AI and the Increasing Instability of Global Relationships

The AI-related boom has garnered significant attention and is unfolding in three distinct stages (as shown below).

AI Market Cycle

Stage 1: Investors chased anticipated winners (infrastructure and compute).

Stage 2: Attention shifts toward perceived victims (e.g., software), where mispricing opportunities arise.

Stage 3 (Ahead): A return to fundamentals and cash‑flow/return discipline.

It appears that we are currently in stage two. Stage one is everyone looking for a winner, which seems to have already taken place during the frenzy. We know who the winners are and who’s not, but in stage two, people start focusing on who the victims are. Who are the businesses that are suffering from this? The view is half-empty now, as investors search for a downside. That’s why you see volatility: investors fear that some old, traditional companies will be wiped out. And that kind of sentiment can sometimes be far more powerful than a focus on the upside.

So, how soon will we experience the third stage? Stage three will be when we start seeing who the final few winners are. Meanwhile, we’ll hopefully see some old companies trying to transform themselves with this tool, including certain software companies. There’s a recent style of thinking that considers some interesting opportunities. Stage three will be more balanced, rather than polarizing around winners and victims.

Historic Victory in Japan

Although AI has dominated the world stage, let’s shift gears by assessing the recent changing of the guard in Japan. New Japanese Prime Minister Sanae Takaichi’s Liberal Democratic Party (LDP) became the first party in Japan’s post-war history to secure a two-thirds majority in the lower house. Takaichi also made history by becoming Japan’s first female prime minister.

While the victory wasn’t surprising due to Takaichi’s strong mandate, the magnitude of her win was impressive. She called for increased physical and defense spending and for temporarily suspending all food and drink sales taxes for two years. And if you live in Japan, you know living expenses are rising, just like in the U.S., but their wages aren’t keeping up.

There was quite a bit of interaction between the U.S. and Japan during the election. And the new Japanese Prime Minister is scheduled to visit the White House in March. Just as the former Prime Minister Shinzo Abe did, she will create quite a phenomenon from coast to coast.

Tension Between Japan and China

China is a big wild card, and the result of this Japanese election could be a game-changer. Takaichi clashed with Chinese leadership when she said that a Chinese attack on Taiwan would pose an “existential threat” to Japan, which could lead to a military response. China suspects that Takaichi will try to change the constitution to normalize the so-called “self-defense” or “defense guard.” So basically, it’s not just for self-defense, as Japan could play a very active role in the Pacific, and the same is true of Taiwan.

Japan’s Imports and Exports (China)

The narrative is that China and Japan think their relationship will go even further downhill. And don’t forget, they’re also trading partners (as shown above). It should be interesting to see how the Chinese will react to all of this, since they rely on the Japanese for certain critical semiconductor components. But the Japanese also import a lot of stuff from China. They’re pretty close with each other, and I think Japan will grow closer to the U.S., which doesn’t have to be directly involved in the Pacific. It seems there will be increasing geopolitical tension in all of that.

Widespread Decoupling

Investors seem to be focused on the decoupling between China and the U.S., but Takaichi has made it clear she wants to reduce Japan’s reliance on China’s supply chain. China also has trade issues with Europe, with decoupling underway, particularly with Germany. The Chinese are decoupling from other folks as well, and other folks are trying to decouple from China, but it’s also coming from America.

In the near term, there will probably be some noise and turmoil, but it’s debatable whether or not the result will be impactful. The Chinese government recently alerted its central bank to be mindful of U.S. Treasury risk. It sounds like they’re telling the bank, “If you hold US Treasuries, be careful.” You have to curb that risk. I don’t recall them ever saying that before, and in such a strong public announcement.

It seems that China and the U.S. might be building up for a potential confrontation, because Xi recently told Trump on a call that he shouldn’t sell arms to Taiwan after the U.S. announced a $10 billion arms deal with Taiwan. Then, after the call, the Chinese media is trying to cancel Trump’s visit to China in April, wondering how the U.S. can sell weapons to its enemy. Meanwhile, the Chinese could be using treasury holdings as another financial weapon to threaten the U.S. China is not the largest holder of treasuries, but it’s among the largest, along with Japan and Europe.

The Potential Investment Impact

The US dollar’s weakness versus the euro and Japanese yen has renewed investors’ interest in Europe and Japan, further supported by Japan’s recent landslide election outcome. The persistence of investors’ meaningful underweighting of non-U.S. equities is likely a byproduct of the AI-driven U.S. market momentum in the second half of 2025. However, interest is accelerating as diversification narratives resonate once more.

Japanese yen to US dollar

If boring is beautiful in stock picking, then perhaps ugly (and beaten down) should not be overlooked. There is value for investors to search for securities that are uncrowded, unloved, and ripe for the picking. Some of these companies have gotten beaten up, but perhaps they have sold off too much. So, with a boring and beautiful mindset as a foundation, investors could patiently wait to buy something unpopular, unloved, and uncrowded, while being mindful of valuation.