highs much sooner than the stock market. This analysis underscores the concept of opportunity cost. While stocks can certainly go up, there have been, and likely will continue to be, better investment alternatives. The S&P 500 is down almost 50% against gold over the last few years, even amidst a major AI boom. The NASDAQ is also down 44% against gold since 2021. Similar to Bitcoin's bull market where altcoins rose but Bitcoin rose more and dropped less during corrections, gold currently presents a stronger relative investment. The speaker cautions against the narrative that Bitcoin is currently outperforming gold, suggesting a broader historical view. Bitcoin typically sees small rallies against gold around midterm years, but these have not historically led to durable changes until later in the year. It is projected that Bitcoin will likely drop another 30-35% against gold to return to 2023 levels, mirroring its recent drop against silver to 2022 levels. Regarding geopolitical conflicts, the speaker hopes for de-escalation but refrains from predicting outcomes. Short-term market reactions to headlines, whether positive or negative, are unlikely to alter the long-term trend. A market decline might correspond to a low from which it builds for a few months, while an ascent would likely be a lower high or a sweep of a prior high. In conclusion, the charts indicate a late business cycle environment, supported by liquidity risk metrics. While the exact timing of a crisis is unknown, continued escalation of geopolitical conflict, coupled with a weakening labor market and rising inflation, would likely accelerate its onset. This framework, though potentially unpopular, is presented as a logical approach to navigating current markets.