Investors should always be looking ahead and asking how foreseeable events will affect their holdings. In this article, I identify three regions where serious trouble affecting the world is most likely to occur:
- The Middle East;
- India/Pakistan, and;
- The Eurozone.
I. The Middle East
Things are obviously not good in the Middle East. Why? Western nations continually promote democratic forms of government wherever they can. And with the Arab Spring, they got what they thought they wanted.
So what is wrong? A little history is in order. Colonial regimes gave sub-Saharan African nations their independence with democratic constitutions. These countries were not ready for democracy, and sadly, blood-baths and great instability have been the result. Keep in mind that Yugoslavia did not break up because of globalization. It broke up because its dictator died, thereby unleashing all the ethnic hatreds of its citizens. It took years to clean up the resulting mess.
And it is not just tribal/ethnic hatreds that lead to trouble. Throughout history, organized religions and ideaologies have been responsible for great death and destruction. More than 2,000 years ago, the first acts of what we now describe as "terrorism" were perpetrated by cause-oriented groups/NGOs from Judaism, Islam, Hinduism, and Christianity. The best known of these were the "Crusades", a series of wars between the 11th and 14th Centuries initiated by Christians to recover the Holy Land from Islam. The Knights Templars were formed. Originally a military order, the Templars added a religious cause, and later became the bankers of Europe. Along the way, many died at the hands of the Templars.
More recently, other causes/ideologies have been important. Hitler convinced well-educated German citizens that its "Super Race" should take over the world and Stalin attempted to use "communism" as an ideology to rule globally. As Eric Hoffer said in his short but powerful book, beware of "The True Believers".
With this as backdrop, consider the situation in the Middle East. As I have reported earlier, while there is great animosity to the US for its coddling of an aggressive Israel, the real problem is warfare between religious sects. And while Middle East experts say it is far too simple to characterize it as a battle between Shiites and Sunnis, that division is a good place to start.
Table 1. Middle East Countries, Dominant Sect and Military Manpower
* While Lebanon is mixed, Hezbollah is in the Shiite camp so it is included along with other Shiite countries.
Sources: Wikipedia, Pew Forum, and the World Bank
View Enlarged...Click on Table
Table 1 makes it clear the the Shia (Shiites) are an out-numbered group. However, the Shia military is now larger than the Sunnis because 5% of their population are "signed up" versus only 2% of Sunnis. However, the financial power of the Sunnis as measured by international reserves dwarfs the Shiites.
"Dictator" Saddam Hussein with his minority Sunni supporters kept Iran focused on the Iraqi threat and Iraqi Shiites under control until the Americans removed him. The Iranians could not have wished for more.
Attention is currently focused on Egypt and and Syria. In Egypt, we see the attempts of various religious groups with little respect for democracy to seize power. In Syria, a dictator is trying to hold on to power against rebel groups with quite different objectives. Less news is given to Iraq, but the situation there has deteriorated dramatically since the US left. The New York Times reports
"Across the country, the sectarianism that almost tore Iraq apart after the American-led invasion in 2003 is surging back. The carnage has grown so bloody, with the highest death toll in five years, that truck drivers insist on working in pairs - one Sunni, one Shiite - because they fear being attacked for their sect."
The entire region is extremely dangerous and unpredictable. Beyond the Sunni-Shiite battles, the religious extremists often do battle with the "secularists". And with 51% of global proven oil reserves, what happens there is important to the rest of the world.
Table 2. Proven Oil Reserves, Middle East, 2013
Source: US Energy Information Administration
II. India and Pakistan
The population of India is estimated to pass China's in 2028 and continue up on up. India is governed by a disfunctional democracy. India has serious problems with Pakistan, including water. Both countries have nuclear weapons.
A. Population and Economic Growth
According to the UN world population projections, India's population could grow from 1.2 billion today to 1.9 billion in 2050 (high fertility estimate). Today, India has 989 people per square mile. With 1.9 billion people, its population density increases to 1,566, or higher than any country with 40 million or more inhabitants except Bangladesh. What is India doing to prepare for its population growth. Relative to China, very little. In 1970, India's per capita income was slightly higher than China's. No longer - China's per capita income is now more than three times higher than India's. As I indicated in an earlier piece, China leads India on almost all measures of well-being.
Table 3. Socio-Economic Data, China and India
Source: World Bank
Equally troubling, while China has invested heavily in a wide variety of infrastucture for the anticipated growth of its growing middle class, India has done very little. Currently, India has only 18 motor vehicles per 1,000 population. One wonders how its road system will hold up as more cars are purchased.
B. Religion and Governance
While more than 80% of Indians observe Hinduism, there is a Muslim minority as well as Buddhists, Christians and Sikhs. And the history of India is littered with conflicts among the extremists in these groups. India is a democracy, and its religious differences are reflected in its political parties. The result is that it is difficult to get large and sensible projects approved. And here again, the contrast with China is striking: in China, once there is party agreement to do something, it gets done. In India, political differences all-too-frequently results in stasis.
