Author: Amanda Ahne

Bi-Weekly Geopolitical Report – Implications of North Korean Soldiers in the Ukraine War (November 18, 2024)

Posted on by Amanda Ahne

by Daniel Ortwerth, CFA  | PDF

In late October, the world learned that North Korean soldiers had deployed to Russia to assist their allies in the Ukraine war. This dramatically changed the geopolitical profile of the conflict. Allies and partners of both Ukraine and Russia have been providing material and financial support to both countries since virtually the beginning of the war. North Korea itself (formal name Democratic People’s Republic of Korea, or DPRK) has been contributing large quantities of arms and ammunition to Russia; however, this is the first known instance of another country sending combat troops to join the fight on either side. This precedent-setting action marks a clear escalation and raises the question of how this development might further accelerate the conflict.

This report addresses that question. We begin with a review of the known facts concerning troop numbers, types, locations, etc. We continue with an assessment of the likely impact of DPRK forces on the course and outcome of the Ukraine war and culminate with considerations of how this development might affect the broader geopolitical landscape beyond the conflict. As always, we conclude with investment implications. Since this report addresses a newly emerging and rapidly evolving development, its status may materially change post-publication. We encourage readers to monitor our Daily Comment for emerging updates.

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Don’t miss our accompanying podcasts, available on our website and most podcast platforms: Apple | Spotify 

Asset Allocation Bi-Weekly – Let’s Talk About Tariffs! (November 11, 2024)

Posted on by Amanda Ahne

by the Asset Allocation Committee | PDF

In recent years, tariffs have made a surprising comeback. Once widely condemned as a relic of the protectionist past, tariffs reemerged in 2016 as a policy tool against China and are now being considered for implementation on goods from all other countries. Populists tend to believe that these tariffs can be used to address a range of domestic economic issues, including persistent trade and fiscal deficits. They also generally believe that by leveling the playing field for domestic industries, tariffs can ultimately boost living standards for American households.

Under the new proposal, the US would impose a blanket tariff of 10% to 20% on all imports, with additional tariffs of 60% to 100% on goods from China. This would significantly increase the US’s average tariff rate to its highest level in nearly eight decades. The primary goal would be to protect US manufacturers and incentivize foreign companies to shift factory operations to the US, thereby creating domestic jobs. Furthermore, proponents believe that the increased tariff revenue could help reduce the US federal budget deficit. This proposed strategy has resonated with a substantial portion of the American electorate.

Despite its popularity with certain segments of the population, the proposal has faced significant opposition as it contradicts conventional economic wisdom. A tariff is a tax imposed on imported goods. Typically, it is levied as an ad valorem tax, which means it is calculated as a percentage of a good’s value. For instance, if the tariff rate were 10%, then importing a car valued at $10,000 would require paying a tariff of $1,000.

The potential increase in import costs has raised concerns about the proposal’s impact on price inflation. While businesses initially bear the cost of import tariffs, they can often pass a significant portion of this cost onto consumers in the form of higher prices. This economic phenomenon, known as tariff pass-through, is particularly prevalent for goods where businesses have significant pricing power. However, the extent to which tariffs can contribute to inflation and impact the overall economy varies.

When US consumers and businesses purchase foreign goods by paying in dollars, the foreign seller typically will exchange the greenbacks received for their own currency in the foreign exchange market. Therefore, increased US demand for foreign goods should lead to increased demand for foreign currencies, which in turn could weaken the US dollar. However, foreign countries often recycle their dollar holdings back into the US economy, in which case the foreign inflow can paradoxically buoy the dollar and widen the US trade deficit, or at least limit the dollar depreciation and the narrowing of the deficit.

For a flat tariff to successfully reduce trade and fiscal deficits without exacerbating inflation, the US would need to transition from a consumption-driven economy to an export-oriented one. US consumers would need to scale back their demand for tariff-laden imports and/or US producers would need to increase their exports. This shift would require the US to reduce its reliance on borrowing and become a net lender to the global economy. By increasing exports, the US could offset the negative impacts of tariffs and strengthen its economic position. Countries, like China, have achieved this transformation by implementing policies that encourage saving and discourage consumption, often at the expense of social safety nets.

The US dollar’s dominance as the global reserve currency could hinder an export-led growth strategy. Historically, large US trade deficits have supported the dollar’s role as other countries have relied on it for international transactions. To shift this dynamic, the US might need to diminish the dollar’s appeal. This could involve implementing capital controls, as many developing countries do, in order to restrict cross-border capital flows. Alternatively, the US could sacrifice monetary policy autonomy, either by pegging the dollar to another currency or by joining a currency union with other nations.

Because we don’t expect the US to make all the necessary adjustments to become more export-oriented, we believe that potential tariffs could induce foreign countries to devalue their currencies to offset the impact of the tax levy. Accommodative monetary policy could make this possible. This scenario would benefit US companies with limited foreign revenue, such as small and mid-cap companies, as their revenues would likely remain unaffected by currency depreciation. However, this could negatively impact US exporters that rely on foreign sales as the price of their goods could become less competitive.

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Bi-Weekly Geopolitical Report – Rising US & Global Debt: A Perspective Check (November 4, 2024)

Posted on by Amanda Ahne

by Daniel Ortwerth, CFA  | PDF

Concern has been rising across American society and throughout much of the world about the level of United States government debt. An increasing number of voices are sounding the alarm that the debt level is unsustainable, and crisis is on the way. Debates rage about how such a crisis will begin and when it will happen, but according to the alarmist view, the country will inevitably face financial catastrophe, with grave consequences for the security of the nation and the welfare of its citizens. Is this true? Are we really on a critical path, and is a catastrophic outcome inevitable? It is time to gather the facts and apply sound analysis to give ourselves a well-founded perspective.

