by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Good morning! Equities are off to a great start, and the Diamondbacks look to prove doubters wrong in the first game of the World Series. Today’s Comment begins with our analysis of the S&P 500’s recent poor performance, followed by a closer look at the GDP data and rising geopolitical risks in the Middle East and the South China Sea. As always, our report includes an overview of the latest domestic and international data releases.

Correction Coming? After getting off to a strong start to the year, large caps may have finally hit an inflection point.

• The S&P 500 closed below its 200-day moving average of 4,238.41 on Thursday, ending the day at 4,179.50. This dip below a key technical level has historically signaled a broader sell-off. The index’s fall was related to a confluence of negative factors, including rising yields on long-duration Treasuries, a war in the Middle East, and a deteriorating outlook for tech stocks. The last of the three has come under scrutiny due to their high valuations relative to earnings, as investors have been willing to pay a premium for companies with strong AI capabilities.
• The Magnificent Seven—Alphabet (GOOG, $123.44), Amazon (AMZN, $119.57), Apple (AAPL, $166.89), Meta (META, $288.35), Microsoft (MSFT, $327.89), Nvidia (NVD, $388.65), and Tesla (TSLA, $205.76)—have seen the least amount of losses since July 21, 2023, outperforming the broader tech sector and the overall S&P 500. Their strong performance is likely due to investor confidence in these companies’ ability to capture market share given their size and expertise. According to an analyst at Bernstein Quantitative, the Magnificent Seven are projected to have profit growth of 33.1% and revenue growth of 10.9% year-over-year, while the remaining companies are predicted to have profit contraction of 8.6% and revenue growth of 0.3%.

• Despite their strong performances, the Magnificent Seven remain more vulnerable to fluctuations than investors may realize, due to their sensitivity to idiosyncratic risk. This was evident in the sell-off in Alphabet and Meta stocks this week, despite both companies reporting strong overall earnings. Alphabet’s cloud business is struggling to meet investor expectations, while Meta’s forward guidance was weakened by changes in the macroeconomic landscape. Investors should keep in mind that the Magnificent Seven’s strong year-to-date performance is due in part to lofty expectations, and it is unclear whether these companies can live up to them. As a result, investors may find value by focusing on other companies with strong fundamentals that are being ignored.

Blowout Q3: The latest GDP report showed that the economy surged in the third quarter in another sign that a recession is not imminent.

• The U.S. economy grew at a robust 4.9% annual rate in the period from April to September, a significant increase from the 2.1% growth in the preceding three months. This sharp rise has raised doubts about the possibility of a recession, as the report showed that consumption remains strong even in the face of rising interest rates. Strong retail sales have boosted optimism that households have not yet run down their pandemic savings, raising the likelihood of a spillover effect into the following quarter. The report was also supported by strong inventories, but this is unlikely to persist.
• Despite strong consumption, GDP data shows that spending has shifted to smaller ticket items. Expensive and interest-sensitive goods like new and used vehicles declined in Q3, while recreational goods like TVs and PCs jumped. This may reflect households having more spending power due to higher wages, as firms compete to retain workers. The stubbornly low jobless claims reinforce this view as they show that labor hoarding is still rife throughout the economy. Assuming our assessment is correct, the economy may be more resilient to higher interest rates than investors realize.

• Despite the strong reading, the report is unlikely to sway policymakers at next week’s Federal Open Market Committee meeting. The yield on the 10-year Treasury fell 4 bps to 4.91%. Meanwhile, the CME FedWatch Tool shows that there is an 80% chance that the Federal Reserve will hold rates steady for the rest of the year. The indifference to the report reflects the broader sentiment that the market expects Fed officials to enter a new phase in its policy stance, in which it looks to navigate a soft landing. Projections show that the Fed will look to cut interest rates in the second half of 2024.

Rising Geopolitical Tensions: The chances of a broadening conflict in the Middle East are increasing, while tensions between the U.S. and China show no signs of abating.

• Israeli forces have undertaken another operation in Northern Gaza, with the aim of neutralizing Hamas fighters and disabling their anti-tank weaponry, as they prepare for an imminent ground invasion. Simultaneously, the U.S. military conducted airstrikes against two facilities located in eastern Syria, which were suspected of having connections with Iran-backed militia groups. These actions by the Israeli and U.S. governments have sparked concerns about the potential for escalating violence across the Middle East, which could result in disruptions in the sales of essential commodities. Following the report, Brent oil prices surged $2 per barrel overnight, hitting $90 per barrel.
• Across the Pacific, the U.S. and China have accused each other of provocations in the South China Sea. The situation started after a Chinese vessel collided with a Philippine boat on Sunday near the disputed Second Thomas Shoal. After the incident, President Joe Biden warned Beijing that the U.S. was willing to defend the Philippines from Chinese aggression. The row escalated on Thursday after a Chinese fighter jet was recorded flying within 10 feet of a U.S. Air Force B-52 bomber. China responded to the allegation by showing a video of a U.S. ship harassing a Chinese navy task group during routine training in the South China Sea.

