Brace For Violent ‘Fourth Turning’ As 80-Year Generational Reset Begins | R. Patrick Kent

Key Concepts

• The Fourth Turning: A generational theory positing a cyclical pattern of societal eras, with the fourth and final era being a period of crisis and potential societal transformation.
• Global Dollar Liquidity: The availability of US dollars in the global financial system, crucial for international trade and debt servicing.
• Quantitative Tightening (QT): A monetary policy where a central bank reduces its balance sheet by selling assets or allowing them to mature without reinvestment, thereby decreasing liquidity.
• Nominal Growth: Economic growth measured in current prices, including inflation.
• Quad Outlook: A framework (developed by Keith McCullough) that categorizes economic environments based on the direction of growth and inflation (e.g., Quad 321: decelerating inflation, accelerating growth).
• Re-industrialization Policy: Government initiatives aimed at bringing manufacturing back to a country.
• Rearmament: The process of rebuilding or increasing military strength.
• Energy Return on Energy Invested (EROEI): A measure of the ratio of energy produced to the energy used in the process of production.
• Biophysical Economics: An economic framework that emphasizes the role of energy and natural resources in economic activity.

The Fourth Turning: An Investment and Societal Theme

The discussion centers on "The Fourth Turning," a significant economic and investment theme for the current generation, exploring its potential impact on civilization and investment strategies over the next decade. Patrick Kent, portfolio manager at Hedgi Asset Management, elaborates on this concept and its implications.

Current Market Positioning and Liquidity Dynamics

1. Liquidity as a Key Market Driver:

• Global Dollar Liquidity: Patrick Kent emphasizes the critical role of global dollar liquidity, stating it's the "most important measure" due to the dollar's dominance in trade and the vast amount of dollar-denominated debt outside the US.
• Transmission Mechanism: Increased money supply generally leads to more available dollars for asset purchases, driving asset prices higher. Conversely, tighter liquidity forces liquidation to fund activities.
• Recent Liquidity Drain: The expansion of the US Treasury's account at the Federal Reserve from $300 billion to $1 trillion, coupled with the Fed's Quantitative Tightening (QT), significantly tightened liquidity, leading to increased market volatility.
• Crypto as a Liquidity Source: Unfortunately for crypto investors, digital assets have become an "easiest source of liquidity" due to their ease of liquidation.

2. Short-Term Outlook (6-12 Months):

• Potential for Liquidity Re-expansion: The Treasury's balance at the Fed is expected to return to its normal range of $300-$400 billion, which could inject liquidity back into the market.
• Fed Easing and End of QT: Anticipated Fed rate cuts and the end of QT are also expected to support liquidity.
• Quad 321 Scenario: A potential "Quad 321" scenario (decelerating inflation, accelerating growth) is projected for the coming year.
• Consumer Tax Rebates: A consumer tax rebate in the first quarter could further boost economic activity.
• Cautious Optimism: While positive factors exist, a cautious approach is advised, with continuous monitoring of the liquidity environment.

3. Long-Term Investment Thesis and Liquidity:

• No Contraction Expected: There's no inherent reason for money supply to contract long-term, especially with the end of QT and potential dovish Fed policies.
• Long-Term "Long" Positioning: This suggests a long-term investment thesis leaning towards being "long" (invested in assets that appreciate).

The Fourth Turning and Long-Term Economic Themes

1. Chronic Deficits and Monetization:

• Deficits as a Driver: Future deficits are expected to be monetized, with a historical tendency to "inflate away" some of this debt.
• Inflation Protection: This necessitates a focus on inflation protection as a chronically needed investment theme.

2. Key Pillars of the Fourth Turning:

• Protectionism: A shift towards nationalistic economic policies.
• Re-inflation: A potential for sustained inflationary pressures.
• Industrial Policy: Government intervention to promote specific industries.
• Rearmament: Increased global defense spending.

3. Impact of Re-industrialization and Rearmament:

• Monetization of Policies: Re-industrialization and rearmament policies will require significant financing, potentially leading to chronic inflation.
• AI-Driven Re-industrialization: The buildout of data centers and the associated power demand for AI are significant drivers of economic activity.
• Defense Spending: Europe's increased defense spending is a secular trend that will persist regardless of specific geopolitical events. The US military's modernization, including drones and cyber capabilities, also contributes to this trend.
• Commodities: While geopolitical events can impact commodities like oil, the market has shown resilience in absorbing supply disruptions through alternative channels and discounts. The break-even price for US shale oil production has increased, suggesting a floor for prices.

4. The Geopolitical Landscape:

• US-China Rivalry: The ongoing cold war between the US and China, with Taiwan as a potential flashpoint, is a significant driver of rearmament.
• Cyber Warfare: Increased hacking activity by nation-state actors indicates an ongoing cyber warfare, making cybersecurity a crucial investment theme.

Inflation Dynamics and the Role of AI

1. Post-COVID Inflation vs. Volcker Era:

• 2008-2009 QE: The Federal Reserve's aggressive balance sheet expansion post-2008 did not lead to significant consumer price inflation, primarily due to deflationary impacts from Chinese imports and a lack of a direct transmission mechanism to consumers. Instead, it fueled asset price inflation.
• Post-COVID Transmission: The COVID-19 pandemic created a direct transmission mechanism through stimulus checks, leading to a surge in consumer spending against a backdrop of supply chain constraints, thus driving inflation.

