This material is provided as a courtesy and for educational purposes only from Olde Raleigh Financial Group, A member of Advisory Services Network, LLC and should not be construed as investment advice. All information contained in this video is derived from sources deemed to be reliable but cannot be guaranteed. All economic and performance data is historical and not indicative of future results. All views/opinions expressed in this video are solely those of the presenter and do not reflect the views/opinions held by Advisory Services Network, LLC. Advisory Services Network, LLC does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state laws are complex and constantly changing. Please consult your investment professional, legal or tax advisor for specific information pertaining to your situation. Advisory Services Network, LLC and Confluence Investments are unaffiliated.
Stories from the Stacks – A Soundtrack to an Investment Advisor’s Life Episode 6 – Are you planning on retiring in Raleigh, NC anytime in the next 30 years? If so, there is a complicated world out there beyond Raleigh, with its own set of goals, aspirations and driving forces that can impact your investments. Olde Raleigh Financial Group loves to keep eye on that horizon with conversations around geopolitical trends and how those trends might affect investment decisions. Please take a listen to this interview with Confluence Investments analyst Patrick Fearon-Hernandez who uses his CIA background to view the world.
This Interview Covers:
- Wolf Diplomacy? China’s more muscular role in global diplomatic organizations and policies making.
- What are China’s military capabilities with particular attention to their Navy. Did you know they have the largest Navy by number of boats in the world. The questions is are they the right boats to move from a regional power to a global power that rivals the U.S. and what’s the timeline of such expansion?
- Analysis of Chinese national interest and goals compared with US Interest and Goals
- Japan: A new president in Suga and an old, often fraught relationship with China. What next for one of the U.S.’s staunches ally as the try to help check China’s power surge?
- Taiwan’s semiconductor Industry is the global leader in microchip production and China wants it.
- Will global supply chains shorten?
- Impacts of The Aging populations on economic growth and inflation in both developed and developing worlds. Investors must pay attention to changing population demographics!
Hey everybody. This is Trevor Chambers from Olde Raleigh Financial. Once again, we log another episode of Soundtrack to an Advisors Life and the Meet the Masters Series. Today I am excited to have our guest Patrick Fearon-Hernandez. Patrick how you doing today?
PATRICK HERNANDEZ: Hey. Good, how are you?
CHAMBERS: Good. You and I just met and you’re a – you seem like a vivacious guy and so I always love having people with good energy on the blog and I appreciate it. So, I’ll get right to it. Patrick is a market strategist. He works for a firm called Confluence Investments and they manage money, long term money for individuals as well as not for profits or you guys manage money for institutions, I should say is what I meant. And been doing it a long time and you’ve been in this business a long time. And today I had you on because I wanted to talk about some big macro global level topics like China and our role with China and them and things like that. And you are a really interesting guy. You have a very interesting background and you are well suited to I think for this time in our history. So can you give us a little background and then we’ll get right into some questions.
HERNANDEZ: Well, yeah Trevor. I’m happy to share, you know, what I bring to the table with you. I’m kind of a strange bird, I think for this industry in that, you know, well first of all, for Confluence in general, we take a kind of a unique approach where we’re pretty top-down, macro, global kind of people. We pay a lot of attention to geopolitics. Everyone at the firm does. But what I bring to it in particular is the unique perspective of a former intelligence analyst at the central intelligence agency. I spent the first part of my career at the CIA. Promise, I was just an analyst. I was not a spy. But it was –
CHAMBERS: I don’t know about that. I don’t know. I gotta (sic) protect my sources on that one, buddy. But go ahead.
