The ground is shifting below our feet. Populism and multipolarity could lead to Cold War II. Is your portfolio prepared for a scenario like this?

It is said that well-known writer George Orwell ("1984") coined the term cold war in an essay in 1945 to describe a state of constant nuclear threat. It was caused by the geopolitical conflict between superpowers (United States and the Soviet Union) and their striving for dominance after world war II.

Why was the war cold you might ask?

Because the two superpowers did not engage directly into wars with each other. Instead, they manipulated other countries to go to war with opposing allies (so called proxy fights). There was espionage going on, the press was often censored and filled with propaganda. On top of that, superpowers wanted to see the "enemy" suffering — by imposing embargoes and sanctions.

How is this similar to what is happening today?

• Multipolarity on the rise & the end of Pax Americana
• Proxy war in Ukraine (Russia vs. NATO)
• Social media/newspapers filled with propaganda
• New blocks of power emerge: Russia, China, Iran vs. USA & Europe
• Espionage via IT hacks and attacks
• Protectionism vs. Globalization
• Sanctions & embargoes (semiconductors, 5G antennas, etc.)

It's sad and unfortunate. But I think you'll get the picture.

How it will unfold?

I don't know. Let's hope for the best, but expect the worst. What concerns me is that we are living in times of prosperity. At least most of us. The economies in the US and in Europe are doing well. Unemployment is at record lows. Inflation and rising costs of living are an issue, but we'll manage.

And still, populism is on the rise. People are angry. And they start blaming immigrants and poor people for their demise. Again.

"Those who do not learn history are doomed to repeat it." George Santayana

Why is this happening?

The middle class is losing grounds. After world war II and in particular after 1950, income and wealth inequality was low and kept falling for years. Salaries rose and an average family could live well on one income and buy a house.

That has changed. And thanks to social media — we are more aware then ever. Why? Decades ago, we did not have a clue how the top 1% live. How often they travel and how their houses look like. Today, we see it all. We do not compare ourselves to our friends or neighbors, but to everyone. Or let's say, to everyone who lives well. Allegedly.

And deep down, we all think that we deserve to live like the upper class as well. We all want big houses, drive fancy cars and travel on a weekly basis, don't we?

You know what? Zero interest rates made it almost possible. Just swipe your credit card, lease your car and get a mortgage. If it goes well, just refinance and use your equity to go on a splurge. You can call easy credit the fuel behind economic growth, I like to refer to it as a morphine-like drug. It might relief the pain, but once you got used to it, it's highly addictive.

When the pandemic hit and supply chain issues as well as excessive stimulus programs were started to revive the economy, inflation emerged from the dead. This caused the central banks around the globe to react and easy credit seems out of reach. No wonder, why everyone waits eagerly until the FED pivots.

But what does this mean on a larger scale? Without easy credit, inequality becomes more obvious again. Donald Trump will use this to mobilize the masses in the upcoming election. What follows is uncertain.

However, we will be confronted with more volatility going forward.

Threats. Wars. Fights. Populism. Sanctions. All of them have the power to create shocks, which cause volatility to rise. And financial markets do not like volatility.

So what does this mean for our investment portfolios?

Firstly, if we expect higher volatility due to more geopolitical distress, riskier assets should demand a higher risk premium. To incorporate this adjustment, asset prices need to fall.

Secondly, if populism rises, not only debt levels tend to increase but also protectionism and sanctions. Higher debt levels usually lead to higher interest rates, because at one point, the risk for default rises. Besides, sanctions and protectionism lead to higher prices, because competition is not able to unfold at a global level. This development usually leads to higher inflation rates. If inflation rises and so does debt, interest rates need to be higher as well. Otherwise, you erode the purchasing power of your capital. Both factors are not positive for asset prices, as future cashflows will be discounted by higher rates.

Thirdly, economic growth can rise at first, but decline later. Sanctions and protectionism are called "beggar-thy-neighbour" policies, because your gain is someone elses' loss.

Lastly, global growth will suffer. The less we collaborate on a global scale, the less we promote the free movement of people, the less progress we will see. Sure, we might see a race between superpowers like we did with space exploration. Just with artificial intelligence and robotics.

However, if technological advances like this can easily lead to mass unemployment, I am not so sure if the overall effects will be solely positive.

What can you do today?

First and foremost, we should not give in to populists. We should try to work together instead of against each other. We must fight for peace. At all costs.

However, it pays to be prepared.

When it comes to your portfolio — think of assets which will suffer when higher interest rates are here to stay. Growth stocks, like the beloved tech stocks derive most of their value from expected cash flows in the future. If those cash flows will be discounted by a higher rate (risk free rate + risk premium), these cash flows will be smaller today. And so will be the value of those companies. Thus, diversify a little.

Take a look at other sectors, which will continue to do well even when global trade takes a hit. Just think about consumer staples, healthcare and so on. Focus on stable growth, manageable debt and solid cash flow.

Of course, defense companies are a great pick, too. However, they are quite highly valued at the moment. As modern warfare focuses on cyber attacks as well, cyber security will definitely be important, too.

What else? Diversification does not end within one asset class or currency. Consider diversifying on a global level as well. As the world becomes more fragmented, we do not know who will be next winner or loser. So don't gamble and invest global. However, be prepared to take some hits as sanctions can easily make a country un-investable.

On top of that, try adding some other asset classes. Gold is a safe heaven asset, which tends to perform well when markets are in distress. Industrial materials are currently trending downwards, because global manufacturing is suffering. However, soft and agricultural commodities like coffee, wheat and rice could be interesting over the next years. Why? Just combine sanctions with negative effects of global warming and you get some serious supply issues. And that causes prices to increase.

Sorry for being a little pessimistic here. But like I wrote — let's hope for the best but expect the wost.

Good luck & take care.

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