• Despite strong advocacy for diplomatic mediation, geopolitical tensions and the ever-present risk of miscalculation loom large, significantly heightening the possibility of a major conflict. The situation in the Middle East remains precarious, with uncertainty surrounding the extent of Israel’s invasion of Gaza, while incidents in the South China Sea threaten a more extensive conflict in the Pacific region. Despite recent promising developments, such as a delay in Israel’s invasion and high-level talks between Washington and Beijing, the mounting geopolitical tensions underscore the potential for defense companies to deliver substantial value to investors in the coming years.

Other News: China’s former premier, Li Keqiang, died on Friday. He was seen as a rival of President Xi Jinping and as an advocate of the business class in China.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Good morning! Concerns over earnings are weighing on equities, and Astros manager Dusty Baker announced that he is retiring. Today’s Comment begins with a discussion about the ECB’s latest rate decision. Next, we analyze the recent plunge in the yen and assess how political realignment may impact support for Ukraine. As always, our report includes an overview of the latest domestic and international data releases.

Throwing in the Towel? With high inflation and a looming recession, the European Central Bank is reluctant to predict the future path of policy.

• European policymakers held policy rates steady at their October 26 meeting, following 10 consecutive hikes. The decision to keep rates at their current levels comes amidst signs that euro area inflation has dropped. In September, the consumer price index rose 4.27% year-over-year, well below the previous month’s rise of 5.01%. At the press conference, ECB President Christine Lagarde reiterated the central bank’s commitment to containing inflation and its readiness to raise rates if necessary. While confident that inflation will continue to make progress, ECB President Christine Lagarde stated that the central bank will take a wait-and-see approach before deciding whether to hike rates again.
• In addition to interest rate uncertainty, the European Union faces concerns about implementing a bloc-wide 3% deficit-to-GDP target and a 60% debt-to-GDP ratio by its self-imposed January 2024 deadline. Although there isn’t an agreement in place, the plan is for EU members to resume their deficit and debt targets, which were temporarily suspended during the pandemic, and amend the fiscal rules to allow governments more flexibility in meeting targets over four years, with a possible seven-year extension in exchange for reforms and investments. Details of the arrangements are still being negotiated, with the sides far apart. The lack of guidance may force policymakers to hold rates tighter for longer to prevent inflation from arising from fiscal spending.

• The European Central Bank faces a more precarious predicament than the Federal Reserve when deciding future policy. Eurozone inflation is higher and growth is slower than in the United States, limiting policymakers’ flexibility to raise rates. On the other hand, policymakers may be reluctant to ease monetary policy on concerns that currency depreciation due to interest rate differentials could counterintuitively push up inflation. As a result, the ECB is more likely to hold policy steady for longer than the Federal Reserve, and rely more on other tools for tightening, such as raising the minimum reserve requirement.

Yen Troubles? The Japanese currency dropped to a 33-year low against the dollar on Wednesday, raising the likelihood of intervention from the Bank of Japan (BOJ) and a policy shift.

• The yen (JPY) closed at 150.25 per dollar on Wednesday, its lowest level since August 1990. The BOJ has stated that it was willing to intervene in exchange rate markets to prevent extreme swings in currency movements. Last October, the Bank of Japan intervened by selling dollars and buying yen, worth about $42 billion, after the JPY breached 150 to the dollar. Although BOJ officials have been mum about whether it is weighing another intervention, the central bank’s reputation of being the “widowmaker” has prevented analysts from betting big against the currency.
• The BOJ may tweak its yield curve control (YCC) policy at its next meeting on Monday, as currency weakness and rising inflation have fueled speculation about an end to its ultra-accommodative monetary policy. The 10-year Japanese government bond (JGB) yield is trading at 0.87%, its highest level in over 13 years, with the current YCC band set at 1.0%. A possible readjustment to the YCC band could reduce pressure on the currency and inflation, while also signaling to the market that the BOJ is transitioning away from its ultra-accommodative stance.

