A good way of tracking the cycles of capitalism is to identify the leaders of each cycle, for it is the cultural and economic forces of the time that appoint its leaders into positions of power.

Western capitalism experienced four cycles since World War II:

They all succeeded for a while, then failed.
What’s next?

This note continues on the GDP accounting model introduced by Gavekal-IS in August 2022, by analysing and comparing the place of energy in the GDP production of the European Union, Germany, France and Italy.

In the context of the 2022 Russo-Ukrainian conflict, the model is able to provide estimates of the potential impacts of energy price spikes or volume shortages on the GDP output, which is a particularly salient issue for the economy of the European Union.

In particular, in the year ahead, with a 1 in 3 chances, the model reports that, even in the absence of any shortage in energy supply, the whole European Union, Germany, France and Italy would go into recession at rate of -1.2% to -0.3%.

The economy having the highest exposure to recession because of primary energy price spikes and volume shortages is Italy.

Is Italy today all about politics?

In August, we developed our first econometric model about economic growth, applied to the European Union. There were two innovations:

This week, we provide simulations to compare Germany, France, and Italy. This letter is published together with the model in full detail for quant teams.

Beware of Italy!

Introducing the first econometric model of Gavekal-IS, about economic growth, as summarized in our previous publication, “Economic Value-at-Risk”. This time, with full transparency, mathematical, data construction, and simulation details.
Our goal here is to track the economic Value-at-Risk of the European Union facing the unprecedented combination of primary energy scarcity, primary energy massive inflation, and secondary inflation.

The first econometric model of Gavekal-IS, about economic growth.

For almost 40 years, financial institutions have developed sophisticated risk measures of investment portfolios, such as Value-at-Risk, and numerical simulation tools, not just central scenario estimators, namely the expectation of return. And surprisingly, economists have done little to no follow-up on this major innovation.

But today, the question of growth in the European Union deserves more than a central scenario. The current political decisions could very well cause the economic trajectory of the European Union to drift dangerously.

Just how far dangerously? And what probability?

Western leaders have spent trillions of dollars in resources to address the Covid crisis.Primary reason? A model.

Two years later, facing uncharted inflation levels for fifty years and energy shortage, Western leaders, especially European leaders, procrastinate. Primary reason? A model.

What if the models were wrong? The first one predicting apocalypse, and the second business as usual. Here, we discuss the second one, i.e., the GDP consequences of primary energy shortage.

Within the Gavekal 4 Quadrants’ framework there is no discussion today that the world economy has moved up the chart from the disinflationary lower quadrants to the inflationary upper ones.

The next question thus becomes: right or left? In other words, boom or bust? The answer to this question has historically paved the way for reasonable hopes or disasters.

On June 13th, Emmanuel Macron announced that France and the European Union were entering a "war economy,” speaking as the newly re-elected President of France but also, possibly, as President of the European Union. No doubt he chose his words carefully.

But what does a war economy mean? What are its economic and financial consequences?

Let history enlighten us.

Luxury is like beauty: Rare, immediately perceivable, extremely valuable, and quite difficult to describe.

From an economic standpoint, however, luxury has a very precise meaning.

If you wish to know whether the product you bought or sold is considered luxury, grab a pen, prepare yourself for some basic mathematics, and jot this down.

What might surprise you along the way is how health may be turning into luxury.

The S&P 500 can be danced like a 3-count waltz: 1 (corporate profits), 2 (price of primary energy), and 3 (interest rates).

Last week, we analyzed the market sensitivity to rising interest rates, all other things being equal. However, rarely are all other things equal.

This week, we integrate the three rhythms, with the conclusion being the cost of primary energy is growing too fast.

Sometimes the stock market suffers from a divergent strabismus. Its left eye observes economic activity in the present moment, and its right eye the value of likely cash flows in the next ten years. Today the right eye is pointing to the ground as the resurgence of global inflation weighs heavily on stocks’ multiples. However, and since the end of last month, the left eye has been staring into the sky: our leading indicator of international trade announces a strong rebound in the next two months.

Which is the guiding eye for the global vision?

To hunt game, you must first track it on the trail. The same is true for the offshore dollar.

Since 2014, we lost track of our wild dollar with increasing perplexity. Not by a single dollar, but a trillion dollars. In this letter, we show how wild dollars escaped from the FED trap and are now nesting on the high branches… of the US stock market!