A country's transport system is clearly important in affecting its energy needs. As Table 4 indicates, 81% of India's energy imports are for oil and 53% for China. In both countries, coal is the primary energy source with very little coming from natural gas and renewables.
Table 4. Energy Sources in China and India, 2009
Source: International Energy Agency
* Renewables include nuclear, hydro, solar, wind, and geothermal
D. ...And Oh Yes, Water
I quoted Jim Thebaut, a water and environmental expert in an earlier piece. He said
"Despite the Indus Water Treaty, things could get out of hand - so here we have two large countries, both with nuclear weapons. And India by itself - a walking time bomb with ineffective governance."
III. The Weak Sisters of the Eurozone
Recent economic news on Europe has been positive. As an example, I quote from a recent piece recommending investments in a couple of Spanish banks:
"The GDP of the EA-17 has finally shown signs of life this quarter as it was announced on Wednesday that the collection of nations posted a 0.3% growth in GDP for the second quarter of 2013; the first time their GDP has grown since the end of 2011.... This growth has led many investors to believe that it is finally time to start feeling safe about buying shares of European companies again.... in a video on FOX Business News, Oppenheimer Chief Market Strategist John Stoltzfus says that it's not too late to get involved in the recovery."
Not too late to get involved in the recovery? What?
The writer goes on:
"The Spanish Economy's GDP has been unimpressive over recent years, but is by no means one of Europe's severe laggards....I believe that the Spanish Economy is on its way back."
I have a somewhat different take on Europe, and in particular Cyprus, Greece, Italy, Portugal, and Spain. I have argued that these "weak sisters" will never be able to compete with Germany, Austria, and the Netherlands. As long as these countries had their own currencies, there was a built-in adjustment mechanism: the weaker countries' currencies would simply depreciate agains the stronger countries' currencies. But with all countries using the same currency, there is no adjustment mechanisms so there will be recurring crises.
But let's look at the current situation and why I view this region as one of the most dangerous in the world.
In Table 5, I present recent GDP growth projections for the "weak sister" countries. I include both the forecasts made by the IMF and FocusEconomics. The FocusEconomics numbers are a consensus forecast made by banks and other financial institutions. As with weather, I view how forecasts are changing as significant. So the numbers in parentheses are estimates made back in March of this year.
For 2013, GDP is predicted to decline in all countries. And for all countries, it is predicted to decline now by considerably more than back in March. Somewhat amazingly, the IMF is predicting positive growth for 2014 in all countries but Cyprus. So what is the source of this optimism? Consider Greece. In 2013, the IMF believes investment will decline by 4% (the FocusEconomics consensus has it declining by 8.7%). In 2014, the IMF believes investment will increase by 8.4%! As you might imaging, not all of the FocusEconomics financial instittions agree with the IMF. For example, Citibank believes investment will fall by 6.8% in 2014.
Pehaps more worrisome are the unemployment projections for the "weak sister" countries (Table 6). Note that for all countries, the projections have worsened for both 2013 and 2014.
Table 6. "Weak Sister" Unemployment Projections
When overall unemployment is approaching 20% or more, youth unemployment will be much higher. This is a formula for more political unrest.
Conclusions and Investment Implications
The world is a dangerous place. The Middle East is close to getting completely out of hand. India, with its rising population and lack of effective governance could become a global burden. And Europe is recovering? Nonsense.
So what are the investment implications? As a hedge against the Middle East erupting, an oil ETF makes sense, something like the United States Oil Fund LP (USO) or ProShares Ultra DJ-AIG Crude Oil ETF (UCO). India: there are many India ETFs, e.g., WisdomTree India Earnings Fund (EPI), iShares S&P India Nifty 50 Index Fund (INDY), iPath MSCI India Index (INP). They have all plunged. Stay away. On Europe and the EUR nations in particular: in the short term, the "Weak Sister" economies will get worse; and nobody wants to face up to the longer term issue that these countries cannot compete with the strong EUR countries.
My conclusion: the US is the safest place for your money. The market has sold off a bit recently out of fear the Fed will stop buying bonds. That is completely the wrong way to look at the issue. Look at the Fed's track record. It has made tremendous efforts to get the recovery going in the absence of an effective fiscal stimulus because of DC gridlock. It is not going to do anything to imperil this. The Fed's decision to cut back on bond-buying should be viewed as good news: it will mean the economic recovery is gaining momentum and is sustainable on its own.
 See Amy Chua, World on Fire: How Exporting Democracy Breeds Ethnic Hatred and Global Instability, Doubleday: New York, 2003 and Fareed Zakaria, The Future of Freedom: Illiberal Democracy at Home and Abroad, Norton: New York, 2003.
 Bruce Hoffman, Inside Terrorism, Columbia University Press: New York, 1998.
 Eric Hoffer, The True Believer: Thoughts On The Nature Of Mass Movements, Harper & Bothers, 1951.