• The BOJ is likely to phase out its ultra-accommodative monetary policy in 2024, as inflation becomes a political problem for the ruling party. Earlier this week, the government announced that it plans to extend utility and gasoline subsidies through April to protect households from rising price pressures. This shift will impact global bond yields, as JGBs will offer more competition to other government debt, such as the U.S. Treasury. It will also hurt investors in the yen carry trade, as the resulting currency appreciation will make debt payments more expensive for borrowers that hold foreign currencies. Additionally, the change should act as a headwind for the USD.

War Fatigue? Political parties pushing to reduce financial support for Ukraine in its conflict with Russia are gaining popularity across the West.

• The U.S. elected its new House speaker following the end of a 22-day stand-off. Republican Representative Mike Johnson from Louisiana won the election to become the 56^th Speaker of the House. Despite having a relatively low profile prior to his win, he has been labeled the most conservative speaker by some publications. After taking the gavel, his first move was to approve aid for Israel in its conflict with Hamas. He is also expected to hold budget talks with the White House, which will likely include discussions on aid for Ukraine. While he has expressed support for Ukraine, he has been skeptical of using U.S. taxpayer money without proper oversight.
• Speaker Johnson is not alone in expressing concerns about how aid to Ukraine is being spent, as politicians in the United States and abroad have also raised doubts. Republican presidential candidate Vivek Ramaswamy has made opposing aid one of the tenets of his presidential campaign. Meanwhile, Germany’s populist AfD party has seen a surge of support in recent months and Slovakia has elected a president that is likely to push back against additional aid to Ukraine. While public support for Ukraine remains strong, public interest is waning.

• War funding is poised to become a central issue in the coming months, as governments grapple with a slowing global economy and elevated budget deficits. The U.S. budget talks will provide a glimpse into how other governments will handle this issue. If U.S. lawmakers struggle to reach a consensus, given their resilient economy, it will be even more difficult for EU countries on the brink of recession to do so. It is too early to gauge the West’s long-term support for Ukraine, but next year’s U.S. presidential election and EU parliamentary elections may provide some clues. Regardless of the outcome, the market will likely favor a quick resolution.

Other News: The U.S. found that a chip made by Huawei may have been made using machines subject to export controls. This discovery suggests that China may not have made as much advancement in semiconductor manufacturing as once feared, but it also raises questions about the effectiveness of export restrictions. Separately, the United Auto Workers (UAW) has reached a tentative agreement with Ford Motor Company (F, $11.54). The deal is likely to pressure other automakers to reach agreements with the UAW as well. Lastly, Israel is preparing to carry out its ground invasion of Gaza. The move raises the likelihood of a broader Middle Eastern conflict.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Good morning! S&P 500 futures are trading lower before the open and the Diamondbacks made it to the World Series for the second time in franchise history. Today’s Comment starts with a discussion about the resurgence of the S&P 500. Next, we will give our thoughts on the recent rally in bitcoin and China’s hardball tactics with foreign companies. As always, our report includes an overview of the latest domestic and international data releases.

There is Life: The S&P 500 rebounded after briefly testing the 4,200 support level earlier this week, but it doesn’t appear that the asset class is out of the woods yet.

• Strong earnings and positive economic data boosted the large-cap equity index performance on Tuesday. Several companies, including Verizon (VZ, $34.30), 3M (MMM, $90.12), and Coca-Cola (KO, $55.64), reported better-than-expected earnings, lifting sentiment that companies are becoming more profitable. Microsoft’s (MSFT, $330.12) results also supported an improved outlook, with the second-largest company by market capitalization rising 4% overnight after posting strong growth for its cloud services business. Additionally, S&P Global data showed that U.S. manufacturing activity entered expansion for the first time in six months, with the Purchasing Manager Index hitting 51. The report suggests that economic momentum from Q3 may carry over into the next quarter.
• However, negative news for the tech sector has dampened some of the S&P’s momentum. Google parent company Alphabet (GOOG, $140.12) reported a failure in its cloud services business, which overshadowed its estimate-beating revenue and earnings. Investors are concerned that Alphabet may not be able to catch up to rivals Amazon (AMZN, $128.56) and Microsoft, especially as it looks to make gains in generative artificial intelligence. Meanwhile, Meta (META, $312.55) is facing lawsuits from 41 different states and the District of Columbia, alleging that the tech giant has harmed children by making its platform too addictive. The allegation comes as lawmakers from both parties are becoming increasingly concerned with the impact social media is having on society.

