by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Good morning! The market is eagerly awaiting the services PMI data, seeking signs that the economy remains resilient. In sports, Cristiano Ronaldo and Lionel Messi have both been left off the Ballon d’Or shortlist for the first time since 2003. Today’s Comment will cover the latest jobs data and its implications for the Fed, why we remain optimistic that the economy is not in recession, and what Michael Barnier’s rise in France reveals about immigration trends in the West. As always, we conclude with a roundup of international and domestic news.

Labor Cooling: The latest employment data reinforced the view that firms are starting to slow down hiring.

• The July Job Openings and Labor Turnover Survey (JOLTS) from the Bureau of Labor Statistics reported a sharp decline in job openings, reaching their lowest level since January 2021. Listings dropped from a revised 7.910 million to 7.673 million, suggesting a potential cooling of the labor market. In response to the report, Atlanta Fed President Raphael Bostic stated that the risks of inflation and unemployment are now balanced, likely signaling his full support for a rate cut at the FOMC’s September meeting.
• The weakening JOLTS data has intensified concerns that the central bank may have kept rates too high for too long. The ratio of job openings to unemployed workers has now dipped below pre-pandemic levels, with approximately one job opening for every unemployed individual. Although the ratio itself remains historically high, its significant decline from the peak of nearly two job postings for every available worker further cements the shift in attitudes about the labor market following last month’s triggering of the Sahm Rule.

• While the JOLTS data is disappointing, it is likely to be overshadowed by Friday’s jobs report, which is expected to show a sizeable increase in payrolls from 114,000 to 160,000 and a slight decline in the unemployment rate from 4.3% to 4.2%. A stronger-than-expected jobs report could undermine expectations for an aggressive easing cycle as it may signal that July’s job losses were a one-time occurrence due to Hurricane Beryl. Assuming the economy maintains its resilience, we anticipate the Fed will cut rates one to two times this year.

Disinversion: Growing concerns about the economy caused short-term rates to briefly rise above long-term rates as the market anticipates a strong response from the Fed.

• The Federal Reserve’s Beige Book revealed that the country is starting to feel the weight of tight monetary policy, with the number of districts reporting flat or declining activity increasing from five to nine. In response to the slowdown in business activity, firms indicated a preference for reducing hours, cutting shifts, and slowing hiring rather than implementing layoffs. Despite these measures, firms expressed optimism about a potential economic recovery in the near future. Additionally, the report revealed a moderate increase in both prices and wages.
• Weak jobs data and a gloomy Fed outlook caused the market to reassess its policy rate expectations. On Wednesday, the yield curve briefly disinverted, with the two-year Treasury rate ending the day a tad lower than the 10-year. The recent upward slope of the yield curve indicates that investors believe the Federal Reserve will need to significantly lower interest rates to stimulate the economy. The latest CME FedWatch tool reflects this sentiment, indicating a 44% chance of a 50-basis-point rate cut in September, up from 34% last week but still below the peak of 85% seen a month ago.

• While traditional wisdom suggests that yield curve inversions are a reliable precursor to economic downturns, data suggests that the disinversion of the curve might be a better indicator, as the chart above shows. Historically, the normalization of the yield curve has been followed by economic downturns. However, it’s important to note that previous disinversions were often driven by the Federal Reserve’s response to something breaking in the financial system. At this time, we see little evidence of market distress and we remain confident that the economy will demonstrate its resiliency over the next few months.

Immigration Fears Rise: A new French prime minister has been selected, and he’s likely to steer the French parliament further to the right.

• Michael Barnier, conservative leader and former EU Brexit negotiator, has been appointed as France’s next prime minister. Speculation about his potential nomination surged after conservative Xavier Bertrand and former socialist Prime Minister Bernard Cazeneuve fell out of favor. Barnier, who kept a low profile after failing to secure his party’s 2022 presidential nomination, had taken a hardline stance on immigration during that campaign, proposing a three-to-five-year moratorium on non-EU arrivals.
• Barnier’s selection likely reflects the growing prominence of immigration as a political issue across the West. While conservative parties lacked parliamentary seats to show it, they won the popular vote in France’s July legislative elections, with a significant share going to Marine Le Pen’s anti-immigration National Rally. This trend has been evident elsewhere, such as in Germany, where a far-right party recently won a state election for the first time since WWII, and in the UK’s decision to leave the EU. Even in the US, both presidential candidates have adopted increasingly restrictive stances on immigration.

