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Podcasts from Confluence Investment Management LLC, featuring the periodic Confluence of Ideas series, as well as two bi-weekly series: the Asset Allocation Bi-Weekly and the Bi-Weekly Geopolitical Report (new episodes posted on alternating Mondays).
Welcome to the Confluence Investment Management biweekly geopolitical report for 04/07/2025. I'm Phil Adler. Should the current strain in traditional US alliances prompt investors to consider an immediate strategy adjustment? Confluence Chief Market Strategist Patrick Fearon Hernandez joins us today to answer that question and explain the detailed approach confluence takes to this issue. Patrick, the title of this week's report is "Growing Fragility in the US Bloc and Prospects for a Breakup."
Phil Adler:We've discussed in the past how confluence views today's geopolitics, broadly speaking, through the lens of separate economic blocks led by The US and China. Some nations are squarely in The US block. Some are squarely in in the China bloc or China Russia bloc, and some lean one way or the other or straddle the line. Your title this week acknowledges a growing fragility emerging within The US bloc. Now it may be easy for us to assume a growing fragility considering current headlines and how they grab our attention, but Confluence takes what I think is a deep data driven approach.
Phil Adler:Could you explain for us, again, the measuring sticks that you use?
Patrick Fearon-Hernandez:Well, hi, Phil. Thanks for having me on the program. And to answer your question, our categorization of countries into various camps or blocks is indeed driven heavily by data. As we noticed the world fracturing into these groups several years ago, we wanted to be able to predict which block any given country would end up in, not by using some subjective analysis or opinion, but by using a set of objective quantifiable indicators. For each country, our methodology tracks 13 different indicators related to its military, diplomatic, economic, and cultural relationships.
Patrick Fearon-Hernandez:For example, it tracks each country's mutual defense treaties, its status as a free market, and how much it depends on exports to The US versus exports to China. For each of these 13 indicators, we give the country a subscore from positive two to negative two with more positive numbers pointing to stronger relations with The US and more negative numbers pointing to stronger relations with China. We add up all the subscores to give each country a total score, and we categorize the countries into blocks based on those total scores. We think this methodology has been pretty accurate in describing today's fractured world. Now we've used it to predict how the different blocks might change in response to president Trump's foreign policies.
Phil Adler:Well, have updates to your original study revealed any changes in the composition of these groups of countries?
Patrick Fearon-Hernandez:Well, yes. That's a key point. Relationships between countries change over time. In addition, new data on trade and other issues gets released. So last year, we updated our original analysis.
Patrick Fearon-Hernandez:In the update, we did see a significant number of countries shifting from one block to another, but mostly in the sense of countries moving away from China and its block. That was largely because of China's slowing economic growth, which reduced Chinese imports and gave countries fewer incentives to stay aligned with China. However, the update implied relatively little change in the membership of The US block. Even in our updated analysis, The US block consists mostly of the world's rich, advanced, highly industrialized liberal democracies and a few closely related emerging markets. Our very latest work suggests The US Bloc will likely weather Trump's policies at least in the near term.
Phil Adler:So using your measurements, there is enough cohesion in The US bloc to hold it together, at least so far.
Patrick Fearon-Hernandez:Yes. We think these results show The US Bloc may be more resilient to Trump's policies than we otherwise would have expected.
Phil Adler:So you were surprised by your findings?
Patrick Fearon-Hernandez:We were not only surprised by these findings, but also gratified. The analysis suggests that the mutual interests holding the countries in The US block together are strong enough and numerous enough to weather even big disagreements over trade and national security burden sharing.
Phil Adler:Patrick, the way you have phrased the key question now is, will Trump splinter The US bloc in the future? You've identified two key scenarios that could lead to an actual splintering. The first is an elimination of US trade deficits. Why did you pick this scenario, and how did you measure this?
Patrick Fearon-Hernandez:Well, yes. Even though we think that in the near term, The US block will hold together, we did wanna look at the worst case scenarios. Trump is clearly very focused on ending the big US trade deficit or perhaps even converting it into a big surplus over time. He seems to be enthralled by tariffs, which are likely to hurt and anger many foreign countries, potentially to the point where they stop cooperating with The US and therefore fall out of The US block. To explore this possibility, we calculated all the different countries' exports to The US under a scenario in which any US bilateral trade deficit deficit was eliminated by a combination of higher US exports to that country and lower imports from it.
Patrick Fearon-Hernandez:We then recalculated each country's trade subscores and its total score under such a scenario to see which, if any, would fall out of The US block.
Phil Adler:What did you find?
