The global power and energy transition

The world is no longer running on a single global cycle. It is running on three. 

The old idea of a synchronized world economy has given way to a new structure—one defined by energy security, industrial policy, and geopolitical risk. These forces result from interplay between the energy transition away from fossil fuels, and the power dynamics that results naturally when the old sources of wealth and power are challenged by new ones.

This is the Global Power and Energy Transition.

Each major region now plays a distinct role in this new system. Our portfolios are designed to reflect those roles—participating in the transition where it creates opportunity and hedging it where it creates risk. The diversification principle is to balance that with neutral areas.

With the three elements of global power dynamics come three centers.

Investors need to recognize that the forces at work have no single point of origin. The results may be undesirable but are traceable to the resurgence of Real Politik.

States do what they can to survive what they must.

This has created a high stakes game of poker, with the ante upped every minute.

Investors need to reframe their thinking in a disciplined way, to diversify portfolios for a new level of geopolitical risk, recognizing that the old energy system is necessarily giving rise to a new industrial system, widespread innovation in technology, and changing supply chains.

This transition will irrevocably alter the world balance of power. Therefore, it is not surprising that political rhetoric revolves around choosing a side in this contest.

I do not believe that choosing a side is a sound way to position portfolios in these markets. Every part of this global market has something to offer.

We must recognize the key players, the forces at work, and the areas of strength.

In this note, I lay out the framework in a tri-polar model of portfolio risk allocation.

Let me begin with the three mega-regions in the diagram above.

• The United States
• The European Region
• The Asian Region

Notice that with the exception of the USA, these are regions, not nations.

United States — The Stagflation Hegemon

The US is the only major economy that benefits from higher oil prices. It anchors the global system through:

• energy dominance
• fiscal dominance
• industrial policy
• defense expansion
• supply‑chain sovereignty

However, the US is now pursuing a foreign policy dominated by tariffs, sanctions, coercive diplomacy and wars, both overt and covert. This is driving supply shocks and rising price pressures. It is not pro-growth, and it will likely lead to stagflation.

The appropriate sectors to play are hard assets, energy, defense, quality tech, and insurance.

The USA had an early lead in electric vehicles, and undisputed lead in military strength, plus a powerful national innovation system in science, engineering and capital markets.

However, the political and social institutions of the USA are under enormous pressure in the midst of rising populism and a perception that the nation lost a status it must now regain.

Whether this is true or not, does not matter, because the politics has swung that way.

Increasingly, the USA is pursuing policies designed to obstruct the development of peers.

This is a combative posture that elevates conflict over cooperation.

We see that now with a war-of-choice in the Middle East.

A stagflation barbell makes sense for US markets.

Choose hard assets, fossil fuel energy, the defense complex and quality technology.

Rising interest rates are likely to harm banks and regular financials.

Insurance companies with quality underwriting may benefit from rising interest rates.

Europe — The Energy‑Vulnerable Stabiliser

Europe imports nearly all its oil and gas. It cannot run a stagflation barbell. Its regime is defined by:

• energy vulnerability
• low growth
• high regulation
• strategic re‑militarisation

Our European exposures reflect this: healthcare, utilities, insurance, defence, and global consumer needs. Europe is the stabiliser that buffers the shocks of the transition.

The appropriate sectors in Europe are renewable energy utilities, defense, quality health and pharma, high-end medical devices and necessities like precision optics in spectacles.

Europe faces particular challenges from Asian manufacturing, but may pursue detente in trade by welcoming factory investment in core industries like electric vehicles.

Europe cannot call the shots in global politics, but it can run interference on both sides, and can also choose pragmatism in backing either side where it finds a key interest.

The Real Politik of Europe is presently clouded by the loss of clear purpose in the European Union, an ongoing fear of Russia, wariness of China, and a fractured NATO.

The stakes are very high for Europe to find a way forward.

Further war, while possible, would not likely improve the situation.

The present Israel-US war against Iran will likely bring the situation to a head.