• Tougher immigration policies could hinder efforts to combat inflation. The influx of foreign workers has played a crucial role in mitigating wage pressures, which have contributed to elevated inflation. A slowdown in the growth of foreign workers could require firms to rely more heavily on productivity improvements to maintain costs. While this is achievable, the timing and nature of such technological shifts are uncertain. However, it’s highly probable that service inflation would remain elevated due to this policy change.

In Other News: President Joe Biden is expected to block Nippon Steel’s takeover of US Steel, underscoring the commitment to protecting domestic industries in the US. Meanwhile, Elon Musk’s Starlink has agreed to restrict access to X in Brazil, reflecting a growing trend of governments tightening control over tech companies. The Bank of Canada lowered its policy rate by 25 bps for a third consecutive meeting in a sign that global financial conditions are loosening.

View PDF

by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Good morning! Markets remain cautious amid lingering concerns about a potential recession. In sports news, Taylor Fritz advanced to his first Grand Slam semifinal at the US Open by defeating Alexander Zverev. Today’s Comment will delve into why recent manufacturing data has not dampened our economic outlook, explain why setbacks have not hindered the development of semiconductor factories, and provide insights on the impact that the Bank of Japan’s monetary tightening is having on financial markets. As always, our report will conclude with a summary of key international and domestic data releases.

Market Jitters: Weaker-than-expected purchasing manager reports weighed on equities on Tuesday as investors grew concerned about the economic outlook.

• The August purchasing managers’ indexes (PMI) from ISM and S&P Global both confirmed a sustained contraction in the manufacturing sector for the second month in a row. Although the ISM index, which is weighted toward larger companies, showed a slight increase, both indexes remained below the expansion threshold of 50. These weak reports were further supported by evidence of declining demand. The ISM index indicated a deeper contraction in new orders and a pickup in inventory levels. Meanwhile, S&P Global reported a seventh consecutive month of declining sales.
• Despite ongoing challenges in the manufacturing sector, the overall economy remains resilient. The service industry, which constitutes nearly half of economic output, continues to drive growth. Meanwhile, goods consumption accounts for approximately a fifth of the economy. Moreover, the labor market remains relatively insulated from the industrial downturn, with over 80% of private sector jobs being service oriented. As a result, the latest Atlanta GDPNow forecast indicates a projected annualized growth rate of 2.0% for the third quarter of 2024, down slightly from the previous forecast of 2.5%.

• Market volatility is expected in the coming weeks as investors await the Federal Reserve’s next policy decision. Although the Fed has hinted at a possible rate cut this month, uncertainty persists regarding the extent of cuts this year. The Fed’s recent economic projections suggest a more cautious approach with just one cut, which contrasts with the market expectations of three to four cuts. In our view, the Fed’s strategy will largely depend on Friday’s jobs report. A strong report could prompt a moderate rate reduction, while a weaker report might lead to strong policy measures to prevent a hard landing.

The Construction Goes On: Semiconductor factory construction spending continues to skyrocket even as firms face roadblocks.

• Concerns are mounting that not all CHIPS Act projects will be fully realized. Intel, in particular, faces significant challenges. The company reported a $1.61 billion net loss last quarter and is exploring the sale or spin-off of its manufacturing division. This setback has raised concerns about the company’s ability to meet production targets necessary for securing CHIPS Act funding. Additionally, companies across the semiconductor industry have encountered opposition from local community groups due to environmental concerns, potentially delaying permit approvals.
• Despite significant funding challenges, the trajectory of domestic semiconductor facility construction remains robust. The development of semiconductor manufacturing hubs has reached its highest level in nearly half a century, with investments in facilities specifically for computer, electronics, and electrical manufacturing accounting for nearly 60% of the total spending as of July. This represents a substantial increase compared to a decade ago, when such investments accounted for approximately 8%. The sharp uptick suggests that firms may be willing to take a chance in hopes that it will pay off in the future.

• The development of domestic semiconductor fabrication plants (fabs) is likely to continue for national security reasons, but their long-term viability may be a concern if firms cannot significantly reduce costs. It has been widely speculated that firms may rely heavily on automation in these new facilities to maintain profitability. However, this could lead to push back from lawmakers who want the firms that have received funding to increase hiring for manufacturing workers. While we do not currently see this as a significant issue, it could become a potential problem in the future.

BOJ Hawkish Turn: Despite growing recessionary concerns in Japan, the central bank remains committed to its ongoing interest rate hike cycle.

