by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EST] | PDF

Our Comment today opens with some notes on a major Communist Party economic conference in China.  We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today, including some new details on Argentina’s economic reforms under newly inaugurated libertarian President Milei and a preview of the Federal Reserve’s likely action as it wraps up its latest policy meeting today.

China: Wrapping up their annual economic work conference yesterday, Communist Party officials said they would launch additional growth-enhancing initiatives and work to ensure economic stability.  Echoing a statement from the Politburo on Friday, the officials vowed to focus on “establishing the new before abolishing the old,” which is widely interpreted as easing up on the recent rules limiting property developers’ debt.

• The summary statement is pretty opaque, but most observers seem to be reading it as a sign that Chinese economic policy will become only modestly more stimulative in 2024 as General Secretary Xi continues to resist the Party’s traditional policy of debt-fueled investment.
• The problem is that China’s various structural economic headwinds are probably too strong for modest stimulus to make much of a difference. If policy remains too weak to spur growth, global economic growth and financial markets could struggle in 2024.

European Union-China: Trade chief Valdis Dombrovskis yesterday announced that the European Commission in January will propose a set of rules designed to de-risk the EU’s trade and investment ties with potential adversaries, such as China.  The rules will include restrictions on outbound investment to ensure that key technologies and know-how aren’t available to an adversary’s defense and intelligence suppliers.  They will also call for screening inbound direct investment to prevent critical assets from being bought by hostile or monopolistic forces.

• While the EU remains behind the U.S. in limiting trade and investment ties with the China/Russia bloc, the rules coming in January will help get it on the same page with Washington.
• The EU’s coming rules are another example of how China’s rising power and aggressive geopolitical moves are fracturing the world into relatively separate blocs and imposing significant limits on cross-bloc trade, investment, technology, and travel flows.
• As we have argued many times before, the resulting de-globalized supply chains will be relatively less efficient, leading to higher average inflation and interest rates.

Japan: Prime Minister Kishida, who had already been dealing with abysmally low polling support, now appears likely to be implicated in a fundraising scandal engulfing the long-ruling Liberal Democratic Party.  The scandal involves unreported political fundraising by several government and party officials, including some in Kishida’s parliamentary faction.  A key risk is that increased political turmoil could undermine the Japanese stock market’s recent big uptrend.

Australia: To combat sky-high home prices, the government has unveiled new measures aimed at cutting immigration by 14% from what otherwise would be expected over the coming four years.  The move comes after the country of 26 million people absorbed about 510,000 net new immigrants in the latest fiscal year.  Despite global concerns about slowing birth rates, declining populations, and rising average ages, anti-immigration voters in countries ranging from Australia and the U.K. to the U.S. continue to drive policy toward less immigration rather than more.

Israel-Hamas Conflict: Illustrating another way the Israeli-Hamas fighting could broaden, Iranian-backed Houthi rebels in Yemen, who support Hamas and Palestinians in the Gaza strip, have continued to launch retaliatory missile and drone strikes at ships in the Red Sea.  At least one missile struck a Norwegian-flagged tanker carrying palm oil to Italy, setting it ablaze.  When a French frigate positioned herself between the Yemeni coastline and the stricken tanker to protect it, the frigate was forced to shoot down two incoming drones.

• Meanwhile, the Israel Defense Forces have reportedly begun pumping water from the Mediterranean Sea to flood Hamas’s extensive underground tunnel network under Gaza, hoping to flush out the group’s fighters and destroy any military equipment there.
• One key risk for Prime Minister Netanyahu is that the flooding could kill Israeli hostages if they are being held in the tunnels.

Argentina: Just days after radical libertarian Javier Milei was inaugurated as president, his economy minister, Luis Caputo, yesterday outlined key economic initiatives aimed at bringing down inflation, cutting the budget deficit, and averting a debt crisis.  According to Caputo, the government will devalue the peso by about half, slash government spending, and reduce energy and transportation subsidies.

• Now that the Milei government seems to be putting some of his policies into place, investors have been driving Argentine stocks higher.
• The Global X MSCI Argentina ETF (ARGT, 51.31) has appreciated approximately 23.5% since Milei was elected in mid-November. It is currently posting a total return of 52.0% year to date.