• A sustained rally in large caps is far from assured, given the lingering risks both domestically and abroad. The Federal Reserve has maintained the possibility of another rate hike, defying suggestions that rate increases are coming to an end. Furthermore, concerns about an escalating conflict in the Middle East are growing, with the U.S. issuing a warning to Iran against exploiting the situation in Gaza to target American troops. This heightened uncertainty explains why the CBOE VIX index briefly exceeded 20 on Tuesday, as investors worry about more volatility over the next 30 days.

Crypto Rally: Investors have flocked to digital currencies, drawn by the prospect of exchange-traded funds based on crypto and rising global tensions.

• A federal judge ruled against the SEC in its bid to block Grayscale’s Bitcoin ETF on Monday. The regulator argued that the ETF lacked adequate oversight to detect fraudulent activity and manipulation. Earlier this week, the SEC stated that it will no longer contest the ruling, boosting optimism that it was ready to allow Grayscale’s Bitcoin Trust to become a listed BTC ETF. So far, regulators have not approved a single spot crypto ETF to be listed on U.S. exchanges but have paved the way for similar investment vehicles containing futures for bitcoin and ether.
• The ongoing conflict in the Middle East has prompted investors to flock to digital currencies as safe-haven assets. Bitcoin rose 7% in the days leading up to the court’s ruling and following the outbreak of the Israel-Hamas conflict. Comparatively, gold price futures rose about 8% within the same period. Bitcoin’s strong performance has led to optimism that it may be maturing past the early adoption stage and into a legitimate asset class. Several asset managers have argued that cryptocurrencies can be used to diversify geopolitical risks similar to other hard assets.

• Despite cryptocurrency’s recent momentum, we remain skeptical of its readiness for widespread adoption. Persistently low trading volumes and a 30-day moving average below pre-stablecoin crash levels suggest that confidence in the asset class remains relatively low, making it vulnerable to substantial price fluctuations. Additionally, significant regulatory challenges loom ahead, including demands for more oversight of the crypto industry, especially related to anti-money laundering. Senators Elizabeth Warren (D-MA) and Kristen Gillibrand (D-NY) are pushing their party to take a stand against the industry. Consequently, we believe that more traditional hard assets and commodities are better suited for conservative investors looking to hedge against geopolitical risks.

Companies Must Choose: Beijing is increasingly assertive in pushing foreign companies to lobby their governments for better trade ties with China.

• Chinese regulators opened an investigation into Foxconn (2354.TW, TWD, 53.30), a Taiwan-based Apple (AAPL, $173.44) iPhone supplier, over alleged tax and land violations. The crackdown appears to target Terry Gou, the company’s founder and largest shareholder, who is running as a long-shot independent candidate in Taiwan’s presidential election in January. Although he has stated that he would push to improve ties between the sovereign island and Beijing, he has maintained that he will not be bullied. The probe has unnerved investors, suggesting that Beijing may be preparing to crack down on other foreign multinational companies as well. Shares of the Foxconn’s stock have dropped 2.2% over the past two days.
• Beijing’s heavy-handedness may have discouraged Western companies from taking sides in the escalating feud with China. Mercedes-Benz (MBGYY, $16.26) CEO Ola Källenius has walked back his claims that China was a potential growth market by describing it as maturing. Tesla (TSLA, $216.52) CEO Elon Musk has warned that the U.S. no longer has a significant edge over its geopolitical rivals and could be defeated in a conflict. European auto suppliers have advocated for regulators to focus on creating incentives for cheaper car production in Europe instead of imposing tariffs on Chinese car imports. However, many companies have responded to China’s actions by redirecting investments to other countries.

• China’s decision to target companies that do not comply with its demands comes with significant risks. Increased pressure on foreign businesses could lead them to seek out alternatives, undermining China’s efforts to attract foreign investment to resolve its debt problems. Additionally, China’s tactics could encourage governments to increase scrutiny of Chinese investment. U.S. regulators are already cracking down on Chinese partnerships and purchases of American tech companies, and this trend could spread to other industries. The growing friction between the West and China suggests that domestic companies with exposure to the other’s market may become less attractive as global tensions rise.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Our Comment today opens with an update on the Israel-Hamas conflict.  We next review a range of other international and U.S. developments with the potential to affect the financial markets today, including weak economic indicators in the eurozone and the United Kingdom, and a discussion of the U.S. government’s deficit situation as shown in a new data release.