• Bank of Japan (BOJ) Governor Kazuo Ueda reaffirmed that the central bank will raise rates if the economy and inflation evolve as expected. His comments come after the market sell-off in early August, partly triggered by the bank’s unexpected decision to raise interest rates. Following this move to tighten monetary policy, the central bank cited the weakness of the country’s currency as one of the reasons for the increase, adding that it believes the decision could support, rather than hinder, economic growth. Following the comments from Ueda, the JPY strengthened against the USD.
• Despite recent market volatility, Japanese investors continue to show a strong appetite for foreign assets. Over the last few years, the BOJ’s historically low rates have encouraged them to seek higher yields abroad, fueling demand for foreign bonds and equities. This foreign investment has helped lower borrowing costs for governments worldwide, especially the United States, and has supported global equity markets. As interest rates rise and the yen strengthens, some foreign capital may be repatriated to Japan, but the overall trend currently remains supportive of overseas investment.

• Although concerns about a more aggressive Bank of Japan have unnerved global investors, it’s crucial to note that Japanese bond yields remain exceptionally low relative to their G-10 peers. Despite hawkish rhetoric, the central bank is still likely to implement a gradual tightening cycle as the world adapts to post-pandemic conditions. While the possibility of another carry-trade driven market panic cannot be entirely dismissed, the market seems to be accepting that ultra-easy monetary policy is nearing its end. This shift should temper the market’s reaction for the BOJ’s next hike which is expected in January.

In Other News: The Department of Justice has subpoenaed Nvidia over allegations of antitrust violations, signaling a tougher government stance on tech firms. Meanwhile, a former aide to New York Governor Kathy Hochul has been arrested on charges of working on behalf of the Chinese government. Additionally, the People’s Bank of China is considering a policy adjustment that could result in an 80 basis point rate cut for mortgages, indicating a willingness to adopt more aggressive measures to stimulate growth.

View PDF

by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Our Comment today opens with a global poll showing that dissatisfaction with high home prices and rental rates is now widespread across the developed world, although it’s unclear whether that will spur lower interest rates or increased homebuilding to improve affordability. We next review several other international and US developments with the potential to affect the financial markets today, including more dangerous interactions between Chinese and Philippine ships in the South China Sea and a statement by Vice President Harris that she opposes the takeover of US Steel by a Japanese steel manufacturer.

Global Housing Market: While it’s tempting to think only people in the US are mad about high home prices and rising rents, new research from Gallup shows voters are dissatisfied across the developed world. Indeed, the population-weighted average rate of dissatisfaction in the countries of the Organization for Economic Cooperation and Development now stands at about 50%. OECD economists tag the shortfall to both high interest rates and insufficient homebuilding, especially at lower price points, which has boosted home prices and rents.

European Union: The European Court of Justice today ruled that the EU’s competition regulator exceeded its authority when it blocked US gene-sequencing firm Illumina’s takeover of cancer-test maker Grail. According to the court, the regulator had no jurisdiction to review the case, and the legal tool it used to block the merger was used improperly.

• The ruling is a blow to the EU’s strategy of blocking so-called “killer acquisitions,” where a firm buys a much smaller player to eliminate a source of potential competition, even if the target currently has little or no EU revenue.
• The aggressive EU strategy has been one bone of contention between EU regulators and powerful technology-oriented companies in the US.

Germany: In state elections on Sunday, the anti-immigrant, far-right populist Alternative for Germany (AfD) came in first in the eastern German state of Thuringia and second in Saxony. The results mark the best showing for a far-right party in Germany since the Nazi period in World War II. It appears that a new populist-left party, the Sahra Wagenknecht Alliance (BSW), will finish third in both states, potentially making it a kingmaker.

• AfD’s strong performance points to continued gains by the far right in the European Union, raising concerns about political stability in the bloc and its prospects for staying intact.
• More generally, the rise of some far-left parties in Europe point to worsening polarization, which will make it even harder for EU leaders to keep the bloc together, formulate policy, and support the economy and financial markets.

Switzerland: In a shocking report late last week, a panel of diplomats, high-level government officials, and military officers told the government that it should consider abandoning the country’s vaunted neutrality policy, which has been in place since 1515. Faced with Russia’s growing aggression, the report says Switzerland should consider developing the capability to work with the European Union and the US in defense matters. It also recommends that Switzerland end or revise its ban on selling weapons to countries at war.

China-Philippines: Over the weekend, a Chinese coast guard vessel once again harassed a Philippine coast guard ship in disputed waters in the South China Sea. To be precise, multiple Chinese vessels surrounded BRP Teresa Magbanua near Sabina Shoal, and one repeatedly rammed her. We have also seen reports that the Philippine ship has now turned off her location transponder, either deliberately because she is trying to hide from the Chinese, or perhaps because she has been boarded and taken over by the Chinese.

