Run to where the ball is going, not where it is.

My kids who are 7 and 9 love playing sports. When it comes to team sports my 9 year old daughter loves basketball and Matthew, my 7 year old is obsessed with soccer. This summer I really enjoyed watching him play the game he loves so much. I wish I could bring his level of enthusiasm and energy to everything I do. Watching his games, it can be hard to know who’s on whose team as every kid on the field will swarm to the ball.

At the age of 7, the kids haven’t learned to space out and to go to where the ball is going to be, not where it is. The best players in any sport seem to be the ones who can see a few moves ahead and get there before everyone else. It’s a skill that takes time, discipline and practice. The team that can move the ball and get to the open space first compared to the team that is always a step behind and playing catch up, quite often is the team that wins. Investing isn’t that different. We need to look ahead and invest in businesses and sectors before the crowd gets there as that is when they are undervalued and cheap. Once the news is on the front page and everyone else has connected the dots it’s too late. So where do we see the world over the coming years and how are we going to position ourselves to take advantage? You’ll notice I said years and not months or quarters. Investing is a long term game and we need to focus on the long term and try not to get caught up in the short-term volatility and noise.

We believe that we are in the midst of a global power shift and World War 3, but first let’s take a look at a bit of history. Since the end of the cold war we’ve had a great globalization experiment. The West was able to import deflation while wages stagnated. We were able to buy more “cheap” stuff from China and other countries even though our wages weren’t going up. In fact from 1964 to 2018 average wages barely moved in the US. US wages from 1964 until 2018. I would also venture to say that most of that growth happened at the top end of the range. By importing deflation it allowed our quality of life to continue to improve even if our average wage did not. Europe, and Germany specifically, were able to use cheap gas and oil from Russia to produce expensive goods for the wealthy to purchase. There was peace and trust and countries cooperated as it was mutually beneficial for them to get along. We created global supply chains where manufacturing moved to either areas that had cheaper labour, cheaper input costs or expertise. As an example Taiwan and South Korea became hotbeds of chip manufacturing while China produced, well just about everything. But as the saying goes, all good things must come to an end.

I remember speaking with an ex-colleague about 10 years ago; he was and still is one of the most well respected Global Strategists in Canada. We discussed how he was seeing cracks in the globalization experiment and thought that the end of importing disinflation was coming quicker then we would like to believe. So, if the cracks were forming 10 years ago, how did the world turn on its head seemingly overnight.

Trust started to break down and things became a bit less mutually beneficial.

The US was fine with China producing cheap TVs, clothes and the stuff that fills the shelves at the Dollarstore. Let’s be honest, we all like to buy things that are cheap. But when China started producing more high tech and important parts of our national security supply chain, then the US started to place restrictions. One of our favourite companies, ASML, is one of the most important companies in the world today and we’ve owned it at different levels for about 2.5-3 years. It’s a Dutch company that manufactures an EV lithograph machine. This is the only machine in the world that allows a chip manufacturer to create semiconductors at a 7nnm or smaller size. Essentially it is needed for all the highest quality and powered chips in the world today. The United States put pressure back in 2018 to stop ASML from selling their highest end machines in China, but has recently tried to pressure them into having a full on ban on sales in China. https://www.hpcwire.com/2022/07/08/us-pushes-for-expanded-ban-on-sale-of-chipmaking-equipment-to-china/ This ban will greatly affect the future chip manufacturing capabilities and is one of the fronts of World War 3. Which is the technology war.

The second front of World War 3 is in global supply chains. By hampering global supply chains, China and its allies are able to continue to drive pain into the West. How China's Covid policies lead to hampered supply chains, higher inflation (cnbc.com). Although not explicitly stated by President XI or anyone else in the CCP, by continuing to have a COVID 0 policy, they have the cover to shut down ports and cities at their discretion. By making it more difficult for products to be manufactured or shipped we continue to see supply chain and inflationary pressures which adds to the pain we are all feeling. There could be other reasons why China is implementing a COVID 0 policy, such as to try and keep inflation in check, but we will never know for sure. What we do know is that it has greatly impacted manufacturing and shipping. The other reality of our global supply chain is that a number of our shipping lanes pass through somewhat unfriendly regions. The Chinese showed how quickly and easily they could block anything leaving Taiwan by their recent military exercises. China military exercises around Taiwan threatens global trade.

Turkey and Russia are seemingly getting a little closer even as Turkey tries to straddle both sides of the current Ukrainian war. Russia and Turkey: Sometimes strongmen need to get along | Lowy Institute and Turkey happens to control one of the most important shipping lanes in the world as well that connects the Black and Mediterranean seas. We’ve seen the importance of this as Turkey can allow shipments of wheat out of Ukraine or Navy ships in or out of the Black Sea.

As geopolitical risks grow, the control that certain countries have over our global shipping lanes be it the Strait of Taiwan, the Suez Canal, the Bosphorous strait or any of the others, will continue to cast a light on how fragile our global supply chain is. It all works great when there is peace and harmony but what happens when that harmony breaks down?