Israel-Hamas Conflict:  The Israeli air forces and intelligence services continue working to set conditions for their expected ground assault against Hamas in the Gaza Strip, while Western leaders urge steps to minimize civilian casualties.  Meanwhile, U.S. Defense Department said the USS Dwight D. Eisenhower and her strike group will now be sent to the waters around the Persian Gulf and Red Sea, rather than joining the USS Gerald R. Ford and her strike group in the eastern Mediterranean as originally planned.  The U.S. will also deploy additional air defense systems to the region.

• The moves follow a series of small attacks on U.S. forces in Syria, Iraq, and near Yemen. They also highlight how the Israeli-Hamas fighting could broaden if regional Islamist groups escalate their sympathy attacks on U.S. interests or military units in the region.
• In the event of a substantial Islamist attack on U.S. interests or military units in the region, a self-defensive or retaliatory attack by U.S. forces could potentially prompt Iranian forces to join the fray. And even worse scenario would be if the half-dozen or so Chinese navy ships in the region came to the aid of the Iranians or the Islamist fighters.

China:  President Xi today officially signed an order firing Defense Minister Li Shangfu, nearly two months after he disappeared from public view.  Xi also signed an order removing former Foreign Minister Qin Gang, who was sacked in a similar way in July, from the State Council.  The Li and Qin cases have sparked rumors of corruption and misbehavior, but they could also reflect internal power politics.  Given China’s opaque leadership, it is impossible to know for sure at this point.

Hong Kong:  Recent data shows Western firms are increasingly leaving Hong Kong on fears that it is being subsumed into the Chinese economy and legal system.  The city’s own data shows the number of U.S. companies operating in Hong Kong has now fallen for four straight years, to 1,258 in June 2022.  Mainland Chinese firms with regional headquarters in Hong Kong now outnumber U.S. firms with regional offices there, for the first time in at least three decades.  While we often note how China’s geopolitical, economic, and legal environment are becoming less amenable to investment, it appears that Hong Kong is now in a similar situation.

Eurozone:  The S&P Global “flash” composite purchasing managers index for October fell to a 35-month low of 46.5, significantly below the consensus expectation of 47.4 (all in seasonally adjusted terms).  As shown in our “Foreign Economic News” section below, the decline in the composite index reflected weaker readings in both the manufacturing and the service-sector indexes.  Like most major PMIs, this one is designed so that readings below 50 indicate declining activity.

• Today’s reading will therefore raise concerns about a further economic slowdown in Europe and stronger headwinds for European stocks because of factors such as high inflation and high interest rates.
• The data is adding to speculation that the European Central Bank will hold interest rates steady at its meeting later this week. Nevertheless, ECB chief Lagarde continues to suggest rates will remain high and won’t be cut again for some time.

United Kingdom:  Similar to the eurozone’s data, the U.K.’s S&P Global/CIPS composite PMI for October came in at a seasonally adjusted 48.6, nearly as weak as the September reading of 48.5 and enough to indicate continued weakness in the British economy.

U.S. Politics:  In the House of Representatives, the majority Republicans yesterday held a forum for the nine candidates now seeking to be speaker, with each laying out their strategy for pushing forward party priorities such as cutting federal spending.

• No single candidate appeared to have a lock on the party, but press reports say the strongest support is swinging toward:
  • House Majority Whip Tom Emmer of Minnesota,
  • Republican Study Committee Chair Rep. Kevin Hern of Oklahoma,
  • House Republican Conference Vice Chair Rep. Mike Johnson of Louisiana, and
  • Byron Donalds of Florida, an ally of former President Donald Trump.
• The Republicans will vote to select their candidate for Speaker this morning, with a floor vote planned in the coming days.

U.S. Fiscal Policy:  The Treasury Department has finally released its report on federal revenues, outlays, and deficits for the fiscal year ended in September.  However, the overall deficit figures for FY 2023 and the prior year are distorted because of the way the department accounted for the entire cost of the administration’s proposed student-loan forgiveness program in just one month, i.e., September 2022, as we showed in a recent Asset Allocation Bi-Weekly Report.  After the courts negated that program, the department reversed its accrual all in August 2023.  The budget deficit therefore looks bigger in FY 2022 than it really was on a cash-accounting basis, and narrower in FY 2023.