HERNANDEZ: But, yeah, I was at the agency back at the end of the Cold War, so late 80’s into the early 90’s. And, you know, it’s sort of interesting. First of all, I really think that’s the world’s best preparation for doing investment strategy because, you know, it teaches you to look at the big picture, to understand how history and geopolitics and, you know, demographics, economics, social changes, all those kind of things meet together to determine what your – what your world looks like and all of those things, you know, you have to keep track of them in order to understand what a global investment environment is and where it’s likely to be going in the near future. And believe it or not, my day now is structured almost exactly like it was in my days at CIA. The biggest difference is that, you know, these days I don’t have access to all of the classified sources of information but still. You know, I sort of bring the skills of CIA style strategic intelligence to the investment world. And the way I like to put it to people is, you know, if the – if the US Navy can rely on CIA style strategic intelligence to decide where to deploy an aircraft carrier battle group, why wouldn’t you use those skills to decide where to deploy your investment portfolio? So, yeah, that’s the perspective that I bring to the table and, you know, it’s sort of, you know, these days with the rise of China, it’s actually kind of a homecoming for me. You know, beginning in 2001 with the September 11th attacks, you know, the US got diverted into this sort of world of terrorism where we were dealing with asymmetric threats and, you know, it – the Soviet Union had collapsed and, you know, it just was not the kind of great power politics and competition that we had gone through for decades and that I was brought up on. But now that China is rising and the US/China competition is the key relationship around the world. It sort of feels like a homecoming to me. You know, I sort of feel like, oh yeah, I have the skillset to apply to this. And importantly a lot of the people in Washington, a lot of the policy makers, and this is something that people don’t appreciate, but, you know, a lot of today’s policy makers were brought up in that world of great power competition as well. And, you know, we know how to deal with this. And it’s all very familiar territory, so. Yeah, like I say, that’s what I bring to the table. I spend a long time applying those intelligence skills to investment strategy and I’m happy to chat about it with you.
CHAMBERS: That’s so interesting. I mean, yeah, your background is just – and it’s right on time, you know. So, let’s – let’s get right into it. Alright. A meatball, I’m going to send right – I’m going to send a heater and you’re going to knock this one out of the park. Are you ready? So, Confluence, you guys are awesome because you put out outstanding content. You guys really do. And I know you do a lot of the writing. And for those that don’t know, google Confluence Investments and jump on their newsletter. They put out a weekly. They put out a daily. And it’s just – it’s just good, you know. And you guys, and you in particular are a great writer and provide some cool insight. And so, you just put out a four-part series on China and the US relationships. Can you kinda (sic) go through on an overview of that document and tell us what’s going on through your eyes when it comes to the balance of power between our two great countries.
HERNANDEZ: Right. Right. And it’s actually is a five parter (sic).
CHAMBERS: Is it a five parter (sic)?
CHAMBERS: Oh my god.
HERNANDEZ: It – it was pretty extensive but, you know –
CHAMBERS: You’re right. It was a five parter (sic). Sorry about that. Yes, go ahead. Even better.
HERNANDEZ: Yeah, it’s really a sort of deep dive. And, you know the thing was is that over the course of, especially over the course of the Trump administration, you know, we had all been sort of thinking and talking more about the US/China relationship but the focus of it had been economic and as I looked at things through my geopolitical and intelligence analyst lens, you know, I started to think it was actually a much broader competition in something that we needed to deal with and get people thinking about in a broader way and so what I do in the series is first of all, part one is an explicit analysis of Chinese national interest and goals compared with US interest and goals. And then part two is a head-to-head comparison of Chinese and US military power. The next part deals with Chinese and US economic power and then the next part deals with the relative balance of diplomatic power between the two countries and then the final part is sort of a wrap up and assessment of where we stand. And I think really the key thing is that, you know, if you look at each one of those dimensions of power separately and in depth, the military, the economic and diplomatic. China is stronger than I think a lot of Americans realized. It’s a – it’s a much closer competition then you might think. And it’s – the country is very deliberately working on developing its power in all those dimensions. And so really the key thing for me was to go the next step and do an assessment and say okay, well where do we stand? And ultimately what I came up with is that if you look at the comprehensive picture, the US is probably still the stronger party between the two. But it’s close. And in certain areas, China is our equal and maybe even our superior and very importantly in the water surrounding Taiwan. China has developed its military power to such an extent that, you know, if there were a crisis in Taiwan the US very well may be reluctant and maybe be prevented from fully engaging and fully coming to Taiwan’s defense. Economically, obviously China’s got a lot of leverage because the half of its economy and the way it’s such a large importer and probably just as important is such a large market so that gives China a lot of leverage. And then finally diplomatically they’re very deliberately developing their position in international organizations, in their improving their diplomatic outreach. So, there’s all kinds of ways in which, you know, the US and the western democracies I think now are waking up to the growing power and the growing threat from China. We’re still probably ahead overall but it’s a close situation and because it’s close that means that there’s always an increased danger that one side or the other is going to make a mistake, think they’re more powerful than they really are, take a risk that maybe they shouldn’t. And so, it’s created a situation in which there’s heightened risk geopolitically and of course those risks can potentially come back to bite investors.
CHAMBERS: Now, I think you all have spoken about this. We just assumed, the US just assumed, US leadership just assumed, right, that China would open up, the economy would be more democratized and the politics would follow and so democracy would ultimately win. That hasn’t happened.
