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Podcasts from Confluence Investment Management LLC, featuring the periodic Confluence of Ideas series, two bi-weekly series: the Asset Allocation Bi-Weekly and the Bi-Weekly Geopolitical Report (new episodes posted on alternating Mondays), and a new monthly Q&A format called the Confluence Mailbag.
Welcome to the Confluence of Ideas, a Confluence investment management podcast focusing on major geopolitical and economic trends and their investment implications. I'm Phil Adler. In its mid year twenty twenty six geopolitical outlook report, Confluence identifies six big picture trends to help guide investment recommendations for the rest of the year. And joining us today to discuss where we stand geopolitically at mid year twenty twenty six are Confluence advisory director Bill O'Grady, chief market strategist Patrick Fearon Hernandez, and associate market strategist and certified business economist, Thomas Wash. Bill, first on this list, which is not meant to be exhaustive, is the issue of sea lanes and hegemony.
Phil Adler:The closure of the Strait Of Hormuz by Iran in the first part of the year does seem to demonstrate that The US acting alone no longer has the capability or the willingness to ensure that this crucial route remains open for free passage of goods or for general use. What does this portend for other critical trade routes and sea lanes around the world?
Bill O'Grady:Well, thanks, Phil. One of the key roles of a global hedgeman is the fostering of international trade. Although the role of international trade in maintaining peace is often overstated, there is evidence to argue that nations engaged in trade with each other do take that into account if they are considering war. By maintaining open sea lanes, the cost of trade is lowered. Without this global public good, merchant ships would need to be armed to thwart piracy, and that would and would be required to make payments to nations that put up tollbooths.
Bill O'Grady:The British supported open trade via international treaties. In fact, about the only area where they gave some leeway was for Turkey and his control of the Dardanelles. And even there, the payments for passage were framed as recompense for navigation support. What Iran has shown is it can interfere with shipping. It wasn't that this factor wasn't known, and it's just that the assumption was that the Strait Of Hormuz was so important that the world would move to reopen it.
Bill O'Grady:But that was also assuming the Strait would be blocked by vessels and mines. Drones were not part of that assumption. That's what's changed.
Phil Adler:Is The US capable of reestablishing hegemony?
Bill O'Grady:Yes. But one of the points that we have been making for some time is that American hegemony isn't under stress just due to other nations' activities. It's also due to domestic political concerns. The feeling is that the costs and benefits of hegemony have not been equally distributed across the economy. It's a bit like parts of society benefit from having a global platform in which to operate and expand their talents while others lose their careers to foreign trade or go fight in foreign conflicts.
Bill O'Grady:The problem is that fewer Americans see the benefits from hegemony. My opinion, the issue is that the political class has been unable to craft a domestic coalition that will support hegemony. Now if the coalition's built, The US has the power to exercise that role.
Phil Adler:Is there a trade route bill other than the Strait Of Hormuz that you're watching especially closely now and for the rest of this year that might be subject to restrictions or even tolls in the coming months?
Bill O'Grady:Yeah. There are a couple. The Straits Of Malacca and the Taiwan Strait are two that are not only vulnerable, but the impact would be significant. In the former case, it's minor powers that border the strait, and so that might be manageable. But in the latter case, it's China that might do the blocking, and that would force a major power confrontation.
Phil Adler:Last question on this first main issue is, do investors need to anticipate rising oil prices and inflation at least through the end of the year?
Bill O'Grady:Well, here's where it gets a little tricky. I would expect inflation to moderate over time. The problem isn't inflation. It's the level of prices. This is what has been deemed the affordability problem, and that doesn't go away.
Bill O'Grady:The risk of supply disruption will tend to lead nations, households, and firms to take steps to protect themselves from supply disruption. In doing so, costs will rise, and that will tend to get passed along to consumers. That may mean the cost of higher inventories or building alternative supply routes or buying more insurance. But in any case, prices will tend to be higher. As to whether or not they will rise at an increasing rate is partially a function of monetary policy.