• As reported, federal receipts in FY 2023 totaled $4.439 trillion, down 9.3% from the previous year. Federal outlays totaled $6.134 trillion, down 2.2% from the prior year.  That resulted in a reported deficit of $1.695 trillion, versus a shortfall of $1.375 trillion in FY 2022.
• One simplistic way to correct for the student-loan program’s accrual accounting would be to strip out its recognized cost of about $383 billion from the monthly figure for September 2022 and add it back in August 2023. Doing so would result in a FY 2022 deficit of roughly $1.312 billion and a FY 2023 deficit of about $1.758 billion.  The chart below shows how the rolling 12-month totals for federal receipts and outlays would look with this adjustment.
• The adjusted chart clearly shows the widening gap between federal outlays and receipts. As we noted in our Asset Allocation Bi-Weekly Report, we still think there will be some fiscal tightening in the coming quarters from developments like the end of the temporary student-loan payment moratorium.  Nevertheless, the current expansion in the federal deficit is likely an important reason for the recent surge in bond yields.

U.S. Labor Market:  The United Auto Workers yesterday announced the union would expand its strike against the major automakers to include the largest pickup-truck factory of Stellantis (STLA, $18.94).  The move came despite the company’s offer last Thursday to boost wages by 23% over the life of the new contract being negotiated, and to increase the firm’s retirement plan contributions by 50%, along with added job security.  The UAW’s tough bargaining reflects how the tight labor market has strengthened labor’s bargaining power and likely portends continued sharp increases in wage rates and higher consumer price inflation in the coming years.

U.S. Energy Markets:  Helped on by the seasonal transition to cheaper winter blends, average prices for unleaded gasoline have fallen recently to just $3.51 per gallon, close to the lowest levels of the year.  The fall in gas prices could help offset the recent rise in interest rates and student loan repayments, thereby buoying consumer spending in the coming months.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Our Comment today opens with the latest on the Israel-Hamas fighting, where we continue to keep our eyes open for signs that it could spread into a broader regional conflict.  We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today, including new tensions between China and the West, and a new selloff in U.S. bonds, which has finally pushed the yield on the 10-year Treasury note decisively above the 5% mark.

Israel-Hamas Conflict:  Among the top news items related to the conflict, the Israeli military continues to launch airstrikes against Hamas targets in Gaza, as well as against Hezbollah fighters in southern Lebanon in response to their missile attacks across the border into Israel.  Pro-Palestinian demonstrations also continue in countries neighboring Israel, further raising the risk that attacks on Israeli interests will prompt a wider conflict, potentially including Iran.  Meanwhile, the U.S. and key allies are urging the Israelis to delay their expected ground incursion into the Gaza Strip to root out the Hamas leadership and military organization there.

• Separately, the Wall Street Journal over the weekend released a detailed video analysis providing further evidence that the October 17 explosion at Gaza’s Al-Ahli Arab Hospital stemmed from an errant Hamas missile rather than an Israeli attack.
• The New York Times today acknowledged that in its initial reporting of the hospital explosion, it relied too heavily on Hamas’ statements that it was caused by an Israeli airstrike and didn’t make it sufficiently clear that those claims couldn’t be verified.

China-United States:  China’s Ministry of State Security released a video purportedly revealing another arrest of a CIA spy.  According to the video, the spy was recruited while he was a visiting scholar at a U.S. university and then passed secrets to the CIA when he returned home to China and began working for an important defense industry firm in the province of Sichuan.  After recent moves to tighten its counterespionage laws and encourage everyday citizens to report suspected spies, the MSS has revealed numerous cases of CIA spies caught in the act.

• Publication of the successful counterespionage cases is most likely aimed at making Chinese citizens more aware of the risk of spies among them.
  • It’s impossible to know if these cases are real or not. If the stories are true, they suggest that the U.S. has had some success in recruiting visiting Chinese students to spy for the U.S. once they return home.
  • On the other hand, such arrests could also mean that the CIA is facing another devastating loss of its spy network in China, similar to when it lost some 30 spies from 2010 to 2012, apparently because of a Chinese mole at the CIA.
• China also continues to pressure foreign businesses with tax and regulatory probes. Today, for example, we’ve seen reports that the Shanghai municipal government has arrested several employees and former employees who worked at a unit of London-based advertising firm WPP (WPP, $41.43) on suspicion of bribery.  Other reports say various provincial governments are conducting tax probes of Taiwan Semiconductor Manufacturing (TSM, $91.31).

China-Philippines:  According to officials in Manila, a Chinese coast guard ship on Sunday collided with a resupply ship trying to reach Philippine marines stationed on a shoal in the disputed Spratly Islands.  The Chinese coast guard and maritime militia forces have long been harassing and trying to prevent such missions as part of their effort to assert Chinese sovereignty over the area, but the event this weekend was the most serious confrontation between Chinese and Philippine forces.  The incident highlights the risk of a more serious military confrontation in the region.

