Summer in a New World Order – Power, Debt and Markets

Article from Beat Wittmann, Chief Investment Strategist @ Key Family Partners


Politics and Power

War and peace, economic growth and decline, business boom or bust and capital market gains and losses – everything is dominated by the only three superpowers, namely the US, EU and China. The geopolitical trends are as clear as they are transformative with the US retreating from international cooperation with friends and foes alike, Russia and China fighting the Western powers and Europe striving for strategic autonomy.

In this emerging new world order free trade, global supply chains, multilateral institutions and the rules-based security order are being replaced by nationalism, protectionism and by might-is-right politics. This new normal means permanent uncertainty and strong-men rules. The wars in Ukraine and the MidEast are a painful testimony with no ends in sight.

G7 in the Shadows and NATO in the Spotlight

The G7 and NATO summits happened yielding the best possible outcome given the dire state of affairs of the US relationship with its Western partners. To be precise, this year’s G7 summit in Canada didn’t yield any result as all nations were simply holding their breath to keep Trump at bay.

On the other hand, NATO partners committed to a 5% of GDP spending target composed of 3.5% on core defense (military personnel, equipment, operations) and 1.5% on broader defense-related investments (critical infrastructure, cyber, industrial base) by 2035. Germany topped that commitment by setting its timeline to reach 3.5% spending on core defense by 2029, leaving lagging European countries including UK, France, Spain, Italy and Switzerland with no place to hide.

Spending targets on defense, however, are insufficient if not backed by strategy and action. Deployment of funds need deliberate and efficient planning to achieve optimal collective European defense capacity and capability in an environment of sharply increased orders and prices for military equipment. Sclerotic national procurement processes and the harmful and unaffordable fragmentation of the European defense industry along national lines must be restructured.

Deals, Deficits and the Dollar

Business and credit cycles are not dead as many think and would like to believe. Complacency and wishful thinking are perpetually rooted in human behavior, thus muddling through and kicking the can down the road remain the favorite modus operandi in democracies and autocracies alike. Animal spirits in the economy and financial markets come and go – currently, more dead than alive as measured by investors’ sentiment and the number of IPOs and M&A deals.

Trump got lucky – he inherits the Godzilla economy in the US and (over-)spends it away. The passing of Trump’s “big, beautiful bill” is most likely marking Trump’s peak time. Trump’s eclectic and self-serving economic mix of tax cuts, deregulation, health insurance cuts, deportations and punitive tariffs won’t add up to advancing long-term growth and prosperity for the majority of his voter base.

The US has entered an unsustainable fiscal trajectory that will produce various collateral damages. The clearest and most reliable leading indicator and only master of POTUS is the US treasury market. Don’t underestimate, however, that the US has bigger debt absorption capacity than most commentators and market practitioners think given the sheer size and liquidity of US capital markets, the USD being the world’s leading trading and reserve currency and relatively modest levels of private and corporate debt.

The interactions between the macro environment and financial markets are complex and often temporarily decoupled. Amongst US risk asset classes US equities are best positioned and supported by resilient US growth, superior productivity and ample liquidity. The loser is the USD bearing the brunt of capital outflows driven by fears of political dysfunction in the US and its largely self-inflicted secular decline as an international reserve currency exacerbated by China’s determination to break away from the USD bloc and the rising importance and attractiveness of the EUR.

Equity Markets Unbothered

Global equity markets with the DAX in Frankfurt and the S&P in New York hit new highs, despite the ongoing wars, permanent trade and tariff conflicts, declining business confidence and the daily news and noise reality show radiating from the White House.

Global equity markets have never cared much about anticipating developments in geopolitics, wars and structural economic shifts but are primarily a function of US monetary policy, liquidity conditions, corporate earnings, dividend payouts and share buybacks. The US clearly still benefits from its formidably competitive ecosystem of capital markets, entrepreneurship, productivity and policy pivot towards monetary easing, tax cuts and deregulation. Nothing could illustrate these developments better than the strong performance of US financial shares.

Trump’s economic zigzagging, however, lives on borrowed time and his relentless political push for easy fiscal policy, easy monetary policy and easy regulatory policy, notabene all simultaneously, is the perfect breeding ground for short term gain and long term pain. For the time being, this is good news for equities, while mixed news for bonds and bad news for the US Dollar.

Investment Rotation towards Europe

As Russia, supported by China, keeps attacking Ukraine while America pulls back, Europe has to face and deal with the fast evolving new realities. The most obvious sign of times regarding the rotation of capital flows into Europe is the steady and solid rise of the EUR against the sharply weakening USD. The EU’s and Germany’s massive push for fiscal expansion, the release of the German debt brake and investments into the defense-industrial sector will yield higher economic growth and accelerated productivity. Russia’s destructive war against Europe has already resulted in a silver lining – in Poland, a steady and strong increase in economic and market performance and in Ukraine in a fast growing and combat-proven innovative military-industrial complex.

In the past, large parts of European capital have been invested in the US, benefitting from US superior performance while financing US deficits. In a more insecure world, fading trust in the US as an ally and attractive investment opportunities in Europe will continuously support direct investment and capital flows into Europe and the EUR.

The speed and size of EUR flows, however, will also be a function of progress in establishing a full banking and capital market union. Unfortunately, not much progress has happened on that front – despite its high importance and priority. The ECB will have to prevail against national capitals in Germany, Italy and Spain despite their attempts to prioritize national interests by protecting local banks against national consolidation and cross border deals.

The dominating investment theme for 2025 and beyond, however, remains the regional home bias with Europe our preferred region. In terms of sectors, defense, infrastructure, energy and finance remain particularly attractive for years to come, supported by undemanding valuations, a stronger fundamental backdrop and a large fiscal capacity and private savings pool for investment in all areas of critical infrastructure.

Managing Uncertainty with Prudence and Flexibility

We expect uncertainty, surprises and shocks to be a permanent feature in geopolitics, economics and capital markets. With this challenging macro backdrop in mind we recommend you grow and protect your investment portfolio as follows:

Invest in equities as the asset class of choice for capital gains, focus on your respective home region and currency – in our case Europe and EUR, favor gold and CHF as safe haven assets, keep cash for best diversification and optionality, hold high quality fixed income instruments for revenue generation and act opportunistically and counter-cyclically while watching out for special situations.