CHAMBERS: That’s a big – that was a bit of logic that we definitely messed up. That’s the point that I’d love to, I don’t know if you have any other thoughts on that.
HERNANDEZ: Well, you know, I know a lot of people look at it like that now as if it was a mess up or mistake or whatever. But, you know, if you — if you go back to the late 80’s into the early 90’s, especially after the Soviet Union disintegrated, you know, it was a reasonable bet to make that China would potentially democratize and liberalize as it reengaged with the world. And not only was it, I think, a reasonable bet but it was sort of hard to not make that bet because, you know, politically if you remember, you know, we had – the West had come out of the cold war with its credentials really burnished. You know, it had become pretty clear to people that Soviet style communism was deeply flawed. That liberalism and free markets and free economies, trade, all these kinds of things were pretty powerful and so, you know, it would have been really difficult to say, oh, well, you know, this population in China that’s more than a quarter of the world’s population that, you know, we’re going to relegate them to, you know, some kind of purgatory where they’re not allowed to participate in this new world. You know, politically that would have been really difficult. So, you know, politically it was something that we sort of had to try and like I say, after coming through the Cold War and basically winning the Cold War, it was a reasonable bet. Even after the Tiananmen Square crackdown in 1989, you know, it wasn’t absolutely obvious that China wouldn’t liberalize, so. And then a final thing is, you know, just remember that, you know, all along if, you know, I think there were analysts who understood that if the bet was wrong and China didn’t liberalize, you know, we could – we could respond. And there would be time to respond and deal with this new competitor. Now, if anything, I think, yeah, maybe we responded a little bit late. We, you know, we’re a little bit late in coming to terms with the idea that, okay, China isn’t really liberalizing. But never the less, you know, I think that we have. We’ve gotten there, now. And so, I don’t think it’s too late for the US and the West to respond to China. It would have been better if we could have done it earlier, yeah. But, regardless, you know, it is something that we can deal with now and, you know, it certainly has got people’s attention. I mean it’s really amazing that there’s a bipartisan consensus in Congress –
HERNANDEZ: — and, you know, not only is it – is there bipartisan consensus in Congress about China but, I think it’s been really instructed that the Biden administration as it has worked to bring our traditional allies into the competition, that is having pretty good success. So, you know I think that tells you that, you know, people all over the world sort of understand that China is disruptive and wants to change the global system to its benefit and that the Western democracies are going to have to respond.
CHAMBERS: How powerful is their military? Chinas?
HERNANDEZ: It is powerful regionally.
HERNANDEZ: So, and for China right now, that’s what counts.
HERNANDEZ: You know, especially given that so much of what the leadership wants to do is to retake control over territories that it has perceived to have lost. So, you know, you saw the crackdown on Hong Kong. You see the border skirmishes in the Himalayas along the border with India. But most important of all is Taiwan.
HERNANDEZ: Which as your listeners will know, you know, the Chinese communist party sees as a breakaway or a runaway province and they intend to bring it back. And so, China has really focused heavily on developing, especially its naval assets. It’s naval and air assets in the waters around the South China Sea, the East China Sea, and then the Taiwan straits.
HERNANDEZ: You know, Chinas navy right now is actually the biggest in the world and if you look at exactly what kind of ships that it has, you know, it has modernized to the point where, you know, if you’re thinking that the Chinese navy is a big bunch of rusting hoaxes from the 1960’s, you’re sadly mistaken. You know, these are now predominantly modern, multirole, technologically advanced ships. They tend to be smaller and more oriented toward coastal defense than the US navy. But all the same, you know, China has, currently has a couple of aircraft carriers. It’s building several more. And as they build out their own indigenous carriers, they’re going to be pretty powerful, modern vessels with, you know, catapult launch systems, complete battle groups available to project power all over the world, really. You know, beyond the carriers, they actually are now sporting some nuclear biolistic missile submarines which give them a strategic deterrent capability. You know, just it’s a very much more powerful navy than you would have thought just a few years ago. Their air forces are pretty strong. Loss of modern fighters and, you know, developing capabilities on that level but just as important, there’s a really – there’s been a really strong drive to develop the surface to air missile capability. So, missile defense, you know, very modern, S-400, S-300, air defense systems all over the coast and especially around Taiwan. So, you know, it’s a pretty powerful military and then I guess the final thing that I would emphasize is that, you know, even though when it comes to strategic defense, in other words the nuclear missiles, nuclear weapons, China only has, you know a couple hundred war heads or something like that compared with many, many hundreds available to the US. But the Chinese have taken care, not only to start deploying some of their missiles on submarines and on bombers, but the land-based missiles now are predominantly mobile. They’re on these rail systems, deep underground, deep tunnels which gives them in theory a much-enhanced survivability so that, you know, if we got into a nasty confrontation between China and the US that went nuclear, I don’t think the US can be assured that we could take out all Chinese nuclear weapons. If they have some survivability, they would in theory be able to strike back. And that’s a pretty dangerous situation to be in.