China-Australia:  In contrast with China’s clearly deteriorating relations with the U.S. and the Philippines, there are new signs that relations between Beijing and Canberra are improving again.  Australian Prime Minister Albanese said he will travel to China next month for a meeting with President Xi.  In addition, Albanese said the Chinese government has agreed to “review” the punitive tariffs it slapped on Australian wine in 2020 to retaliate for former Prime Minister Morrison’s suggestion that China be investigated for its role in the global coronavirus pandemic.  Since China is such a large export market for Australia, the continued improvement in relations and reduced trade barriers should be bullish for Australian stocks.

China:  Chinese stock values fell as much as 1.3%, leaving them down about 15% for the year to date.  The key stock indexes are also now at their lowest level since before the coronavirus pandemic.  The Chinese economy and financial markets continue to struggle with a range of headwinds ranging from poor consumer demand and high debt levels to bad demographics and trade and investment tensions with the West.

Switzerland:  In parliamentary elections yesterday, the right-wing populist Swiss Peoples’ Party (SVP) was projected to come in first with 29.1% of the vote, which would be its second-best showing ever.  In contrast, the liberal pro-business FDP came in with just 14.5%, its worst showing.  The combined share for the country’s two big Green parties fell to 16% from 21% previously.

• The parties will now embark on a period of negotiating on the makeup of parliament and the Federal Council, the country’s executive branch.
• The election results suggest Swiss policy could now shift toward greater skepticism toward Europe’s support for Ukraine in its effort to defend itself from Russia’s invasion. The SVP will likely also push harder to limit immigration into Switzerland.

Argentina:  In yesterday’s first-round presidential election, Economy Minister Sergio Massa of the ruling Peronist Party unexpectedly came in first with 36.3% of the ballots, while radical libertarian Javier Milei, the leader in pre-election opinion polls, came in second with 30.1%.  The conservative coalition’s candidate, Patricia Bullrich, came in third with 23.8% of the vote.

• Massa and Milei will now face off in the final round of voting on November 19.
• That sets up a contest between the statist Peronist Party, which has presided over years of poor economic growth, increased state intervention into the economy, and high inflation, against Milei and his call for radical budget cuts and the dollarization of the economy.

U.S. Politics:  The House of Representatives remains in limbo as the majority of Republicans in the chamber continue struggling to agree on a new speaker.  The Republicans today plan to hold a candidate forum for the half-dozen or more of its members who have thrown their hat into the ring following the recent failed candidacies of moderate Steve Scalise and right-wing firebrand Jim Jordan.  The party plans to hold a new vote on the speaker’s position on Tuesday.

U.S. Bond Market:  After falling just short of the 5% barrier last week, the yield on the benchmark 10-year Treasury note this morning has finally broken through that barrier.  As of this writing, the yield stands at 5.021%, up from approximately 3.800% at the beginning of the year.  As we note in our latest Asset Allocation Bi-Weekly Report, published today, the recent surge in bond yields could well reflect a broad-based change in the overall market regime, with global geopolitical and economic fracturing pushing up inflation and interest rates over time.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Good morning! Equities are off to a rough start, while the Houston Astros and Texas Rangers are tied in the ALCS. Today’s Comment begins with our analysis of Fed Chair Jerome Powell’s comments at the Economic Club of New York. We then explain why forecasters have become more optimistic about the economy, discuss the upcoming presidential election in Argentina, and provide other financial market news. As always, our report includes an overview of the latest domestic and international data releases.

Powell’s Message: During his speech at the Economic Club of New York, Fed Chair Jerome Powell sent mixed messages about the path of future policy.

• Powell signaled that the central bank is unlikely to raise interest rates again unless economic growth clearly undermines progress on inflation. He also said that he does not believe current rates are too tight, suggesting that the Fed may not be finished with its hiking cycle. The Fed Chair’s comments reassured investors that the Fed will likely hold rates steady at its next meeting, but they did little to clarify the path of policy for the following year. Markets initially responded positively to his comments but then turned negative over the course of the day. The S&P 500 dropped by 0.8% on the day, while yields on the 10-year Treasury rose sharply.
• Policymakers are likely to pay close attention to several market events before deciding whether to pause or hike interest rates. One key event to watch is the conflict in Israel, which has expanded outside of Gaza and into Lebanon, prompting the U.S., U.K., and Germany to advise their citizens to leave the region. Conflict in the Middle East can potentially lead to a reacceleration of inflation. Additionally, Thursday’s initial jobless claims data suggests that the labor market may be too tight for policymakers to take their foot off the pedal. Lastly, Powell may also be paying close attention to government debt talks as he has mentioned that the fiscal path is unsustainable.