The third and fourth fronts where we see this war playing out both were thrown to the forefront when Russia invaded the Ukraine. The need for a military reaction to a sovereign country being invaded is a clear line in the sand that the West wasn’t willing to look past. As we know, allied countries have not sent soldiers to the front but they are spending billions of dollars sending weapons. This drawdown in Western weapons is causing a massive need for manufacturing and spending to restock previous supplies and continue to support Ukraine for as long as they need to be supported. However in light of the above points of supply chain and manufacturing issues restocking some of these weapons isn’t as easy as just turning on the taps. Which also leads us to the fourth front which is the weaponization of commodities.

When the Ukraine was invaded it also brought to light the cruel reality that Europe has relied on a cheap supply of Russian oil and gas and that the world has relied on the wheat, fertilizer and other commodities from the Ukraine and Russia. According to Credit Suisse, Germany leverages $20B of Russian gas into $2Trillion of GDP German gas imports. It’s no wonder they came asking Canada to help supply them with natural gas. Canadian lng could play major role Germanys shift Russian gas Scholz 2022-08-23/ Why we’re not helping to supply them with natural gas is a conversation for another day.

What all of the above shows us is that we are living in the midst of a significant shift of geopolitical risk. The luxuries and the comforts that we have become accustomed to in the West, have been allowed to happen through easy monetary policy that was possible because of our global supply chains and cheap energy. We are seeing what happens when those partnerships start to crack. So where does that leave us? As stated in the open, we need to go where the ball is going and not where it currently is. If we truly believe that the world is shifting and the above scenario is true, then we have to recognize that there will be challenges, but challenges provide opportunities.

We are using these opportunities to reassess our positions in energy, both green energy which is crucial to our future, but also traditional fossil fuels as the green revolution won’t happen overnight. The investment of funds to continue to develop traditional oil and gas reserves to supply what has been and will continue to be a constant increase in demand, Oil demand, has for a number of reasons been cut dramatically. We are now living with the fallout of these decisions. The U.K. has just announced a cap on household energy costs and multiple new licenses being given for exploration in the North sea.

Unfortunately that just moves the cost over to the government from the household and any new developments are still years away. We are also believers that the world is going to continue to move toward green energy. This isn’t an all or nothing proposition and both can coexist until the supply of green energy is abundant enough to meet our demands. We know the environmental reason to move towards renewable energy but there is also a national security reason. We’re seeing how being reliant on a country such as Russia for your energy needs can put you as a nation or continent in a very challenging corner. When we look at the oil producing nations in the World Worlds largest oil producers a number of the largest ones are not ones where the West is aligned in their beliefs and values. This makes it a precarious relationship.

We are looking at manufacturing and supply chains. As the CHIPS act has shown, the US government will throw billions of dollars into onshoring manufacturing. These factories won’t be like the Ford assembly lines of decades past, we believe they will be full of automation and robots. AI will help to drive efficiencies and 3D printing will help relieve some of the supply chain issues. Yes we’ll need people to work those lines but as the current labour shortage has shown us, we need to adapt to technology to help fill the gaps and increase our productivity.

Agriculture is another area that we see real change needed. Countries are looking at their food supply as well as the efficiencies or lack of efficiencies in producing the food we need to support the world. We think that we will see continued need for fertilizers and innovation in our farming to continue to yield higher levels of food.

With increased geopolitical risk, governments need to continue to yield the threat of traditional warfare. We need to restock our supplies and the “war machine” will want to get their piece of the pie. It’s not just high tech weapons that are needed, but also the simple things like artillery shells. Ukraine ammo stocks become crucial as artillery rages Our belief is that this war will linger on for longer than most of us would have believed and if that is the case the West will have to greatly increase their production to continue to support the Ukraine. I hope we’re wrong, but as an investment advisor in charge of protecting and growing your wealth we need to be aware of the larger picture, even when it doesn’t align with our personal hopes and beliefs.

This war isn’t just being fought on the battle fields, it’s also being fought in cyberspace. For this reason we believe that we will want to continue to have exposure to cybersecurity. As our industrial and infrastructure complex is attached to the web it’s much cheaper and lower risk for a bad actor to hack into our systems and shut them down then it is to fight with traditional weapons. We believe that these attacks will not be going away anytime soon and that governments will propose further restrictions and laws like the ones tabled in Canada. Canada cybersecurity bill

In closing, we see challenges ahead but those challenges present opportunities. At the end of the day as investors, it’s our duty to find quality businesses that we want to own for an extended period of time. For that reason, we won’t run away from the dividend producing companies that we all know and love, such as the utilities and banks. However, we do need to be aware of changing dynamics. We have spoken for a number of years of the 4th industrial revolution. All the above doesn’t change that view, it may in fact help speed it up.

Finally, we are not macro investors but we have to be macro aware and be able to put aside our personal views in order to look at the whole, as it’s the only way to try and see where the ball is going and not where it is.

As always if you have any questions, thoughts or concerns then please feel free to reach out as we are always here for you.

CIBC Wood Gundy

Andrew Lacas, CFP, CIM, RIAC

Wealth Advisor

Portfolio Manager

Lacas Advisory Group