Bill O'Grady:But in general, the disruptions caused by the conflict with Iran will take months to fully be accommodated. With energy, we have probably avoided the big spike, but instead, we'll face higher prices than we otherwise would have. So instead of $60 per barrel, for example, we'll probably settle in around $75 per barrel. For other commodities like grains, we may not see the full impact until this time next year. The interruption of fertilizer and subsequent higher prices probably won't affect the North American crop this fall, but may have an adverse effect on the South American crop later this year and for next year's North American crop.
Bill O'Grady:And for metal, the loss of sulfur, which is part of making sulfuric acid, also tends to boost costs.
Phil Adler:The second big picture trend for the second half of the year is what you term reindustrialization or reserve currency status. And I guess the basic question is, does America need a weaker dollar to rebuild our industrial base?
Bill O'Grady:Probably. The way to think about this is if foreigners want to acquire dollars, they will engage in behaviors designed to run a trade deficit with The US or a trade surplus with a dollar acquiring nation. If treasuries were good, The US would be trading stuff such as cars and furniture and all that for treasuries. But the process of doing that puts tremendous pressure on industries that compete with foreigners. This has led to the deindustrialization.
Phil Adler:Bill, you say in your report that the problem isn't that the dollar is the reserve currency per se. It's that treasuries are the reserve asset. Will our government seek to discourage foreign governments from buying US Treasuries in an effort to lower the value of the dollar? Well, that would be
Bill O'Grady:a more sophisticated way of addressing the problem, or we we could require foreigners to build productive capacity here in The US. Of course, foreign nations balk at this outcome because then it makes it hard to acquire dollars. But another tactic would be to apply a surcharge to foreigners buying treasuries.
Phil Adler:And what are the market implications, and what should investors watch for in the coming months?
Bill O'Grady:Well, so far, the Trump administration is trying to use tariffs as a tool to address deindustrialization. It's usually a less effective tool because it leads foreign nations to depreciate their currencies offsetting the price impact of tariffs. In general, the dollar's been strong recently in part due to America's ability to cope with the disruptions caused by the Iran conflict. It's also due in part to chair warship's hawkish monetary stance. At some point, I expect the White House to try to pressure the dollar lower, but we may see dollar strength for a few more months.
Bill O'Grady:But longer term, I expect greater government involvement in directing investment. Economic theory suggests this will lead to a less efficient investment. But since deindustrialization is a national security issue, the concerns about malinvestment will probably be tolerated. To some extent, this may require some finesse on the part of investors as they will need to invest in what the government is favoring.
Phil Adler:Issue number three is titled the Donroe doctrine. Thomas, you write about this issue in the mid year report. Venezuela comes to my mind first and perhaps Cuba next as we consider Washington's efforts to exert more influence on Latin America. Exactly what is The US trying to achieve with this increasing political pressure?
Thomas Wash:You know, at a high level, the the goal seems to be to reassert US influence across the Western Hemisphere. The US already has deep institutional ties with Canada and Mexico through trade agreements, but its relationship across much of Latin America are comparatively shallow. What we're seeing now is a more deliberate effort to rebuild that influence economically, politically, strategically, and a key part of that strategy is ideological alignment. As we noted in our 2025 Geopolitical Outlook, right leaning governments in the region have historically been more aligned with Washington, while left leaning governments have tended to maintain closer ties with China. So this is not just about regional influence.
Thomas Wash:It's also about competing with China's footprint in the hemisphere.
Phil Adler:Where could this mostly play out in the coming months?
Thomas Wash:Well, I think we're already seeing it play out through a mix of both soft and hard power. On the soft side, we've seen The US has extended economic support to countries like Argentina. It has deepened investment and security ties with Chile following its political shift. And on more of the harder edge, we're seeing much more direct pressure on governments that are less aligned with Washington. That includes actions like the legal pursuit of Venezuela's leadership, renewed pressure on Cuba, and even more subtle tools like tariff threats against Brazil.
Thomas Wash:The common thread is clear. The US is using a full spectrum of tools to pull the region more firmly into its orbit.
Phil Adler:I was wondering what might be possible downsides for The US.
Thomas Wash:Personally, I I think the biggest risk is political backlash. When The US is seen as openly backing specific governments, it can undermine those governments' domestic legitimacy. Latin America has a long history of skepticism toward US involvement, and that sentiment can resurface quickly, especially during periods of economic stress. There's also a reputational risk. If The US is perceived as supporting leaders with weaker democratic or human rights records, that can create long term instability and erode trust in the region.