This report uses standardized, internationally recognized data for 43 of the largest countries, from the beginning of the century to the present, to analyze US and global debt levels according to broadly accepted methods. It assesses the progression of debt levels across the period, between countries and country groups (i.e., developed and emerging) and between sectors of society (i.e., government and private). Our goal is to provide a fact-based sense of the situation and its trends. The report pays particular attention to the comparison between US and Chinese debt levels, since this plays a role in the geopolitical competition that has emerged. As always, we finish with implications for investors.

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Don’t miss our accompanying podcasts, available on our website and most podcast platforms: Apple | Spotify 

Business Cycle Report (October 31, 2024)

Posted on by Amanda Ahne

by Thomas Wash | PDF

The business cycle has a major impact on financial markets; recessions usually accompany bear markets in equities.  The intention of this report is to keep our readers apprised of the potential for recession, updated on a monthly basis.  Although it isn’t the final word on our views about recession, it is part of our process in signaling the potential for a downturn.

The Confluence Diffusion Index remained in contraction. The September report showed that six out of 11 benchmarks are in contraction territory. Last month, the diffusion index improved slightly from -0.2152 to -0.1515 but is still below the recovery signal of -0.1000.

  • A drop in interest rate expectations helped to loosen financial conditions.
  • The Goods-Producing sector is improving, but overall activity remains weak.
  • The labor market continues to show resilience.

The chart above shows the Confluence Diffusion Index. It uses a three-month moving average of 11 leading indicators to track the state of the business cycle. The red line signals when the business cycle is headed toward a contraction, while the blue line signals when the business cycle is in recovery. The diffusion index currently provides about six months of lead time for a contraction and five months of lead time for recovery. Continue reading for an in-depth understanding of how the indicators are performing. At the end of the report, the Glossary of Charts describes each chart and its measures. In addition, a chart title listed in red indicates that the index is signaling recession.

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Asset Allocation Bi-Weekly – The Inflation Adjustment for Social Security Benefits in 2025 (October 28, 2024)

Posted on by Amanda Ahne

by the Asset Allocation Committee | PDF

Even for dedicated, successful investors who have built up a substantial nest egg, Social Security retirement and disability investments can be an important part of their financial security. For many Americans, Social Security benefits may be the only significant source of income in advanced age. On average, Social Security benefits account for approximately 30% of elderly people’s income and more than 5% of all personal income in the US. There is one aspect of Social Security that is especially important in the current period of higher price inflation: By law, Social Security benefits are adjusted annually to account for changes in the cost of living. In this report, we discuss the Social Security cost-of-living adjustment (COLA) for 2025 and what it implies for the economy.

In mid-October, the Social Security Administration announced that Social Security retirement and disability benefits will increase 2.5% in 2025, bringing the average retirement benefit to an estimated $1,976 per month (see chart below). The increase, much smaller than those during the last couple years of high inflation, will bump up the average recipient’s monthly benefit by approximately $49. The benefit increase was right in line with expectations, given that it is computed from a special version of the Consumer Price Index (CPI) that is widely available. The COLA process also affected some other aspects of Social Security, although not necessarily by the same 2.5% rate. For example, the maximum amount of earnings subject to the Social Security tax was raised to $176,100, up 4.4% from the maximum of $168,600 in 2024.

Media commentators often fret that the Social Security COLA could be “eaten up” by rising prices in the following year, or that the benefit boost could provide a windfall if price increases decelerate. In truth, COLA merely aims to compensate beneficiaries for price increases over the past year. It is designed to maintain the purchasing power of a recipient’s benefits given past price changes with price changes in the coming year being reflected in next year’s COLA.

For the overall economy, the inflation-adjusted nature of Social Security benefits is particularly important. Since so many members of the huge baby boomer generation have now retired, and since more and more people are drawing disability benefits than in the past, Social Security income has become a bigger part of the economy (see chart below). In 2023, Social Security retirement and disability benefits accounted for 4.9% of the US gross domestic product (GDP). Having such a large part of the economy subject to automatic cost-of-living adjustments helps ensure that a big part of demand is insulated from the ravages of inflation, albeit with some lag. In contrast, if Social Security income were fixed, a large part of the population would be seeing its purchasing power drop sharply, which might not only reduce demand, but could also spark political instability. Of course, the additional benefits in 2025 will help buoy demand and keep inflation somewhat higher than it otherwise would be.

Finally, it’s important to remember that an individual’s own Social Security retirement benefit isn’t just determined by inflation. The formula for computing an individual’s starting benefit is driven in part by a person’s wage and salary history. Higher compensation will boost a retiree’s initial retirement benefit, which will then be adjusted via the COLA process over time. As average worker productivity increases, average wages and salaries have tended to grow faster than inflation, and as a result, the average Social Security benefit has grown much faster than the CPI. Over the last two decades, the average Social Security retirement benefit has grown at an average annual rate of 3.5%, while the CPI has risen at an average rate of just 2.6%. In sum, Social Security benefits provide an important source of growing purchasing power that helps buoy demand and corporate profits in the economy.

On the bottom line in our view, this year’s COLA announcement will prove to be market neutral. Although recipients may experience initial disappointment with this adjustment relative to those of recent years, the adjustment is actually more in line with those that came before the recent period of heightened inflation.

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