by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Our Comment today opens with some interesting comments by a major Japanese defense industry leader warning that civilian industrial firms will not necessarily be able to exploit growing defense budgets around the world. We next review several other international and US developments that could affect the financial markets today, including the latest developments around the global oil market as the Strait of Hormuz reopens to shipping and the weekend launch of the “Trump Accounts” program.

Global Defense Industry: Amid a growing global trend of auto firms with underutilized factories trying to convert to green energy and defense products to take advantage of better prospects there, the head of a major Japanese defense contractor today has warned that auto factories probably can’t be used successfully to produce high-demand military drones. According to Eisaku Ito, chief executive of Mitsubishi Heavy Industries, the problem is that production issues between drones and autos are so dramatically different.

• As Ito explains it, factories geared toward automaking or producing other types of standardized, high-volume industrial products would not be able to handle the constant technological changes associated with drones.
• Ito’s statement is important because many struggling industrial firms around the world likely see a silver bullet in the world’s rising defense budgets, which we have discussed in detail. However, investors should probably be wary of whether such “conversion” efforts can work. Experienced defense contractors and closely related technology firms are likely to be more successful in exploiting the trend.

Global Oil Market: The Wall Street Journal today carries a useful article noting that oil tanker traffic through the Strait of Hormuz is starting to recover rapidly following the new US-Iran ceasefire and prices have fallen almost back to their pre-war levels. Near Brent crude futures are trading at about $71.94 per barrel this morning, and some analysts think they could fall to the mid-60s soon. However, the article notes that countries trying to rebuild their emergency stockpiles could help push prices higher again later in the year.

China: The People’s Liberation Army today said a PLA Navy submarine has test fired a long-range ballistic missile carrying a dummy warhead from the waters off northeast China. The missile apparently landed in the southern Pacific Ocean. Although the PLA notified neighboring countries of the launch ahead of time and publicly asserted that it was part of its normal training cycle, US allies in the region have condemned it as destabilizing.

• More broadly, the launch is further evidence that Beijing is trying to take advantage of the US administration’s preference to ease tensions and establish a kind of détente with China after years of escalating bilateral tensions.
• If Chinese officials really do believe that the US will now pull its punches, they could miscalculate, raising the risk of going too far and sparking an international crisis that could be unsettling for financial markets.

United States-Italy: Ahead of this week’s summit of the North Atlantic Treaty Organization, during which leaders from the US, Canada, and many European countries will meet, President Trump has posted a social media meme saying Italian Prime Minister Meloni needs a restraining order. The meme illustrates the rapid deterioration in relations between the erstwhile allies. It also comes as even many right-wing European leaders have begun to distance themselves politically from the US president, signaling continued tensions even as more right-wing parties gain power.

US Politics: In a speech commemorating Independence Day on Friday, President Trump warned that a “resurgence of the communist menace in our land” is currently the “greatest threat” to the US, on par with both world wars and the 9/11 terror attacks. The statement illustrates what is likely to be a key Republican attack line against the Democrats in this autumn’s midterm congressional elections, given that Democratic Socialists have recently won many Democratic primaries across the US.

• It’s not clear that the attack line will be successful.
• However, to the extent it is successful, it would offset other favorable trends that have buoyed Democratic hopes for taking control of at least the House of Representatives.

US Financial Markets: Over the weekend, the Treasury Department officially launched the new “Trump Accounts” program, which gives citizens born between 2025 and 2028 ‌a government-funded, tax-deferred investment account of $1,000 that families can build on over time. Firms can also elect to match employee contributions to the funds. Initially, contributions will be invested in low-cost US stock index funds, such as the State Street SPDR Portfolio S&P 500 ETF (SPYM).

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