CHAMBERS: Yeah. Alright, so you mentioned – so thank you for that synopsis. And the only other thing I would say, and not to go too deep into this, is that I agree – I don’t know anything compared to you, but I would agree. It seems to me that China is a regional bear that you don’t want to poke. Also, they are traditionally a land power and, you know, they’ve got carriers in the water. There’s more on the way but they’re – we’ve got 13 or 12, at least and more on the way and theirs – for the most part we run the international waters and keep those supply – those ships that move around the globe with container ships full of Chinese made stuff. You know, we largely make that all happen with our navy. So, they’ve got a long way to go on that. There’s running a region and then there’s running the globe. At least that’s my ten cents worth, so.
HERNANDEZ: Yes. But, even though, you know, like I just said, I think the current situation is that Chinese, the Chinese military is strong mostly regionally. It is true though that over time their view of the world almost by necessity implies that they’re going to have to develop a blue water navy. They’re going to have to develop the capability of projecting power literally on a global basis. And you know they already have one naval base in Djibouti.
HERNANDEZ: In Africa. Just as important, you know, this big global economic development program that they have called the Belt and Road initiative where they provide assistance to countries all over the world to develop their transportation infrastructure including ports. You know, all those things are designed to give them a capability of projecting power literally all over the world in the coming decades. You’re right, they’re not there yet but and they have a ways to go but that is something that they are intent on pursuing over time. And you know the thing is that even if they say oh well, you know, we just want to protect our own territorial integrity. We want to protect our own ability to trade, protect our own access to the sea lanes etcetera. You know, the thing is that when it comes to a great power, anytime you think that okay I have a — this small limited set of interests in this region. You know, by logical extension, it’s easy to say well, in order to protect this region, I need to, you know, move my defensive line a little bit further out and then once you do that you realize that protect – in order to protect that defensive line, you need a defensive line even further out. And so, the logic would be for China literally to gain power and military capability that’s as global as the US.
CHAMBERS: That’s probably a 30-to-50-year timeline.
HERNANDEZ: I would think maybe not that long.
HERNANDEZ: Something that, you know, that –
CHAMBERS: Twenty-five years?
HERNANDEZ: — the Chinese are being very deliberate. They have specific goals when they want to reach different milestones and it is true that their official goal is to have a world class military by 2049, which would be the 100-year anniversary of the founding of the Peoples Republic of China. But all signs are that by the mid 2030’s is where Shi Ping would like to have the Chinese military at a clear position with regard to the US.
CHAMBERS: Wow. Okay, thanks for that update. I – okay. Taiwan, I know you guys are going to be doing some publications about Taiwan. There’s a chip shortage. So, and Taiwan as we just discussed is right in China’s backyard and likely that will be – I think there’s going to be a little skirmish over that, myself, sooner or later, but anyway. What’s going on? What’s the – what’s shaking with that?