• China’s continual harassment of Philippine ships, including multiple instances of ramming and other physical contact, suggest the territorial disputes in the South China Sea will continue to present a risk of broader conflict.
• As we have noted previously, the US and the Philippines have a mutual defense treaty, and Manila has implied that if a Philippine sailor is killed in a conflict with China, it might turn to the US to help defend it.

China-Canada: Beijing today said it will investigate whether Canada is dumping canola on the Chinese market at predatory prices. The anti-dumping probe is almost certainly in retaliation for Ottawa’s decision last week to impose anti-dumping tariffs on Chinese steel, aluminum, and electric vehicles. The new probe by China is the latest sign of a possible global trade war as Beijing tries to boost economic growth by flooding the world with its exports and major developed and emerging countries erect trade barriers to protect their workers.

United States-South Korea-China: As the Biden administration continues trying to cajole US allies into clamping down further on selling advanced semiconductor technology to China, the South Korean trade minister yesterday said Washington should provide incentives for Seoul to play along. The statement reflects some allies’ resistance to losing lucrative trade flows with China, even as many business leaders in the US and the rest of the US-led geopolitical bloc resist giving up on the Chinese market.

US Economic Policy: Illustrating how nationalist populism has been embraced by both major political parties, Democratic Vice President Harris yesterday said she would oppose Japanese steelmaker Nippon Steel’s pending takeover of US Steel. Harris’s opposition to the deal, made at a union hall in Pittsburgh as part of her presidential campaign, echoes the opposition from President Biden, former President Trump, and other Republican and Democratic lawmakers.

• As we’ve noted before, populist policies are likely to be reflected in the major policies put into place whether Trump or Harris wins the presidential election in November.
• Those policies are likely to include more trade barriers and protectionism, more industrial policy to favor certain domestic industries, and tax cuts and benefit programs for the working class. Of course, the specific policies pushed by Trump or Harris would be different, but many will probably be geared to addressing today’s populist sentiment.

View PDF

by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Our Comment today opens with a note on the eurozone’s consumer price inflation, which has become (shall we say it?) more demure. We next review several other international and US developments with the potential to affect the financial markets today, including a look at the upcoming weekend elections in Germany and new research on the fiscal impact of the policies proposed by both US presidential candidates.

Eurozone: The August consumer price index was up just 2.2% from the same month one year earlier, matching expectations and marking a big slowdown from the 2.6% rise in the year to July. Excluding the volatile food, energy, and tobacco components, the August “core” CPI was up 2.8%, cooling only slightly from the 2.9% rise in the year to July. The data may help convince the European Central Bank (ECB) to institute a second interest-rate cut at its next policy meeting.

• Still, a new ECB rate cut isn’t assured. For example, in a speech in Tallinn today, ECB board member Isabel Schnabel warned the drop in the eurozone’s headline inflation rate is misleading because prices in the region’s service sector continue to rise rapidly.
• The pace of rate cuts by the ECB and Federal Reserve could be especially important for exchange rates. If the Fed cuts rates relatively slowly, as we think it may, faster rate cuts by the ECB could help buoy the dollar and weaken the euro. In contrast, if the Fed cuts rates at the same pace or even faster than the ECB, it could catalyze a drop in the value of the greenback.

Germany: Much of the economic weakness pulling down eurozone price inflation is a reflection of Germany’s faltering economy. A potential further risk for Germany is the balloting to be held in the eastern states of Thuringia and Saxony on Sunday. Polling suggests the far-right Alternative for Germany (AfD) could take control of one or both of those state parliaments. If the AfD manages that, business groups fear the party’s sharp anti-immigrant rhetoric and agenda could further worsen eastern Germany’s demographic decline.

Poland: Prime Minister Tusk’s government has proposed a 2025 defense budget equivalent to $48.7 billion, up about 17.3% from the $41.5 billion in 2024. If approved by parliament, Poland’s defense spending would top 4.7% of gross domestic product, giving it one of the biggest defense burdens in the North Atlantic Treaty Organization and cementing its role as a leader in European defense and politics.

Australia: The Australian government and Norwegian defense firm Kongsberg said they will jointly build a new factory in New South Wales to produce Naval Strike Missiles and Joint Strike Missiles. Initially, the missiles will be for the Australian armed forces, but they will eventually also be for export. The announcement illustrates the reindustrialization of countries in the US geopolitical bloc and the revitalization of the defense industry in many countries.