China — The Industrial Deflation Engine

China is not a consumption story. It is an industrial one. Its regime is shaped by:

• deflation
• energy insecurity
• strategic sector support

We hold only the sectors China will defend: EVs, batteries, energy security, telecoms, and financial stability. The problem of involution, namely excessive domestic competition has been recognized by the government as a key obstruction to further development. However, changing ingrained domestic savings habits to favor greater consumption will take time.

The appropriate sectors in China are renewable energy, electrification, minerals, batteries, robots and the domestic semiconductor supply chain, telecommunications, domestic oil and gas, and banks for income.

There is huge potential in China for the development of listed infrastructure, especially given the need for a retirement savings industry, but the institutional knowhow is underdeveloped. This will change over time but is a multi-decade project of reform to focus on profitability rather than pure system expansion. This is recognized officially but happens slowly.

For example, China has the largest and highest quality network of toll roads and high-speed railways anywhere on the planet. However, this is not yet institutionally investible.

There are listed toll roads, which are interesting, but the market needs to be developed.

In our view, China offers plenty of long-term opportunity that is likely to increase with the shift towards a lower headline GDP growth, but higher quality investment environment.

This point is lost in Western financial media.

They do not appear to know very much about contemporary China.

Japan — The Industrial Reflation Engine

Japan is the mirror image of China. It is the only major economy with:

• rising wages
• rising capex
• defence expansion
• BOJ normalisation
• supply‑chain reshoring

Our Japan sleeve reflects this perspective.

The appropriate sectors in Japan are defense, energy systems, commodities, trading houses, and financial reflation. High quality capital goods are the Japanese specialty.

The largest trading partner of Japan is China, which buys many machine tools, and high-end materials from Japan. This trade is upset by the US-led efforts to contain and obstruct Chinese economic and technological progress. However, Japan trades with China.

Some of our best-performing stocks in Japan are semiconductor equipment firms that do a brisk trade selling machinery to China. 

The Sogo Shosha trading houses handle about 30% of imports to Japan and 20% of exports. These receive little attention in the Western financial press, although they did garner press mentions when Warren Buffet emerged as a large shareholder in all five.

We have held them since 2011.

Minor but Essential Anchors

These are small weights globally, but strategically indispensable.

Historically, Australia has played a large role in commodities trade in the region. This will likely continue but we are less bullish going forward. The biggest buyer is China, and government policy in Australia seems intent on shifting away from high exposure to this buyer.

This is not good for Australia as the USA is not a big buyer of minerals.

We have supplemented our positions in Australian miners with Chinese miners. These are of higher quality than most investors realize and have allocated capital away from Australia to prospective markets in Africa and Latin America. The risks are higher, but so are returns.

Our Strategy: Participation + Hedging

The Global Power and Energy Transition is with us, ready or not.

Our global portfolios have adjusted to the new opportunities:

• participate in the transition through industrial, energy, and defense exposure
• hedge the transition through healthcare, utilities, telecoms, and insurance
• balance the transition through regional diversification across the three regimes

The dominant approach of many financial institutions today is to play a narrative on winners versus losers. This makes little sense in the context of the world at large.

Presently, the USA dominates the global weighting in both equities and fixed income.

In our judgement, the policies pursued by the United States will have an unintended drag on the global standing of that nation as a trade partner, security partner, and markets center.

There remain splendid opportunities in the USA, but we are underweighting that market.

Europe is very challenged in direction because of psychology.

When considering the psychology of geopolitical power:

• The dominant center of power has something to lose
• The rising center of power has something to gain
• The fading center of power has confusion and indecision on who to back

The standard political rhetoric in the West, is to pitch the geopolitics of our time as an epic struggle between the West and the Rest to defend Western civilization.

This briefs well as a tabloid headline.

In my view, it is a rotten way to allocate capital in a global financial market.

The Rest have been around a long time.

They will be here tomorrow, and long after the self-absorbed West has degenerated into chaos from the political bun fight to apportion blame for the coming energy crisis.

The overweight we have is to Asia.

This is the region that is rising, and the one with hybrid civilizational and economic vigor.

It is not one civilization, but many, and they trade and rise together.

This does not brief well as a tabloid headline. 

I do not care how it briefs to those who do not invest for a living.

Tabloids are junk.

I am backing the rising region because they think positively about shared gains.