HERNANDEZ: Yeah. Taiwan is a – as people have started to focus on the US/China competition they – it’s becoming increasingly clear that a big part of the issue or a big part of the problem is Taiwan. In fact, I think just the – this latest issue of the economists this week, has Taiwan as it’s cover story and, you know, it’s especially important because Taiwan and Taiwan’s semiconductor manufacturing, the company in particular has become absolutely critical to the global semiconductor industry, the global semiconductor value chain. And it’s true that an awful lot of semiconductor manufacturing happens in the US or in Europe or elsewhere in Asia. But the key is that the very most advanced computer chips that come out these days are mostly made in Taiwan. In fact, mostly in a specific region of Taiwan and from Taiwan semiconductor. And these are the chips that power things like mobile telephones and super computers that do artificial intelligence and these big quantum computing projects and stuff like that. The real cutting-edge chips. And so, yeah, we’re doing a lot of work on this and looking at the risks. And, you know, first of all from China’s perspective, you know, that’s one of the real targets of one of the real reasons of why they would want Taiwan. I mean they want Taiwan politically anyway. But if China – if the mainland was able to take over Taiwan immediately, China would become this master of the most advanced microchips in the world. And it could reserve those chips for itself so if you think there’s a chip shortage now, you know, it could become a situation where China has all the chips they want and everyone else is starved and held back. From the perspective of the US, obviously, that that’s an issue and we want the opposite. We want to make sure that those chips are still available to the US and to our allies and we want to clamp down on the provision of those chips to China. So, you know, what we’re thinking is that Taiwan is a great example of how different countries and even companies worldwide now are being faced with the dilemma of having to choose between being responsive to China or being responsive to the US and its allies and it’s a very uncomfortable situation for countries and companies to be in. If, you know, one of the big risks is that if we got into a shooting war over Taiwan, you know, if China invades militarily, you know, if those manufacturing plants, the Fabs, the fabricating plants that make those chips on Taiwan, you know, if they’re damaged, that’s a major threat to literally the world economy. And so, yeah, Taiwan is a big source of rifts. Now as we’ve done our work, we think that, you know, the risks to losing those Fabs is so great that it’s probably a reason not – it’s a reason for China not to invade militarily. We actually are thinking that the more likely way that China would put pressure on Taiwan would be, say a quarantine, like a trade quarantine or a blockade or something like that. Or just a continuation of its political efforts to get countries to stop working with China – with Taiwan diplomatically etcetera. But the problem is all those kinds of activities run the risk of someone making a bad move that leads to a military confrontation. So, it’s a – it’s a big risk.
CHAMBERS: So, thank you for that update on China and Taiwan. I appreciate it. Let’s move on, I know I don’t have you forever, so I want to cover a couple more topics. One is Japan. It’s kind of staying in Asia. They got a new president. They’re a big ally of ours. They actually have a pretty good navy as well and they’re obviously a major factor in Asia. Can you give us an update on Japan and what’s going on over there?
HERNANDEZ: Well, you’re right. They have a new (inaudible) — continuity with the previous government of Prime Minister Abe. Both pretty intent on maintaining a close alliance with the US, trying hard to maintain the economic growth in Japan. Build up their military capability over time, etcetera, so. You know, that all has been a positive thing in the US/Japan relationship. Suga’s had a number of scandals, shortcomings, you know, COVID in particular has been an issue and they’re in the middle of another wave that is threatening the Tokyo Olympic games for this summer, so, you know, it’s a – it’s an evolving situation but, you know, there is a certain level of continuity with the Abe government. And Japan, you know, when it comes to geopolitics, Japan really is a lynch pin in the US strategy with regard to China and with regard to, you know, our whole policy throughout the region. And, you know, when it comes to the chips that we were just talking about, the microchips, you know, Japan in particular is pretty dependent on those advanced chips from Taiwan and so I think what we’re trying to get the message out about is that Japan is also a really big part of the US/China competition. You know, Japan even though they have a passivist constitution that limits their ability to develop their military, you know, they are feeling pretty threatened by China and its possibility of taking over Taiwan and so, you know, we sort of think that over time Japan is going to be brought ever closer into the US orbit and stick with us and it will be a big part of the future geopolitical makeup of the region.
CHAMBERS: And they, on a historic basis, they have no love loss. China and Japan. There’s a lot of static, historical static with those two, for sure.
HERNANDEZ: Right. Right. Exactly.
CHAMBERS: And that stuff just does not go away because that’s embedded in the DNA of both of the cultures.
HERNANDEZ: Yep, exactly.
CHAMBERS: Yeah. Yeah. Alright, that leads us into another kind of interesting topic that you guys are covering and it has to — Japan is kind of an interesting example of population because they have a very much an aging population. So, you guys have done some studies on population aging on a global – population aging on a global basis and inflation on a global basis. We are, you know, one of topics we’re all, you know, clients are asking about and the headline news when it comes to finances is inflation. And population is one of these things that demographics is just an area that I think sometimes it’s so slow creeping that people just don’t, you know, pay attention to it and you guys do. So, what were some of the – what’s going on and what were some of the conclusions that you guys, you and Confluence came up with or your team at Confluence came up with regards to this topic of aging and demographics and inflation?