South Korea: New data shows that the South Korean acreage committed to growing bananas and other subtropical fruits and crops has expanded tenfold just since 2021. According to analysts, the expansion reflects rising average temperatures associated with global warming. In our view, the expansion also illustrates why investors should avoid politicized views of global trends and instead look for the investment opportunities and the risks they might provide.

China: The People’s Bank of China (PBOC) today announced that it made a small net purchase of sovereign foreign notes in the country’s secondary bond market this month, marking its first such intervention in decades and illustrating how the central bank is trying to keep Chinese bond yields from falling further. The PBOC is especially concerned that volatile bond values could destabilize the Chinese banking system.

• Illustrating the continuing economic lethargy that has prompted strong bond buying at the expense of stocks and other risk assets, new data shows office utilization in China’s major cities is now below even the low rates seen during the coronavirus pandemic. Office rents are reportedly at least 10% lower than they were two years ago.
• Unlike in the US, where the work-from-home phenomenon is a major reason for high office vacancy rates, property managers and brokers say China’s vacancy problem is mostly a reflection of slow economic growth.

US Fiscal Policy: New analyses by the Penn Wharton School of Business show the economic proposals of presidential candidates Donald Trump and Kamala Harris would both expand the federal budget deficit over the coming decade. According to the research, former President Trump’s proposals would expand the deficit by $5.8 trillion over current projections, mostly because of his aim to extend his 2017 individual income-tax cuts. Vice President Harris’s proposals would boost the deficit by $1.2 trillion, mostly by expanding the child tax credit.

• According to the research, total federal debt in 2034 would be 9.3% bigger than current projections under Trump, while it would be 4.4% bigger than current projections under Harris.
• The Wharton projections are consistent with our view that the populism embedded in each candidate’s proposals would expand the US budget deficit and boost overall debt.

US Labor Market: New projections from the Census Bureau show the fastest-growing job type in the coming decade will be “wind turbine service technician.” By 2023, the Census Bureau projects the country will have 60% more jobs of that type than it currently has. The jobs are currently concentrated in the Dakotas, Iowa, and Colorado.

US Military: According to a US Navy spokesman, the service will meet its goal of 40,600 recruits in the fiscal year ended in September, after two straight years of shortfalls. The other armed services have also seen an improvement in recruiting, especially over the last four to five months. That’s consistent with the recent cooling in the civilian labor market. Historically, the armed services have found it more challenging to find recruits when the civilian labor market is strong.

View PDF

by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Good morning! The market is closely analyzing Nvidia’s latest earnings report to assess its implications for the future. In sports news, the New York Giants honored rookie wide receiver Malik Nabers by unretiring the iconic No. 1 jersey. Today’s Comment will explore the broader significance of Nvidia’s earnings for the Magnificent 7, delve into why policymakers are having cold feet heading into the monetary easing cycle, and offer a discussion about the ongoing chip war between China and the West. As always, we’ll conclude with a roundup of key international and domestic data releases.

 AI Hype Fades: Nvidia’s disappointing results will likely intensify pressure on AI-related companies to demonstrate profitability.

• Despite exceeding analyst expectations with second-quarter revenue of $30 billion compared to the projected $28.7 billion, the US chipmaker’s stock price declined. Investors sought a more substantial earnings beat and were disappointed by the company’s subpar outlook. While the company has expressed confidence in its Blackwell processor, a next-generation AI chip, production delays due to design issues have raised concerns. Despite these challenges, the company expects revenue to increase to $32.5 billion in the current quarter, surpassing analyst estimates of $31.9 billion.
• Nvidia’s underwhelming earnings could foreshadow broader challenges within the Magnificent 7. This cohort of tech giants has been a major catalyst for the S&P 500’s gains this year, but recent signs suggest a potential slowdown. Investors are growing wary of tech companies’ abilities to sustain their current valuations, especially given their significantly higher price-to-earnings ratios as compared to the broader large-cap market. These concerns have become more pronounced as companies like Microsoft, Amazon, and Google have vowed to plow more money into AI, despite a lack of concrete results.

• Today’s results could further fuel a shift in investor sentiment, driving a rotation toward new market leaders. While other sectors may benefit from this change, large cap stocks are unlikely to be completely overlooked. The emergence of a new market leader will hinge on the economic trajectory over the coming months. As signs of a potential slowdown emerge and the Federal Reserve prepares to ease monetary policy, interest rate-sensitive sectors like Financials and Real Estate may experience a resurgence. However, market volatility is expected to be elevated as investors cope with the uncertainty.

Not So Fast: While many Federal Reserve officials have struck a dovish tone, there are still some holdouts who aren’t entirely convinced about the need for a rate cut in September.

