Entropy, the second law of thermodynamics, says that all closed systems will tend to greater disorder. It's also a quickening process. The greater the disorder becomes, the faster the system breaks down completely.
In a nutshell, things just tend to fall apart.
That systemic law may be just as true outside the world of physics, as several forces look to be ushering us to an age of disorder. Eurasia Group, the political think tank, has warned that the world is entering a year of geopolitical recession in 2017.
Strategists at Goldman Sachs told CNBC last week that it may take either a war or recession to shock the stock market out of its low-volatility range.
While the investment bank estimates only a 25% chance of recession over the next two years, the risk of a geopolitical conflict could be just around the corner.
The world seems to be turning to a more uncertain and hostile future, one where geopolitical and economic events may cause a spike in stock volatility. Instead of buying general protection or shifting money to safety assets, there are investments that can thrive in the environment.
Are We Heading For A Global Breakdown?
There are three trends I'm watching that could tip the world into greater uncertainty, and even as far as a multinational conflict.
Worthless crude would send the Middle East and several other exporting nations into chaos as governments crumble from lack of revenue. Russia would completely lose control of its hacker element and extremist groups would recruit easily from millions in abject poverty. Here in the United States, the economies of several states would buckle after tying their futures to energy production at the wrong time.
With a global economy barely recovered from the last crisis, it won't take much to push us back into recession. Even without a full-blown trade war, it's looking highly likely that trade protectionism could be the catalyst for the next recession.
The Trump Administration has already levied tariffs on Canadian lumber and we're still waiting to see the effect of NAFTA renegotiations. The Commerce Department has been studying steel imports in the context of national security and is expected to release its findings within weeks, findings that most expect to lead to new tariffs on steel coming into the country.
The United States is the largest steel importer in the world, accounting for a fifth of the global steel trade. Imports come from many countries but the top four, Canada, South Korea, Brazil and Mexico, account for 51% of inflows.
Claiming a national security imperative to impose trade barriers is a slippery slope, and can be applied broadly. The European Union has already threatened to retaliate if steel tariffs are imposed. This will surely not be the only trade dispute we see over the next four years, and any one could send global commerce plunging.
Finally, the general drop in U.S. support for international institutions like NATO could embolden states like Russia and China to take on expansionist policies while entire regions struggle in a power vacuum.
North Korea has been relentless in its antagonization of the United States, and is driving a wedge between what appeared to be strengthening ties with China. The Middle East is moving quickly to a two-sided confrontation with Qatar and Iran on one side against the rest of the region.
Against all of this, it is looking less likely that the Trump Administration will be able to deliver on sweeping regulatory and fiscal reforms. Healthcare reform has stalled and investors are getting impatient about tax reform that could bring economic growth.
Investments That Thrive From Uncertainty And Chaos
Within this potential for a new world disorder, there are some investments that may actually thrive from the chaos. These are the companies and industries that will profit from a breakdown of security and economic optimism.
Defense contractors are the most obvious beneficiary of greater geopolitical uncertainty and the military buildup that comes with it. President Trump has called for a 10% increase in defense spending and some key members of the senate are saying that doesn't go far enough.
Raytheon (NYSE: RTN) is one of the five major suppliers to the U.S. military and books 30% of sales from international customers. Its funded backlog of orders reached a high of $25 billion in 2015. Cash flow from operations jumped 21% last year to $2.85 billion and the company returned $1.86 billion to shareholders through dividends and buybacks.
I highlighted the increased risks to cybersecurity in May after it was reported that a hacker group publicly released government-quality hacking tools free of charge across the net. Those tools have now been used in two massive, multinational ransomware attacks targeting governments and corporations.
With or without a near-term conflict on the horizon, cybersecurity firms like Fortinet (Nasdaq: FTNT) have a solid runway of growth ahead. Cybercrime now transcends simple identity theft and is being nurtured by some governments. Fortinet is a leader in protecting small- and mid-size businesses, which are less well protected than larger corporate clients. Fortinet's low-cost solutions and recurring service revenue should help support stronger sales over the next few years.
Infrastructure stocks may be the win-win scenario, jumping on any development in fiscal stimulus but also doing well in a world that will eventually need rebuilding. Fluor Corporation (NYSE: FLR) is one of the more diversified engineering and construction companies, with projects across industrials, utilities, energy, and mining. The company holds the single largest support services contract for the U.S. military and held a $45 billion backlog of projects at the end of last year, nearly 2.5 times its annual revenue.
Beyond these three specific sectors that could benefit from the heightened uncertainty around the world, investors might also look to gold to retake its position as a safety asset. Tame inflation data in most of the developed world has kept a lid on gold prices but that might not matter if investors flock to haven assets on a geopolitical flare-up. The wealth management unit at UBS Group recently recommended that clients buy gold around $1,200 an ounce as "insurance" against unforeseen risks.
Risks To Consider: If geopolitical and economic uncertainty were to increase, weakening investor enthusiasm could limit gains across the board for stocks, though chaos stocks should still perform relatively better.
Action To Take: Protect your assets with positions in stocks that thrive amid chaos and investments that will hold up in the coming global disorder.
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