HERNANDEZ: Yep. Yeah, no it’s a – this is an important topic and like you say, you know, demographics evolve so slowly over time it’s really easy for investors to just, you know, not focus on it and not really see the impact in current economic or financial data or whatever. But, yeah, it’s a very important topic and, you know, if you’re of a certain age, you may remember that way back in the 60’s and 70’s, you know, everyone was talking about the population bomb. You know, there’s a rapid increase in population and, you know, lots of births and things like this and what people don’t realize is that, you know, a lot of what had happened after World War II is that, and in fact even before World War II. The world went through decades where we were making all kinds of progress in terms of improved sanitation, you know, water sanitation, stuff like that. Improved medical care. We were driving down the death rate and all that happened before the birth rate changed. To change the birthrate, you know, that takes a real change in culture. And so, you know, by the 60’s and 70’s the global death rate had fallen pretty rapidly but births were pretty high and so you did see this sort of momentary spike in population growth. But what people don’t realize is that eventually societies adjust. And, you know, they adjust to factors like the need for education and just the development of the economy etcetera. And so, long story short is, we’ve gotten to the point now over the last few decades where birth rates in countries all over the world have fallen down and are starting to approach the death rate. And so over time, you know, what that means, you know, if you have a relatively smaller number of births then the average age is going to increase and the rate of population growth is going to slow. And that is happening in developed countries like Japan and Germany and the US, you know, multiple countries around the world are actually in population decline where literally the number of people is in those countries is going down. And the average age is getting older. That’s also happening in emerging markets, including in China where the population is really slowing and becoming much older and of course there you had those broader trends exacerbated by the one child policy for decades. Well, what people have to keep in mind is that there’s a lot of economic implications to a slower economic, or a slower population growth. For one thing just, you know, if you have a smaller number of people, the volume of gross domestic product is going to grow slower. But it’s even more than that. What you have to keep in mind is that especially in the developed countries as people get older, at some point they start to spend less and my work has shown that after people hit the age of about 55, after they start to approach and then finally enter into retirement, their spending goes way down and the implication of that is that there’s less demand in the economy and so the analysis that I’ve been working on recently really works to trace through how that impacts inflation and as you might expect, as the rate of demand slows, it is associated with a slowdown in the rate of price growth. Now, there’s clearly a lot of other things that can impact inflation rates in the near-term. Everything from the, you know, commodity supply disruptions to monetary policy, fiscal stimulus, etcetera. But the way that my analysis is pointing is to say that, you know, slowing population growth and population aging are really important background factors that are likely to be a headwind to inflation over the coming decades. They won’t be the only drivers but they will tend to decrease inflation and prevent inflation from getting as bad as it otherwise would over time.
CHAMBERS: So is – do you think when the – maybe it’s to short of a time but when the fed is saying that this inflation is transitory, is that kind of – I think that plays into the overall theme that you’re saying too, by the way. Because every, like I said, we speak with the – we speak with investors all the time, you know. And topic of conversation – I went out and played golf with a couple people yesterday and the talk of inflation came up, you know, so. But the fed saying hey this is transitory. So is that – I think that dovetails quite well into what you’re saying form a long term point of view.
HERNANDEZ: Yes. Although, I think the fed still is, when they’re talking about the inflation being transitory, it’s a couple of shorter term considerations that are most in their minds.
HERNANDEZ: One of which is simply the base effect issue where, you know, when the pandemic really took hold, literally a year ago right now –
HERNANDEZ: — a lot of prices actually declined and so as you compare today’s prices to their year earlier levels, you know, it makes it look bigger, you know, inflation looks like more of a problem than it will likely look ways as we get towards the end of the year –
HERNANDEZ: — because, you know, late in 2020 prices started to recover and then, you know, as the – as we move past the pandemic and the economy starts to open again and you get people spending again, you’re likely to have this situation where there’s a lot of near term demand like in the spurt in near term demand while a lot of companies are still not back to normal in terms of what they can provide, you know.
HERNANDEZ: Staffing level or their equipment levels or whatever and so, you know, you’re also likely to see some transitory price pressures from that alone. But yes, in the background you still have this demographic headwind for inflation that is going to mean that, you know, say if inflations going to spike to say three percent by summer, maybe without the demographic headwind, who knows. Maybe it would have gone to three and a half percent or something like that.
HERNANDEZ: That’s what we’re trying to say. It’s not the absolute and only determinate but it is something that is likely to hold down inflation over time. And for investors, you know, what that means is that, you know, if you’re worried about, you know, your bond portfolio or thinking well, do I need to adjust my allocation, you know, and buy more gold or tips or whatever. That’s something that you want to keep in mind. As scary as those near termed inflation dynamics might be, you need to step back for a moment and remember that there’s also these inflation headwinds out there that are going to work in the opposite direction.
