Entropy: The Degree of Disorder or Randomness in the System

When a high level of entropy exists, people tend to just shut down. When events occur too frequently, chaos develops, volatility increases to extreme levels and risk aversion ensues. With President Trump, through the desire to implement trade policy through the unconventional means of social media, the level of entropy has hit an extreme high. In reality, the trade war was actually lost decades ago. The key issue is the fact that in China’s 2025 economic strategy high tech industries are the main focus, and this is the battle ground.

The reality is that this is not so much about trade wars but trade theatre. With mid-term elections coming in the fall, the President needs to be seen fulfilling his election promises. A deal on intellectual property rights will be made and it may take some time. In the end President Trump’s bark is bigger then his bite.

The United States can on longer absorb the excess capacity generated by Germany and China. John Maynard Keynes warned that this bridge would eventually be crossed during the negotiations at Bretton Woods in 1944. He rightly predicted that the World Trade Organization was not strong enough to deal with the inherent problems created by a closed economy. Countries that manufacture trade surpluses are reticent to back up or create conditions to consume more internally. This is known, and will be dealt with through negotiations.

While economic conditions point to a period of strong company earnings, the heightened political risk, caused by concern regarding an impending trade war, has caused extreme volatility in the financial markets. Prudence suggests investors reduce exposure, and we have with the Pendragon Fund. While earnings will be strong, we expect the market to be volatile in the short-term and a deal will be made before the mid-term election season starts. When this happens, fundamentals will again take center stage. Until then, a high level of entropy will exist in the markets.

This does not mean the evolutionary process and the global economy has stopped. If the politicians and regulators step aside, the financial markets and the global economy will continue to grow and the new data driven economy will continue to evolve at a rapid pace.

Investors should look at this period as the pause that refreshes.

Dr. James E. Thorne

Chief Capital Market Strategist & Senior Portfolio Manager


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