• Atlanta Fed President Raphael Bostic on Wednesday expressed skepticism about the need for an immediate interest rate cut at the upcoming Federal Reserve meeting. During an interview, he noted that while inflation has exceeded his expectations and unemployment has risen more rapidly than anticipated, he still wants more conclusive data before fully supporting lowering rates in September. Over the next two weeks, the Federal Reserve will have two inflation reports for Personal Consumption Expenditure (PCE) and another for the Consumer Price Index (CPI) as well as another jobs report to analyze before its upcoming meeting.
• Bostic is not alone in expressing concerns that inflation may resurface if central banks become complacent. Bank of England Governor Andrew Bailey has tempered expectations for another rate cut at the central bank’s next meeting, due to concerns of a reacceleration in inflation. Despite the recent decline in inflation data, the Bank of England anticipates a higher inflation rate at year’s end. In South America, Brazil was one of the first major economies to implement rate cuts but is now considering an interest rate hike to address an unexpected resurgence in inflation.

• The PCE is not anticipated to accelerate significantly as some of its components were showing signs of moderation in the Producer Price Index (PPI), but the August CPI report could introduce uncertainty to the Fed’s aims for a rate cut. Historically, prices tend to rise during the fall months. This should not be a problem as long as the month-to-month figures remain relatively in line with last year’s increase of 0.2%. If inflation rises about that amount, it could call into question the path of future interest rate cuts.

The Fight Over Chips: Western nations have shown no signs of backing down in the face of China’s threats over export controls.

• The Netherlands delivered a major setback to China’s semiconductor aspirations on Thursday by denying ASML license renewals for servicing its advanced ultraviolet lithography equipment within the country. This move effectively curtails China’s access to the cutting-edge technology essential for developing domestic chip manufacturing capabilities. ASML’s lithography machines are indispensable for producing high-performance chips and China has no way of replacing them. The move comes as China prepares to limit export of key materials needed for chip production.
• The Netherlands’ decision aligns with the US-led effort to impose unilateral restrictions on chip exports to China. Japan and South Korea, while expressing reservations, have also complied with US requests to limit exports that could bolster Beijing’s ambitions of developing a domestic chip industry. Behind the scenes, US officials have employed the threat of invoking the Foreign Direct Product Rule against countries that fail to comply. This rule would enable the US to restrict the flow of exports containing even the smallest amount of US technology.

• Denying China access to chipmaking technology is unlikely to prevent the country from eventually developing its own industry. However, it does provide the West with a strategic advantage by incentivizing firms to invest more in the materials needed for chip production. This aligns with the West’s broader goal of reducing reliance on Chinese commodities. The escalating competition between the West and China is likely to persist for the foreseeable future as both sides seek to establish dominance in the clean energy and chipmaking sectors as a means of asserting global influence.

In Other News: As anticipated, Brazilian President Lula da Silva has selected his political ally Gabriel Galipolo to lead the country’s central bank. This choice is likely to temper expectations of a rate hike at the central bank’s upcoming meeting in September. Russia is finding it difficult to retake land captured by Ukraine in a sign of growing uncertainty about the direction of war. The California AI bill has garnered significant attention as lawmakers seek to establish safeguards for the development of new AI technologies.

View PDF

by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Good morning! Anticipation is high for Nvidia’s upcoming earnings report as markets hope for another strong performance. In sports news, NCAA football is considering eliminating the spring transfer window. Today’s Comment will explore the reasons behind rising confidence but declining job expectations. We will then delve into the ongoing clash between governments and social media companies and analyze Argentina President Javier Milei’s policy adjustments. Additionally, this report offers a comprehensive roundup of international and domestic news releases.

Sentiment Improves Despite Job Concerns: Consumer optimism increased in August, even as concerns about employment grew.

• Consumer sentiment reached a six-month high in August as households reported increased confidence in both business conditions and the overall economy. The Conference Board Consumer Confidence Index climbed from a revised 101.9 to 103.3, driven by gains in both the Expectations and Present Situation indexes. The Expectations Index, which remained above 80 for the second consecutive month, rose from 81.1 to 82.5, its highest level since August 2023. Meanwhile, the Present Situation Index improved from 133.1 to 134.4.
• Despite the broader market’s positive tone, concerns persisted about the labor market. The report indicated a decline in respondents expressing optimism about job availability and an increase in those finding jobs more challenging to secure. This weaker outlook reflects a broader concern that firms are beginning to slow hiring as the economy shows signs of losing momentum. This sentiment aligns with the Federal Reserve’s increased focus on its employment mandate. In July, the employment rate surged to its highest level since October 2021, while job openings showed signs of deceleration.