2. Future Inflationary Pressures:

• Gradual Dial Turning: Future inflation is expected to be more of a "gradual dial turning" rather than a sharp spike like the Volcker era.
• Drivers: Energy cost-driven inflation, the long lead times for new utility supply, mine development, and significant spending on re-industrialization, rearmament, and AI/data centers are potential drivers.

3. AI's Deflationary Argument and Counterarguments:

• Technological Progress: Technological advancements, including AI, are generally deflationary by nature, potentially increasing productivity and reducing costs.
• Current Inflationary Force: However, AI is currently viewed as an inflationary force because companies are subsidizing demand by selling AI endeavors at a loss.
• Financing AI Buildout: Companies are borrowing heavily to finance AI development, leading to increased debt and reduced stock buybacks, which can indirectly impact the economy.
• Energy and Material Costs: The massive scale of AI buildout will necessitate significant energy and material consumption, driving up costs.

The Bond Market and Demographics

1. Long-Term Structural Bull Market Ending:

• The long-term structural bull market in bonds appears to have ended around 2021.
• Reappearing Inflation: If inflation reappears, a long-term structural bear market for bonds could continue.

2. Historical Bond Yields:

• Average Yield: Historically, the average risk-free rate over hundreds of years has been around 4-5%, driven by growth and inflation.
• Future Projections: Demographic trends and potential inflation increases could push bond yields closer to 4.5-5.5%.

3. Demographic Shifts:

• Aging Population: An aging demographic and declining fertility rates (below replacement levels in many developed countries) are significant societal changes.
• Impact on Finance: This leads to fewer consumers, less economic growth, and increased dependency ratios.
• Societal Burden: The burden of financing healthcare and social security for an aging population will fall on younger cohorts, potentially leading to higher taxes or debt monetization.
• Productivity Drag: An aging population can be a drag on productivity as a larger portion of society relies on the working population for support.

Energy and Commodities Play

1. Energy Transition and Realism:

• Never Stop Using Energy Sources: Humanity has never stopped using an energy source; rather, older sources decrease as a percentage of the total energy mix.
• Realistic Transition: The transition away from fossil fuels is not as straightforward as some believe, given their high energy density and return on investment.

2. Nuclear Energy and Natural Gas:

• Resurgence of Nuclear: There's a resurgence in interest in nuclear power due to its reliability, low carbon intensity, and high energy density.
• Natural Gas for Balancing: Natural gas will be crucial for balancing intermittent renewable energy sources.
• Industry Indicators: Strong order backlogs for gas turbine companies and the potential return of facilities like Three Mile Island indicate this trend.
• Germany's Experience: Germany's decision to shut down nuclear power led to increased dependence on Russian gas and significant de-industrialization due to high energy costs.

3. Financing Nuclear Facilities:

• Government Support: Governments are actively supporting nuclear development through policies like the Inflation Reduction Act and initiatives from both the Trump and Biden administrations.
• Private Sector Involvement: Private companies are investing in both traditional nuclear and advanced technologies like small modular reactors (SMRs) and fusion energy.

Biophysical Economics and Energy's Role

1. Energy as a Fundamental Input:

• Misunderstood Component: Energy is often treated as a substitutable good in traditional economic models, but it's a fundamental input.
• "Capital without energy is a sculpture, labor without energy is a corpse." (Economist Steve Keen)
• Economic Fragility: The disappearance of energy companies would cause immediate economic collapse, highlighting their critical, albeit often undervalued, role.

2. Energy Efficiency and Tech:

• Multiplying Force: Technology, particularly in the digital age, significantly increases the output generated from a unit of input, including energy.
• Energy Return on Investment (EROI): Software and tech sectors demonstrate high EROI, efficiently converting energy into economic value.

Digital Assets and the Fourth Turning

1. Hedgi's Bearish Stance on Crypto:

• High Volatility: Hedgi Asset Management has been vocally bearish on crypto, citing its high volatility.
• Correlation to NASDAQ: Crypto assets have shown a high correlation to the NASDAQ, rather than to assets like gold, which are typically considered stores of value with low supply growth.
• Speculative Activity: This correlation is attributed to significant speculative activity in the crypto market.

2. Intermittent Portfolio Inclusion:

• Risk Management: While currently bearish, Hedgi will intermittently consider digital assets for portfolio inclusion, emphasizing the need for careful volatility management.
• Blockchain and Tokenization: The broader implications of blockchain and tokenization within the Fourth Turning narrative are not explicitly detailed but are tracked by Hedgi.

Conclusion and Where to Follow

Patrick Kent's insights highlight the interconnectedness of global liquidity, geopolitical shifts, technological advancements, demographic trends, and energy dynamics in shaping the economic landscape. The "Fourth Turning" framework provides a lens through which to understand these complex forces and their potential impact on investment strategies. Investors are advised to focus on inflation protection, rearmament, and energy security, while remaining cautiously optimistic about potential liquidity improvements.

• Follow Patrick Kent: @RPKent on X (formerly Twitter).
• Hedgi Asset Management: Visit their website for fund information and research.