Patrick Fearon-Hernandez:Well, this assumption reduced many countries' trade subscores and, therefore, their total scores, but not by very much. In this scenario, believe it or not, only Fiji dropped out of The US block.
Phil Adler:The second scenario is The US exiting NATO. What did you find here?
Patrick Fearon-Hernandez:In our second scenario, we also assume that the North Atlantic Treaty org Organization disintegrated under Trump's criticisms of the alliance. After zeroing out the NATO subscore, only a few additional countries dropped out of The US block, all from Southeastern Europe. So in other words, even assuming the end of all US bilateral trade deficits and the disintegration of NATO, our analysis suggests that most of the dozens of countries in The US block would remain in the block and still be closely aligned with The US even though the overall level of cohesion for the block has declined, raising the risk of a future disintegration.
Phil Adler:Patrick, you've also looked into a potential future and discussed how a radical economic bloc breakup scenario might fit the Trump administration's foreign policy and what it might look like. What seemed to be the key goals of the Trump administration foreign policy?
Patrick Fearon-Hernandez:Right. Even though our analysis suggested The US bloc will merely lose some cohesion and won't splinter in the near term, we did wanna take this opportunity to start exploring how the world might look if Trump's policies do lead to a breakup of The US block and the establishment of a new world order. We think the key to understanding such a dramatic change is to think about what Trump's priorities seem to be. Of course, presidents come into office with lots of different goals, but they quickly learn that they can only achieve some of them. Therefore, they start to prioritize.
Patrick Fearon-Hernandez:We think Trump's priorities include, one, avoiding a major war, two, fixing The US trade and budget deficits, three, creating what we call Fortress America, and four, punishing the European allies for allegedly taking advantage of The US over the years. We think that that's also Trump's rough order of priorities, although we're still watching closely for confirmation of this.
Phil Adler:If the Trump administration achieves these goals in full or in part, how might a breakup in the blocs unfold?
Patrick Fearon-Hernandez:We think a new world order without today's US Bloc could take one of three closely related structures depending on what Trump's real order of priorities is. For example, we agreed with other analysts who posit that Trump may be trying to set up a world system based on spheres of influence where each top power is allowed to operate pretty much however it wants in its own geographical area. In this system, The US, China, and Russia would all have their own sphere of influence. Another possibility is what we call great power competition, which is a more fluid system where every top power continually competes on the world stage for political and economic advantage. Finally, we think Trump could be looking for a world dominated by right wing populist governments under strong executives.
Patrick Fearon-Hernandez:All these systems represent a more multipolar world, but which one Trump wants to build will depend on his priorities.
Phil Adler:Well, Patrick, let's return now to my initial question posed when I introduced us today. And that question is, is now the time to adjust investment strategy?
Patrick Fearon-Hernandez:For right now, given that The US block is so attractive to investors as it is today and should survive in the near term, we aren't calling for any major change in the strategies that we've already been advocating. However, once we have a more certain view about Trump's priorities and how the world system will evolve, we are likely to adjust our approach more dramatically.
Phil Adler:Do you think one of these potential disruptive outcomes could happen very quickly once set into motion?
Patrick Fearon-Hernandez:We think there certainly could be sharp breakpoints where the current world is basically dismantled quickly. Of course, governments and businesses would need time to complete their adjustment to such a world, but something like a sudden US reproachment with China and Russia or a breakup of NATO would certainly give investors a clear sense that major changes are in train.
Phil Adler:What investments, Patrick, are favored if The US block, while less cohesive, at least holds together?
Patrick Fearon-Hernandez:As of right now, we still see the global fracturing in the current block system as making consumer price inflation and interest rates higher and more volatile than in the past. We therefore continue to favor US equities over bonds. And because of rising global tensions, we still favor defense stocks, uranium, and precious metals.
Phil Adler:And what happens to investment strategy if something more radical takes place?
Patrick Fearon-Hernandez:That will depend in large part on which type of world system replaces today's geopolitical blocks. For example, if Trump pushes for a sphere of influence world, the resulting stability might conceivably argue for reducing gold exposure. In contrast, a world built on great power competition could increase tensions and call for even greater gold exposure. For now, however, it's probably too early to make any large scale changes in investment strategy. We think this is still the time for closely watching, analyzing, and thinking through our options depending on how things go.
Phil Adler:Thank you, Patrick. This week's report is titled growing fragility in The US bloc and prospects for a breakup. You'll find in that report a chart of countries residing in today's geopolitical and economic blocs. 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, and this information does not constitute a solicitation or an offer to buy or sell any security.
Phil Adler:Our audio engineer is Dane Stole. I'm Phil Adler.