• The rise in consumer confidence is another indication that earlier-month recession fears may have been exaggerated. This bodes well for the equity market, bolstering the chances of a soft landing, especially given recent signals from numerous Fed officials favoring a September rate cut. However, it also suggests that a substantial rate cut may be less likely, given the economy’s relative stability. Nevertheless, the upcoming jobs report will likely be pivotal in determining the size of the rate cut, as another surge could reinforce the notion that the Fed is behind the curve.

Social Media Takes the Stage: Social media companies and governments are increasingly at odds over the definition of free speech.

• In a letter to the House Judiciary Committee, Meta CEO Mark Zuckerberg accused the Biden administration of pressuring the company to limit content related to the COVID-19 pandemic. Zuckerberg argued that such restrictions were inconsistent with Meta’s content standards and vowed to resist any future attempts to influence the platform’s policies. In response, the White House defended its actions, asserting that its requests for tech companies to curtail misinformation were aimed at protecting public health during the outbreak.
• His comments come amid a growing public outcry over the role of social media in disseminating divisive content. Earlier this month, Elon Musk, CEO of X (formerly Twitter), faced criticism from the UK government for suggesting that the country was on the brink of civil war. This shift coincides with the aging of the US social media audience, hindering the platforms’ abilities to increase advertising revenue. Despite being perceived as a platform for younger users, Meta’s median user age is between 30 and 39, with less than a quarter of its user base under 24.

• The ongoing debate about social media content has significant implications for the Communications sector. Many of these companies rely heavily on online advertising as a solid revenue source. Over the past few years, Meta and Alphabet have been major drivers of growth within the Communications sector. While these firms are likely to benefit from the upcoming election season, subsequent regulatory efforts could weigh on the overall sector as lawmakers seek to curtail the power of these tech giants.

 Argentina: While he has had some victories, Argentine President Javier Milei is increasingly making more concessions as he looks to revive the economy.

• Since taking office, Milei and his administration have implemented a series of policy adjustments. On Tuesday, the Argentine government announced a reduction in tariffs aimed at combating inflation. Milei’s decision to lower the import tax from 17.5% to 7.5% represents a reversal from his initial post-election increase. Additionally, he has softened his stance on China, shifting from campaign rhetoric that labeled Chinese party leaders as “assassins” to a recognition of the importance of Chinese investment and trade for Argentina’s future.
• Milei’s policy pivot comes amidst Argentina’s struggle to achieve economic growth, despite implementing painful austerity measures. Since taking office, Milei has enacted significant cuts to real pensions and public sector wages, while freezing public infrastructure projects. These measures have strengthened the government’s financial position, resulting in five consecutive budget surpluses and a faster-than-expected deceleration in inflation. However, the economy entered a recession in the first quarter, with economic activity in all but one sector posting annual declines in June.

• Despite being early in his first term, the president has demonstrated the challenges faced by those perceived as extremists in attempting to deviate significantly from their predecessors’ policies. While presidents play a crucial role in setting agendas, they often inherit situations that necessitate compromise. Therefore, it’s essential to consider the broader political landscape when assessing the potential impact of a new leader on the market. That said, Argentina’s long-term outlook is looking better since Milei has implemented some of his reforms.

In Other News: The US has affirmed its commitment to defend Israel if attacked by Iran, underscoring the ongoing threat of conflict in the region. In domestic politics, Democratic presidential candidate Kamala Harris and her running mate, Tim Walz, are scheduled for their first CNN interview, which aims to provide voters with deeper insights into their candidacies. Meanwhile, Mexican President Andrés Manuel López Obrador has suspended relations with the US and Canadian embassies in response to disagreements over his judicial reform plans.

View PDF

by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Good morning! The market is eagerly awaiting earnings reports from several chip companies. In sports news, Dallas Cowboys’ wide receiver CeeDee Lamb has signed a new multi-year contract. Today’s Comment analyzes the influence of the Fed on equities, the impact of China’s trade restrictions on the West, and why Germany’s economy appears to be in the gutter. As always, the report concludes with international and domestic data releases.

Smaller is Better? A highly anticipated Fed pivot has helped boost smaller companies, but there are still many unknowns.