CHAMBERS: And going back to China, what – from an investors point of view, where does the rubber meet the road there? I mean what’s your – what should investors, from an investor point of view, what should they be thinking about when they look at – they forementioned a relationship with Asia. Is there any comment on that?
HERNANDEZ: A couple of points. First of all, in the near term, not only is there, you know, risks of, you know, a war, some kind of military confrontation, you know, nasty geopolitical tensions. All those kinds of things that are going to be unsettling by themselves. But, you know, I think more subtly or more in the realm of the financial markets, a couple of things. First of all, that idea that I mentioned about, you know, countries and companies being forced to choose between China and US, that’s another way of saying that this world of global value change that we’re all used to is likely to be adjusted. You know, we’re going to probably be in a world where at least in some industries or some product groups, supply chains are going to be more regional.
HERNANDEZ: I’d say, things that we use to rely on China for, we’re going to produce ourselves or we’re going to get it from Mexico or Canada or –
HERNANDEZ: — among our allies etcetera. That’s going to be something that will tend to raise costs and so –
HERNANDEZ: — it will, that actually is something that over time could work to make inflation worse but just as important in terms of the capital flow. So not trade flows, but capital flows. One thing that we’re watching closely is how – starting with the Trump administration and now we’re seeing it continue with the Biden administration, what we’re seeing is that the US is willing to cut off China of capital flows. You know, there’ve been these different initiatives that have made it harder for Americans to invest in Chinese stocks. Say for companies that support the Chinese military or they don’t recognize US accounting standards and things like that. That’s all a risk. Especially given that, you know, Chinese equities have been on a roll at different points over the last couple of decades and, you know, if US or western investors run the risk of having those positions cut off, then, you know, obviously that’s something that is potentially going to be bad for pricing –
HERNANDEZ: — of those positions, so. That’s something that we’re watching pretty closely in the near term. And like I said, longer term is more of the issue of the military risks, risks to the economy, that kind of thing.
CHAMBERS: Interesting. Well, that’s – thank you for that analysis. I appreciate it. It certainly is a topic worth keeping an eye on and I know you guys are. And I appreciate that and I appreciate the insight from an investors point of view because sometimes you get into these intellectual conversations and it’s like okay, well what does that really mean? You know what I mean? So, I appreciate you talking more specifically. Alright. I’m going to –
HERNANDEZ: And by the way –
HERNANDEZ: — one thing I would add just to –
HERNANDEZ: — the end of that is that –
HERNANDEZ: — you know, I’m trying very consciously to emphasize that these are risks, you know. These aren’t necessarily –
HERNANDEZ: — things that are absolutely going to happen. And –
HERNANDEZ: — you know, we monitor them and we’re trying to gauge when they become, you know, more eminent but, you know, you can also be hurt by responding too quickly, you know.
HERNANDEZ: We’re not necessarily saying that oh, you don’t want to hold any positions in Chinese stocks or anything like that. You know, we’re definitely not saying that. So, I just want to emphasize that.
CHAMBERS: Yeah. No, I get it. I – it’s – absolutely, understand that. And I’m sure our listeners do as well. Alright, I’m going to switch it up. I’m going to ask a couple more personal questions. I don’t know if you want to get in on this, but I’m hoping. What is – what is Patrick reading, streaming or podcasting these days? I’m sure you read some absolutely awesome stuff so what – what’s going on, on that front?
HERNANDEZ: You know, that’s a great question. I actually just finished a book called The War that Ended Peace by Margaret MacMillan. I think it came out maybe a decade ago or so. I don’t think it’s super new but it deals with the lead up to World War I and the reason I read it was that there’s a lot of people who, you know, as they think about the US/China competition and rivalry. You know, people look at it in terms of the Thucydides trap. You know the term from international relations about the risk of war being really heightened when an established hegemon is being threatened by a rising power and, you know, a lot of people look at the US/China relationship and think that well, you know, this is kinda (sic) like the rivalry between Britain and a rising Germany at the end of the 1800’s and the early 1900’s which, you know, ultimately ended up in World War I, so. That’s the reason I read the book and it’s pretty good. Not the greatest book ever but certainly interesting in that, you know, it does talk a lot about how a lot of the background issues that led to World War I were the fact that this rising power in the middle of Europe, in other words Germany. You know, saw itself as the wave of the future, you know, they recognize – they’re very self-aware that they were becoming more powerful and wanted their place in the sun and at the same time, Britain and to a lesser extent, France and other powers were frequently blocking Germanys attempt to sort of gain space, you know, as they tried to get new colonies and things like that. So, you know, it was a useful book to understand that dynamic but just as important, you know, it’s really interesting that even when you have that dynamic it can be, you know, that just introduces certain frictions or fragilities into the international system. But the thing that actually can spark a war can be, you know, some smaller scale subsidiary conflict like in Serbia and the Balkans as it was with the lead up to World War I, so.
