Even before Donald Trump shattered the idea of a western alliance over the weekend, an uneasy spectre had begun to roil through the global economy.
As with the onset of any major downturn, global stock and bond markets have begun jumping at shadows, nervously over-reacting to even minor blips in economic events while simultaneously attempting to digest what just a few months ago seemed unimaginable.
Troubles are brewing on at least three fronts.
The first is the sudden rewriting or even the abandonment of global strategic alliances that have been in place for 80 years.
The second is the imminent imposition of yet more US tariffs on American friends and foes alike, a strategy that appears likely to weaken an already fragile global economy still recovering from a global pandemic, the first inflation outbreak in half a century and wars in Europe and the Middle East.
Even without those titanic forces in play, overheated financial markets already had become susceptible to a correction.
Global markets have become hugely concentrated, as computer generated investment programs have poured money into Wall Street and, more pointedly, into a mere handful of technology stocks.
Wall Street has risen almost 55 per cent in the past two years on the back of an expected future bonanza from artificial intelligence, pioneered by just seven mega-cap companies.
If anything threatens those earnings projections — such as the emergence of a new player like DeepSeek or even a dose of earnings reality — the prospect of a severe downturn becomes ever more likely.
Wall Street has reaped the rewards of an AI bonanza, but any downturn leaves markets vulnerable. (Reuters: Eduardo Munoz/File Photo)
Buffett heading for cover
He’s the world’s most famous investor for a reason.
For most of the past two years, the brains behind Berkshire Hathaway, 94-year-old Warren Buffett, has been selling down his stock portfolio.
Last year, he sold about $US133 billion worth of shares, including more than 615 million Apple shares, reducing his stake in the tech giant by more than 67 per cent.
He’s sold so much that cash now makes up 27 per cent of the company’s entire investment portfolio.
That’s a record level for Berkshire Hathaway. The only other times Buffett has built a cash reserve anything near that was just before the 2000 tech wreck and immediately before the Global Financial Crisis in 2007.
On both occasions, he swooped in after the carnage, snapping up bargains on everything from banks to industrials and technology outfits.
Buffett is now ready to profit from another downturn.
While he may again emerge the winner, such a correction would seriously damage investor and consumer confidence.
Warren Buffett has spent the last two years selling down his share portfolio. (Reuters: Scott Morgan)
Recent American surveys, from the University of Michigan and from the Conference Board already have seen a marked downturn in consumer sentiment as Elon Musk’s chaotic cost cutting program ramps up.
The Musk-led cost cutting has been instituted to engineer a turnaround in America’s massive ongoing budget deficit and ultimately reduce the nation’s crippling $US45 trillion debt.
There’s a theory that Trump and his Treasury secretary Scott Bessent wouldn’t be averse to a US recession, as it would force the US Federal Reserve to cut interest rates and thereby reduce the interest payments on that huge debt.
The problem, however, is that the economic downturn delivered by the tariffs could come with higher consumer prices, delivering the worst of both worlds.
That could force the Fed to, at a minimum, keep rates high and, at worst, raise them as growth deteriorates.
The US Federal Reserve may be faced with conflicting future priorities. (Reuters: Joshua Roberts)
Why markets could be even more volatile than expected
Warren Buffett is one of the old breed. And not just because of his age.
Buffett is what’s known as an active investor. He sniffs the wind, looks at the trends and uses good old fashioned instinct along with a strict set of mathematical rules about when it’s time to buy and sell.
Much of the world of investing, however, is dominated by artificial intelligence. Machines now play a large role in deciding where your retirement savings are going to be put to work.
Ironically, in the past few years, the machines have decided to steer your cash towards creating even more sophisticated machines to generate AI.
It is known as passive investment. Originally, these funds — which mostly operate as Exchange Traded Funds or ETFs — were designed to deliver the exact performance as the market. They wouldn’t beat it. But they wouldn’t make horrible mistakes and underperform either.
Not only did they perform every bit as good as funds run by humans over the long term, they had the added advantage of being far cheaper to operate, which meant returns often beat active fund managers.
They’ve now become so successful, they dominate investing. And to an extent, they may now be partly responsible for the tech bubble that has emerged on Wall Street.
Trader works on the floor of the New York Stock Exchange. (Reuters: Brendan McDermid)
Rather than merely replicating performance, they now may be exaggerating rises and falls, making stocks more volatile than previously.
That’s because passive funds don’t look for trends. They simply allocate funds in proportion. The biggest company attracts the biggest investment. And because the biggest company attracts more funds, it becomes even bigger.
Not surprisingly, a large part of the global funds’ flow has been directed towards Wall Street in recent years, simply because it is the world’s biggest market. And the companies attracting the lion’s share of that fund flow have been the Magnificent Seven, technology stocks.
In 2020, the Magnificent Seven accounted for 20 per cent of Wall Street’s total value. That’s now risen to 32 per cent, which has left many wise old heads concerned about the lack of depth on global stock markets.
In the past few weeks, about $US1.4 trillion already has evaporated from big tech.
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Caught in the middle
If ever there was a metaphor for our increasingly perilous position in the world, it was encapsulated by twin events of the past fortnight: the public dressing down of an ally in the White House and the circumnavigation of the Australian coastline by three Chinese navy ships.
This week could be every bit as dramatic.
On Tuesday night, the US president will address a joint session of the US Congress to urge a lifting of the debt ceiling.
It is possible Trump will outline his new punitive trade regime on Canada and Mexico — essentially tearing up the free trade agreement he forced them to sign during his previous term in office — while imposing a further 10 per cent tariff hike on China and provide more detail on tariffs to the European Union.
Even if he grants Australia immunity from tariffs, the trade battle with China inevitably will ensnare us, something currency markets already have identified with the Australian dollar taking a hiding in recent weeks.
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On Wednesday, delegates from the National People’s Congress will gather above Tiananmen Square to consider China’s upcoming budget that may or may not include the impact of America’s increasingly hostile trade position.
It shares at least one key attribute with America. It is carrying huge amounts of debt, where it differs with the US is that it is fighting a potentially debilitating battle with deflation which could be exacerbated by even higher US tariffs.
China’s property market meltdown has sapped confidence and the deflationary spiral in real estate markets has spilled over into the broader economy.
To counter the ever-tightening Trump trade war, may involve a big lift in stimulus spending, something from which Australia traditionally has benefited.
This time, however, we may not be so lucky, especially if that stimulus is directed towards military spending.