Are you prepared for Financial Armageddon?

With the U.S. election exactly one month from today, that’s the question on my mind. If the campaign trail is any indicator, the aftermath might be unprecedented, potentially unravelling the financial logic of the world as we currently know it. The resulting chain reaction could make the Great Depression of the 1930s seem like a smaller event.

Let’s imagine a scenario in which the US election results are contested by the two candidates, regardless who actually gets the most votes in the electoral college. Let’s also assume that the highly-divisive and partisan political situation is so contentious that the two parties would rather sacrifice democratic institutions than concede defeat. The stakes are just too high and, if one side tries to game the system, the other side must surely do the same to have a chance at assuming or retaining power. Of course, the public can’t do much about this either, firmly stuck in our own media bubbles served up by social media platforms, only affirming what we already believe — true or not.

Consider that the world is still in the firm grip of the COVID-19 pandemic, now infecting the leader of the free world himself. Governments across the globe have poured out massive resources to soften the blow of the lockdowns, allowing their already frail finances to rack up more than double-digit budget losses, all the while printing new money at a pace we’ve seldom seen. In 2021, the US federal debt as a percent of GDP is projected to be higher than just after the second world war, and there is no plan in sight to get the ballooning deficit under control over the coming election cycle, judging by the declarations of the Presidential candidates

So, why then should government debt providers continue to accept no risk premium whatsoever, as we now see with the current zero-interest environment? Why should anyone provide risky loans to an over-leveraged and mismanaged U.S. government, which is apparently willing to undermine its own institutions of governance?

During the next couple of quarters, approximately two trillion dollars of new public debt must be financed to keep the lights on in the US Government, currently running a staggering 17.5% in the red. The total outstanding public debt is about 18 trillion dollars — which translates to $52,000 per capita, and substantially higher than the net worth of the average US Citizen. Consequently, it would not be irrational to expect lenders to ask for a higher risk premium, which would put pressure on to increase interest rates. Under normal circumstances, most economists would say that increased interest rates would strengthen the currency. And since the dollar up until now is undoubtedly the world’s reserve currency, there are many stakeholders who have a vested interest in keeping the stability of the currency, as not to change the underlying agreed value of most international commercial contracts.

However, I argue that it is very different this time. We are facing a galloping public debt, with no intent or ability by the US Government to contain the risk for the creditors, meaning that there is a risk of the US defaulting on its loans in the midst of a constitutional crisis. If that were to happen, you could expect a swift market sell-off of US-denominated assets and loans in order for millions of institutions and capital-market actors to reduce risky dollar exposure. This would inevitably lead to a rapid weakening of the dollar, and strong inflationary pressures. The United States Treasury has 10x:ed the money supply — through various quantitative easings since 2008 — i.e printing money — which has historically been a fertile ground for hyperinflation once market confidence is lost. With a COVID-fueled recession, and a constitutional crisis that accelerates it, the US could then head into an uncontrolled tailspin. As many times before, Europe will also be hard hit by a US-triggered deep recession, exacerbated by our traditional industrial structures, inflexible labor market, and even weaker government balance sheets.

So, perhaps a year from now, we are in a high-inflation, high-interest, negative-growth economy, with a collapsed dollar and a swathe of painful collateral damage: perhaps a stock market and real estate price collapse, mass unemployment, and mortgage and corporate credit defaults. Looking a bit closer on such a doomsday scenario, there would certainly be winners and losers in the capital markets. I’d argue that it’s wise for each and every person to prepare for this.

As a venture investor in the tech sector, I am obviously biased — and of the firm belief that COVID-19 was only the opening act of a much deeper, digital transformation of society that was bound to happen over the coming decades. That said, a Financial Armageddon would short circuit that process in a severe way. It could dramatically strain our society, potentially leading to civil unrest at a much larger scale than what we saw in cities like Portland, Chicago, and Paris during the pandemic. This was certainly not how I was envisioning the arrival of the hyperconnected information society, but here we are.

Leaving the civil unrest and skyrocketing inequalities for a later discussion, what would our own savings options be and what would be appropriate marching orders for the money managers handling our pension accounts? How do we ensure that a Financial Armageddon doesn’t eradicate years of savings? Should you be in the stock market at all, one might argue?

Below are a few simple concepts that could guide an allocation strategy leading up to a potential crash.

Winners are likely to have at least a few of these characteristics:

· Asset-light and primarily equity-financed

· Recurring revenue as the predominant business model

· Cash-flow positive, or a clear path to becoming cash flow positive

· Scalable, digital customer acquisition models that capitalize on lower advertising costs when traditional advertisers pull back

· High product gross margins

· A cost-efficient, variable cost structure that is quickly adjustable when demand changes

· API-based platforms that allow more operating flexibility, better product development speed, and lower costs in uncertain times

· Direct-to-consumer propositions rather than reliance on indirect physical retail channels that are suffering and failing to represent products

· Low-touch, low-cost software as a service (SaaS)

Strugglers are likely to look like this:

· Asset-intensive, debt-leveraged businesses

· Primary industries, where the dollar is the representation of value

· Low product gross margin

· High cost of sales

· Vertically-integrated physical businesses

· Businesses with a high portion of fixed cost

· Businesses and industries that have been slow to adopt modern digital technology

· Financial institutions with big loan books that could go bad

· Businesses and industries that have their primary customers with such “loser” characteristics

Savvy readers have probably already seen that the winners’ pool is pretty much a description of the tech sector. With exceptionally strong stock market performance, is it wise to place your bets on a sector that has already increased in value at more than double the clip of industrials over the past three years and barely got a scratch by the COVID correction?

In a Financial Armageddon scenario, I would argue that the capital flows will quickly redirect to the winners’ pool, and thereby collapse share prices of traditional industries firmly stuck in old ways. That would feed a self-sustaining downward spiral, spelling the end of many iconic brands that can’t service their debt or raise new equity when all the business fundamentals are pointing in the wrong direction. If you are a private investor, I’d advise you to inform yourself on how to prepare for traditional companies’ nuclear winter. Read up on the tech sector.

In a similar manner, professional money managers need to rapidly rebalance their portfolios and step deeper into both public and private tech. Looking closer at European private tech, the collective share allocated to European Venture Capital by European pension funds is less than 0.2%. This asset class has produced tech successes such as Spotify, iZettle, Klarna, Adyen, Farfetch and many, many others. Over the past five years, European Venture Capital has experienced strong investment performance, even eclipsing the US venture market. More importantly for our societies, the tech sector has grown its workforce five times faster than other sectors over the past seven years.

Of course, I am hoping that we’ll entirely avoid a Financial Armageddon. The US election may deliver a clear victor and, hopefully, an effective COVID-19 vaccine will hit the markets early 2021 to make my dire predictions seem alarmist. That said, over the next decade, the underlying transformation is happening nevertheless and those who heed my advice to double down on technology won’t be terribly wrong, as I see it.

As the saying goes: Hope for the best, but plan for the worst. Your pension savings will fare much better if you do.

Sources: S&P, Brookings Institution, Investopedia, Invest Europe