• Fed Chair Jerome Powell is likely to remain tight-lipped over the next few months about his plans, as investors eagerly await any signs of a pivot. Powell has stated that the Fed intends to keep rates higher for longer, but he has not explained what that means in practice. The September FOMC dot plots shows that members are aiming to cut rates by 50 basis points next year, suggesting that policymakers’ “higher-for-longer” stance does not mean they will not cut rates, but rather that they will be cautious in easing policy. As a result, investors should not expect rates to fall significantly over the next few months unless there is a major crisis.

Economic Resilience: Economists have dialed back recession fears as data consistently surprises to the upside.

• Several GDP forecasts have been revised up for the third quarter of 2023, suggesting that the U.S. economy grew strongly during that period. Bloomberg surveys show that analysts have raised their estimates for Q3 GDP growth from 3.0% in September to 3.5% in October. These revisions reflect the optimism generated by the Atlanta GDP Nowcast, which estimates that the economy grew 5.4% from July to September. Much of the optimism is related to expectations that consumption rebounded after slowing to a seasonally adjusted annualized rate of 0.8% in the second quarter.
• A growing shift in recession expectations is underway. At the start of the year, most economists expected the U.S. to fall into recession sometime in 2023. However, with two months remaining in the year, economists are becoming more optimistic about avoiding a recession altogether, thanks in part to the continued tightness of the labor market. The latest surveys show that the consensus estimate is the U.S. economy will not contract until at least 2025. While some economists still believe that a mild recession could occur in late 2023 or early 2024, the overall outlook has improved significantly.

• Investors should keep in mind that predicting recessions is a very difficult task, and no one has perfect timing. A 2018 study by the International Monetary Fund (IMF) found that public and private sector forecasters missed a majority of the 153 recessions that occurred in 63 countries between 1992 and 2014. While economists cannot predict recessions with perfect accuracy, they can identify conditions that would make an economy more vulnerable to a recession. For example, the 1990 and 2000 recessions may have been avoided if it weren’t for the 9/11 terrorist attacks and the Gulf War. As a result, investors should still be vigilant, as geopolitical and domestic risks still pose a threat to the expansion.

Argentine Elections: Investors are already seeking safety assets in anticipation of a controversial candidate winning the presidency.

• Far-right candidate Javier Milei is currently leading in the polls, closely followed by Sergio Massa and Patricia Bullrich. Milei is an extreme candidate who has vowed to ditch the Argentine peso (ARS) for the U.S. dollar. Additionally, he has also promised to privatize state-owned businesses and get rid of the country’s central bank. His potential victory has concerned investors since his policies are so extreme. Companies have halted sales, fearing that the election result could lead to a drop in currency values, which will wipe out their revenues. Additionally, exchange-traded funds tracking Argentine stocks have experienced their biggest outflow in more than two years as investors flee for safety.
• The next president of Argentina will inherit a struggling economy, with triple-digit inflation, a recession, and a growing risk of government debt default. The other two candidates, Patricia Bullrich from the center-right Juntos por el Cambio coalition and Sergio Massa from the center-left Unión por la Patria coalition, have offered more traditional solutions to the economy, such as implementing austerity to reduce inflation or cutting taxes for businesses to boost growth. However, a growing share of the population, particularly young men, are drawn to anti-establishment candidates like Javier Milei. Polls show that he is most popular among men under the age of 44.

• Despite his popularity, Javier Milei’s victory in Argentina’s presidential election is far from assured. To avoid a runoff, he would need to win over 45% of the vote outright, or 40% with a 10-point lead over his closest rival. The most optimistic polls show that Milei has a 3% lead over Massa and a 10% advantage over Bullrich. However, another poll shows that he is down 5% against Massa and is virtually tied with Bullrich. Surveys show that Milei would defeat Massa by 2 points in a run-off but lose to Bullrich by 5 points in a runoff. An upset loss for Milei would likely lead to a rally in the country’s stock market and currency.

Other news: Delinquencies are rising in the U.S. as borrowers struggle to repay pandemic loans, suggesting that households are under increasing strain despite rising consumption. The United Nations is having a hard time sending aid to Gaza, thus raising the likelihood of a humanitarian crisis in the Middle East and refugee problems for neighboring countries Egypt and Jordan. Republican nominee Jim Jordan is expected to fail in his third bid for House speaker, exacerbating concerns about growing U.S. political dysfunction and raising the likelihood of another credit downgrade.

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