• Investors will closely watch the Fed for the next few weeks as it prepares to cut rates in September. While Fed officials have signaled a 25-basis-point cut at the next meeting, they have been less committed to future policy moves. On Monday, San Francisco Fed President Mary Daly advocated for rate cuts, while Richmond Fed President Thomas Barkin acknowledged inflation risks but saw no harm in a modest rate reduction. Their comments build on Fed Chair Powell’s remarks at Jackson Hole on Friday, indicating a shift in the central bank’s focus from inflation to safeguarding the labor market.
• Since the Jackson Hole speech, investors have adopted a more risk-tolerant stance. On Monday, the S&P small-cap and mid-cap indexes rose as high as 2.2% and 2.6%, respectively. This robust performance reflects a shift in investor preference toward factors like profitability and dividends, which have outperformed traditional metrics like size and momentum. Historically, smaller firms have offered higher dividend yields than those of their larger counterparts. Additionally, declining borrowing costs will enhance profitability for small-cap firms, which are more likely to hold floating-rate debt.

• Smaller companies have outperformed larger tech stocks, which have experienced a slight pullback despite year-to-date gains. Investors searching for undervalued opportunities have led to a shift away from mega-caps, whose stock prices have outpaced earnings growth. AI-related companies have been particularly vulnerable to this sell-off as skepticism mounts about their growth potential, given their strong performance over the last two years. Earnings from chip companies will release this week, and those, especially Nvidia’s, will be a crucial test of tech’s resilience in the current market.

Chip Wars: Beijing has imposed trade restrictions on critical minerals needed for chip production as trade tensions continue to escalate with the West.

• China’s recent aggressive trade policies have started to worry firms with limited alternatives. Last year’s export controls on gallium and germanium, both crucial for semiconductor manufacturing, have led to a surge in prices for the commodities as other countries have been forced to make up the gap. The move comes as Beijing signals that it is willing to retaliate if its companies are targeted. In two weeks, China is poised to further restrict antimony, a vital component in defense technology, such as infrared missiles, night-vision equipment, and even nuclear weapons.
• The West has struggled to counter China’s strategic advantage in critical minerals. China dominates global production of gallium (over 80%), germanium (60%), and antimony (48%), while Western countries, hampered by stringent regulations, have found it difficult to develop competitive domestic industries. So far, companies have relied on existing stockpiles to maintain production. However, there are concerns about how long this can continue. Companies like Intel have continued to rely on gallium to make breakthroughs in semiconductor efficiency, even as prices have more than doubled.

• China’s market dominance is primarily due to its ability to undercut competitors’ prices. By restricting the supply of resources to the rest of the world, China is likely to spur greater competition from other countries that were previously unable to compete. Since the restrictions were implemented, there have been increased discoveries of these resources in Utah and Montana. Moreover, governments are likely to leverage these restrictions as a justification for increased support of key industries as they seek to reduce their reliance on China in the future.

Germany’s Industrial Crisis: There are growing concerns that industrial capacity in Europe’s second largest economy will not be able to recover in the coming months.

• The German economy contracted by 0.1% in the second quarter of the year, which was primarily driven by a 2.2% decline in capital spending and a modest 0.2% drop in consumer spending. Waning consumer confidence, which was fueled by concerns about job security and a struggling manufacturing sector, contributed to these declines. The GfK Consumer Climate indicator registered a five-month low, reflecting these concerns. Meanwhile, factory output has declined for three consecutive months, raising fears of a prolonged manufacturing downturn.
• The negative report marks a setback as Germany struggles to regain its economic footing after a disappointing 2023. Despite an initial 0.2% growth in the first quarter, the overall economic activity remains relatively unchanged from the previous year. The country’s flagging industrial sector has been the primary drag on growth, with German output declining steadily since its 2017 peak. Rising competition from China and the United States, coupled with difficulties in securing cheap Russian gas, has contributed significantly to this industrial downturn.

• A significant risk to the German economy is the ongoing green energy transition. Although the government has committed to clean technology, public resistance to the associated costs has been substantial. The current economic downturn could exacerbate populist sentiment, especially as the country also confronts rising concerns about illegal immigration. Consequently, we anticipate a potential shift toward easing some of the more stringent regulations on fossil fuels in the coming years. This could help mitigate further declines in Germany’s factory output.

In Other News: Canada announced that it will impose a 100% tariff on Chinese cars and a 25% tariff on Chinese steel in a sign that the West is working together to isolate China. A pivotal Mexican congressional committee sanctioned Mexican President Andrés Manuel López Obrador’s restructuring of the judiciary in a move likely to incite a potential impasse with the United States and Canada regarding the existing trade arrangement. French President Emmanuel Macron ruled out the possibility of a left wing coalition as he looks to form a government with moderate politicians.

View PDF