Phil Adler:Are there clear investment winners that may emerge?
Thomas Wash:From a market's perspective, the shift could be a net positive for Latin America. You know, the the region is rich in natural resources, many which are critical inputs for AI infrastructures, including energy and key minerals. If US capital and political support increase, that could accelerate investment flows into those sectors. Now at the same time, more market friendly fiscal policies from right leaning governments could improve the investment backdrop as well. We've already seen strong relative performance from MSCI Latin America this year, even without the heavy exposure to tech.
Thomas Wash:For investors, that makes the region a potential diversification play, especially as a hedge against concentrated exposure to AI driven equities in the broader emerging market sector.
Phil Adler:Let's move on to issue number four, which you also wrote about, Thomas, in this report. It's titled AI's non laissez faire. What you're referring to is the federal government's increasing role in supporting AI companies. For instance, what comes to my mind is when the government took a direct stake in Intel. Do you expect this interventionist trend to broaden?
Thomas Wash:Honestly, yes. And I think it could have broadened quite significantly. As AI becomes more central to economic and national security, the government is unlikely to remain hands off. We're already seeing early signs of this, whether it's discussion of direct stakes in companies, supporting IPOs, or shaping the competitive landscape more actively. What's notable is that this isn't strictly partisan.
Thomas Wash:There's growing bipartisan openness to a more interventionist approach, whether framed as industrial policy, national security, or economic strategy. And intervention may go beyond equity stakes. It could include credit support, guarantees, or mechanisms to stabilize funding for large scale AI infrastructure.
Phil Adler:Could this, you think, become a taxpayer funded safety net for AI companies which are in the process of building huge data centers? In other words, can investors count on a government backstop for these companies if the stock rally driven by AI firms runs out of steam?
Thomas Wash:Well, I think that is a question no one has the perfect answer, but I will try my best. The scale of capital required for AI infrastructure, particularly data centers, is enormous. As companies tap credit markets to fund that buildout, the system wide importance of these assets increase. At some point, parts of the ecosystem could become too important to fail, especially if stress in the sector spills into broader credit markets. That said, any government support would almost certainly come with conditions.
Thomas Wash:If we look at historical precedents like the post Lehman interventions, support tends to limit shareholder upsides through restrictions on buybacks, dividends, or executive compensation. So while a backstop may reduce downside risk, it doesn't necessarily protect equity valuations in a downturn.
Phil Adler:Should investors then take steps in the coming months to protect themselves from overreliance on an AI driven stock market?
Thomas Wash:Well, I I think my view is that it just comes down to your overall exposure. Over the past few years, a handful of large tech companies have come to dominate the S and P 500, which means simply owning a broad large cap ETF may not provide the diversification investors expect. Because of that, we continue to encourage investors to look beyond the index, both across sectors and geographies, and to be more selective. In some areas outside of mega cap tech, you're actually seeing more attractive valuations can offer a better risk reward profile going forward.
Phil Adler:The Russia Ukraine war holds the number five position in the Confluence list of major geopolitical issues at midyear. Patrick, you wrote about this issue. You see Ukraine improving its position recently in this grinding war. How has the shape of this war changed?
Patrick Fearon-Hernandez:Well, the biggest change is Ukraine's growing success with aerial and other types of drones. After years of attritional warfare that seemed to favor Russia's greater size and resources, Ukraine has found a way to impose significant costs at relatively low expense. Ukrainian drones are now conducting surveillance, targeting Russian forces, and striking infrastructure deep inside Russia, even in major cities such as Moscow and Saint Petersburg. Those attacks on refineries, airfields, and logistics hubs not only affect military operations, but they also increase economic and political pressure on Moscow. The result is that Ukraine has improved its position and regained some tactical momentum even though the conflict remains highly contested.
Phil Adler:Is Russia perhaps nearing a critical point in terms of strains on its economy?