HERNANDEZ: You know, I guess the lesson for me or whatever it reminded me about was that when you have stresses between the big powers — the bottom line is just that, you know, when you have a – an international system where you’ve got some real frictions and stresses between the great powers, you know, you have to keep in mind how smaller scale subsidiary conflicts among those – the allies of those great powers. You know that can be a danger point and you really need to monitor that and be careful about that.
CHAMBERS: Yeah. For sure. Doesn’t take much. Another cool book is Lords of Finance. I’m sure you’re familiar with the bankers who broke the world. That’s a great book that kind of talks about that era as well.
CHAMBERS: That’s a great book. I love that book. I want to thank you so much for your time. It’s so cool to talk to people like you about this – these topics because I just think your perspective on it is – you just don’t run across it every day so it’s absolutely fabulous to have you. And I’m sure we’ll have you again. I’d love to have you again, you know, as things unfold and the topics come up, I’d love to maybe have you again as a guest. You’ve been wonderful.
HERNANDEZ: I would love to. This has been fun. It’s always great to share out view point and I like to be asked questions too.
HERNANDEZ: It keeps me – makes me think on my feet and, you know, it’s a good intellectual exercise.
CHAMBERS: Yeah, no I love it. Real quick though. I know I just wanted to – another – where – any particular restaurants in your community that you want to shout out to that maybe you’ve been supporting with to go or perhaps you’re beginning even to dine in with? I was – I’m a big food guy so I always love to ask that question.
HERNANDEZ: Yeah. You know, I – I don’t know, I’m sort of a Francophile —
CHAMBERS: Oh, nice.
HERNANDEZ: — Mediterranean cuisine and so in west St. Louis county there’s a restaurant called YaYa’s which I like quite a bit. It’s – the one that I’ve been to most recently, so yeah.
CHAMBERS: What kind of cuisine?
HERNANDEZ: If you’re ever in the area, that’s where we’d have to go.
CHAMBERS: What kind of cuisine is that? Like Mediterranean?
HERNANDEZ: Mediterranean, you know, sort of healthy –
HERNANDEZ: — you know, sort of French, Italian –
CHAMBERS: What’s your, like go to – what do you – do you get number three or what’s the – is there any particular one, like a dish that you get there?
HERNANDEZ: I get – just about everything on the menu, I think is like —
CHAMBERS: Equal opportunity. I love it. I love those places. That’s great. Well, you know, during this time, obviously I like to support restaurants. It’s been a hard year for restaurants in particular, so. The service industry in general and so I always – when I have guests on, I always like to shout out to their local place, so. YaYa’s. I like that. That – so if you’re ever in St. Louis, you gotta (sic) go there.
CHAMBERS: Alright. Patrick, thank you so much again. I appreciate it. Let’s do this again and have a great weekend and we will talk soon.
HERNANDEZ: Alright. Well, you too. Thanks so much for having me.
CHAMBERS: Yeah, of course, my friend. Thank you so much. We’ll talk soon.
HERNANDEZ: Bye bye.
CHAMBERS: Bye bye.
Patrick Fearon-Hernandez – Full Bio
Patrick is a Market Strategist at Confluence Investments. He analyzes financial market trends, global economics and geopolitical developments, including international security issues in order to map their implications on investment strategy. Patrick also writes various reports that lay out the firm’s geopolitical, economic and market insights. Prior to joining Confluence, Patrick worked in a wide variety of investment roles. He served as a portfolio manager at AdvisorNet Financial Partners in Arizona, a portfolio manager at Terra Nova Ventures and also an alumnus of A.G. Edwards & Sons, Inc as the firm’s international economist.
Trevor Chambers – Full Bio
Trevor joined Olde Raleigh Financial Services in January of 2015 and his primary role is new business development and marketing. Prior to joining the firm, Trevor spent 12 years working at his family’s restaurant, Raleigh’s Bella Monica Cucina & Vino. “Exceptional service, no matter the industry, is paramount and we attract clients who value and take comfort in being taken care of.”