For most of modern history, investors have organized the world using a simple framework: states compete for territory, economies consume resources, markets allocate capital, and (more recently) central banks manage money.  The framework is imperfect, but it has worked because the primary sources of power were visible and relatively stable.  With the fall of the Berlin Wall, however, these “reliable norms” began slowly eroding.  China’s admission to the World Trade Organization (WTO), the onset of the Global Financial Crisis (GFC), followed by the Covid pandemic and then in quick succession, Russia’s invasion of Ukraine, the West’s subsequent confiscation of their currency reserves, and the mother’s rush of A.I. frenzy unleashed when OpenAI dropped ChatGPT (and fifty years of academic machine learning R&D) on the economy, have only accelerated the breakdown of this framework.  The challenge is not that the world has become more volatile.  It is that multiple systems that have historically operated separately or with linear cause-and-effect progression, are now colliding – simultaneously.  Natural resources, trade relations, supply chains, intellectual property, geopolitics, defense alliances, demographics, and monetary & fiscal policy are increasingly interacting in ways that traditional models struggle to capture, interpret, or forecast without linear dependence.  Society’s ability to “manage” these systems has intensified as long-held, long-relied upon operating conventions fray, fracture, or are replaced entirely.  We have thought of this as the “Era of Polyfragility[1],” and the implications for what we rely upon, think we know, or take for certain are likely to be profound.

For centuries, the primary object of competition was land.  The Treaty of Westphalia established a system built around sovereign territory.  The great powers of Europe, the Eastern & Western Roman empires, along with the Islamic caliphates, the Persians[2], and Egyptians, among others, competed to control physical space.  The end of European colonization, commercial circumnavigation, and two world wars shifted the focus in the twentieth century from territorial control to control of resources – energy in general and oil in particular.  Much of the strategic logic of the twentieth century can be understood through this lens.  Today the theater of competition is changing again.  Investors’ objective is not to predict a single outcome, but to prepare for an environment where multiple pressures emerge simultaneously and reinforce one another.  Investing through polyfragility requires a new – and evolving – playbook.

The shift from territory to resources to networks and nodes reflects a deeper change in how power is organized.  The state remains powerful, but it is no longer the sole container of economic activity or political influence.  Supply chains span continents, capital flows globally, and digital platforms provide the common connection for populations larger than most countries.  Power increasingly resides in networks that transcend borders and within hyper-local nodes of knowledge, scarcity, craftsmanship, trust, and judgment. 

We can observe this through the evolution of economic units of measurement.  For the better part of fifty years, nations – in the U.S. through the Office (later Bureau) of Economic Analysis – measured economic value add through the prism of Gross National Product (GNP₁), all the value added that is ours no matter where it is.  Only in 1991 did the focus shift to Gross Domestic Product, all the value added that’s here no matter whose it is.  And while national statistics remain expressed in GDP terms, investors tracking economic influence, activity, productivity, and value, appear increasingly to focus on two evolving non-state aggregations: a form of Gross Network Product (GNP₂), reflecting value generated through ownership and control of natural & digital resources, intellectual property, protocols, platforms, power, capital, and their global delivery & consumption mechanisms; the other, Gross Local Product, capturing value created through the provision of geographically constrained goods and services.  As old systems give way to new, economic reward may increasingly accrue to the owners of the largest and most efficient networks and the owners of the most irreplaceable local nodes.  Thus the defining second order question going forward is whether and where gains derived from network value ultimately accrue at the local level (however defined) or do they remain concentrated among those who control the networks themselves; and conversely, at what cost – of capital or efficiency – do the irreplaceable local nodes pose to borderless networks? 

The driving capital allocation principle in the geopolitical and economic West over the last fifty plus years is inverting.  Asset-light sectors face growing competitive pressure, compressing margins, weakening competitive moats, and lower valuation multiples while hard-asset industries benefit from increasing scarcity, decades of underinvestment, strengthening barriers to entry, and impediments to scale.  The economic opportunity of the twenty-first century may be the network linking financing, extraction, processing, manufacturing, transportation, distribution, provision, and consumption.  The generic, repeatable, scalable-but-not-dominant participant is where value appears most vulnerable.  Much of the public market exists in this space.

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This shift is certainly visible in the A.I. echo chamber.  The digital economy scales rapidly; investors discount the seemingly infinite potential – and the contributions to Gross Network Product – atlevels bounded only by the imagination.  And so, the trouble is, where software, algorithms, and capital can scale rapidly, physical systems cannot.  The physical world is beginning to impose itself on the digital one.  A.I. is increasingly an industrial story and harbors a contradiction that the public market investors appear only just – and begrudgingly – to appreciate, the technology that promises extraordinary productivity gains requires one of the largest physical infrastructure buildouts in modern history to deliver at enterprise escape velocity. Case in point: when was the last time you had a substantive discussion on valuation?  If our meetings with clients are any indication, it’s been a while.  A good measure of the market’s collective view on valuation is the proliferation of/demand loop for 2x and 3x levered single-stock ETFs.

For allocators, the investment implications follow naturally from the evolving framework.  The collision of digital abundance with physical scarcity, then capital should increasingly gravitate toward businesses that own assets, infrastructure, cash flows, and pricing power rather than those dependent upon perpetual multiple expansion.  With this writing we are reducing exposure to Emerging Market equities and increasing allocations to Large and Mid-Cap Value and Mid-Cap Core.  Notably, many of largest Growth names increasingly exhibit traditional Value characteristics – though stewardship of both cash and debt leave something to be desired.  More broadly, recent market action suggests that asset prices are increasingly responding to geopolitical bottlenecks rather than purely economic fundamentals. Whether Equities outperform Bonds or Commodities in the near-term may depend less on traditional valuation metrics than on the status of shipments through the Strait of Hormuz.  This reality reflects a world in which supply chains, energy systems, monetary policy, and geopolitical events have become tightly interconnected.

Nicholas Bohnsack