Patrick Fearon-Hernandez:Well, Russia isn't at a breaking point yet, but the pressures are clearly mounting. Growth is slowing. Labor shortages are becoming more severe, and defense spending now consumes an enormous share of the federal budget. At the same time, high interest rates are weighing on investment, while Russia's stronger currency is actually hurting some export revenues. The key question is whether these strains eventually become serious enough to influence a Kremlin decision making.
Patrick Fearon-Hernandez:That's not certain, but the probability is rising.
Phil Adler:And what is the most likely outcome for this war do you think in the next six months?
Patrick Fearon-Hernandez:Well, in our view, the most likely outcome is continued stalemate rather than victory by either side. Ukraine has improved its leverage, but Russia still retains significant military capacity. That suggests the conflict that remains active but increasingly bounded. We could see greater diplomatic activity, perhaps focused on cease fires or limited agreements, but a comprehensive peace settlement still appears unlikely in the near term.
Phil Adler:Should investors continue to accumulate defense stocks?
Patrick Fearon-Hernandez:Yeah. We think the broader outlook for defense remains favorable. And this isn't just about Ukraine. As global order seems to break down around the world and as The US becomes less willing to commit its forces to helping other nations, governments are increasingly feeling that their military spending and their security needs have to be improved. The war has especially highlighted demand for missiles, munitions, drones, air defense systems, and other military technologies.
Patrick Fearon-Hernandez:As long as geopolitical tensions remain elevated, the sector should continue to benefit from a supportive long term backdrop.
Phil Adler:The final issue in your midyear report is quantum computing and the next technological arms race. Have investors ignored quantum computing as they focus on AI?
Patrick Fearon-Hernandez:Well, to some extent, yes. AI has understandably captured most investor attention because it's already generating commercial results. Quantum computing remains at an earlier stage. But what stands out is the growing level of government support and strategic concern. Just a few months ago, the federal government channeled about $2,000,000,000 into major technology firms in the quantum space to help boost their research and development abilities.
Patrick Fearon-Hernandez:Increasingly, policymakers view quantum technology as a critical national security issue, which suggests investors may be underestimating its long term importance.
Phil Adler:Can you give us then an idea of quantum computing's potential?
Patrick Fearon-Hernandez:Well, theory, quantum computers could solve certain problems that are essentially impossible for today's machines. One of the biggest implications involves encryption because a sufficiently advanced quantum computer could potentially break into any existing security system. Beyond that, quantum technology could eventually transform fields such as pharmaceuticals, advanced materials, logistics, energy, and even AI itself. The potential applications are enormous if the technical hurdles can be overcome. And based on the information we've seen in the industry people we've talked with, those technical hurdles are starting to be overcome.
Phil Adler:Patrick, is this industry at the stage where serious investor interest is warranted?
Patrick Fearon-Hernandez:I think serious attention is warranted even if caution is still appropriate. Quantum computing remains developmental and commercialization could take longer than many expect. What makes it compelling is the combination of private investment, government funding, and geopolitical competition. The sector has clearly moved beyond the purely speculative stage and deserves a place on investors' radar screens.
Phil Adler:As we wrap up now, we mentioned at the beginning of our discussion that this list of big picture geopolitical issues, six of them, is not exhaustive. Exhaustive. Patrick, which issues didn't make the cut but still bear close watching?
Patrick Fearon-Hernandez:Well, one issue I'd highlight is Japan's emergence as a more important arms exporter. As Tokyo expands its military role and becomes a larger source of defense industry goods, it could have significant implications for security in Asia. More broadly, I'd continue watching the steady fragmentation of globalization. Many of the issues we've discussed today, from industrial policy to AI to quantum computing reflect a world that's becoming more geographically competitive and less economically integrated. That's likely to remain an important theme for investors well beyond 2026.
Phil Adler:Well, my thanks to all of you, Bill, Thomas, and Patrick. I'm looking forward to revisiting some of these issues in our podcasts in the coming months. Our listeners can find the written report on which our discussion is based on the Confluence webpage, confluenceinvestment.com. Today's discussion is based upon sources and data believed to be accurate and reliable. Opinions and forward looking statements expressed are subject to change without notice.
Phil Adler:Also, this information does not constitute solicitation or an offer to buy or sell any security. Our audio engineer is Dane Stole. I'm Phil Adler.