COP28 Climate Change Conference: As the annual United Nations climate change conference came to an end in Dubai today, the delegates issued a compromise statement that calls for “transitioning away from fossil fuels in energy systems, in a just, orderly, and equitable manner.”  That’s tougher than the draft statement we discussed in our Comment yesterday, which, under pressure from major oil producers, omitted any reference to phasing out fossil fuels such as oil, natural gas, and coal.  Nevertheless, the politicking on the issue at the conference and in national capitols recently still seems to reflect growing pushback to climate change rules.

U.S. Monetary Policy: The Fed today wraps up its latest policy meeting, with its decision due at 2:00 pm ET.  The policymakers are widely expected to keep their benchmark fed funds interest rate at the current range of 5.25% to 5.50%.  The question is what they’ll say about future policy moves.  Many investors are hoping for a signal of near-term rate cuts, but as we’ve stated before, we think officials remain focused on rebuilding their inflation-fighting credentials and are more likely to repeat their “higher for longer” mantra.

U.S. Financial Regulation: Yesterday, the House Committee on the Chinese Communist Party released a report suggesting the Fed should stress test U.S. banks’ ability to “withstand a potential sudden loss of market access to China.”  The report said the Fed should also assess how U.S. financial markets might be affected by potential sanctions against Chinese firms in the event of a conflict between the U.S. and China.  As we have written before, the growing U.S.-China geopolitical rivalry will likely lead to stronger state intervention in each country’s economy.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EST] | PDF

Our Comment today opens with a disagreement at the big COP28 climate change conference over whether to call for an eventual phase-out of fossil fuels.  We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today, including an Israeli threat to widen its conflict with Hamas to include attacks on Hezbollah militants in Lebanon and new evidence of weaker white-collar labor demand in the U.S.

COP28 Climate Change Conference: At the ongoing United Nations climate change conference in Dubai, officials have released a controversial draft communique that drops any reference to phasing out the use of fossil fuels such as oil, natural gas, and coal.  The draft statement has sparked outrage aimed at Saudi Arabia, host-nation UAE, and other major oil-producing countries, which are accused of using their influence to water down the document.

• Although several European and other countries are still working to amend the draft with required cuts in the use of fossil fuels, the document as currently written illustrates what we see as rising political pushback against onerous climate-change rules.
• Even if the communique is toughened before it is ultimately adopted by the conference, global fossil fuel companies don’t seem at risk of being pushed out of business anytime soon. Indeed, since capital discipline and environmental restrictions to date have held down investment in new exploration and development in recent years, future supply is likely to fall short of demand, pushing up prices and profits.

Israel-Hamas Conflict: As Iran-backed Hezbollah militants in southern Lebanon continue to fire rockets into Israel in response to Tel Aviv’s offensive against Hamas in the Gaza Strip, the head of Israel’s National Security Council has warned that Israel might also be forced to launch ground attacks against Hezbollah.  Despite some signs that Hamas military forces in Gaza may be starting to disintegrate, an Israeli infantry offensive into Lebanon is just one way that the conflict could still spread.

Russia: Top opposition leader and anticorruption activist Alexey Navalny, who was jailed by the Kremlin and has been kept in a penal colony, has apparently been moved by the authorities to an unknown location.  According to his spokeswoman and U.S. officials, he fell out of contact about a week ago after complaining of health problems, and Russian officials claim they don’t know where he is.

• The news comes just days after President Putin said he would run for another term in the March 2024 election.
• Putin probably still judges that it would be too politically risky for Navalny to be killed outright, as so many other Putin critics have been. At the very least, however, Putin would probably like to keep Navalny from making any public statements until after the election is concluded.

United Kingdom: The share of residential mortgages in arrears rose to a six-year high of 1.14% in the third quarter versus 1.02% in the second quarter.  The rise appears to reflect both the impact of punishing inflation in the U.K. over the last couple of years and the impact of aggressive interest rate hikes by the Bank of England.

• The rise in mortgage delinquencies illustrates how homeowners in the U.K. and Europe have less access to U.S.-style fixed rate mortgages and are therefore more exposed to their central banks’ rate-hiking campaigns.
• The fact that their homeowners are relatively less insulated from rate hikes compared to U.S. homeowners is probably a key reason why the U.K. and EU economies are currently growing so poorly and are at greater risk of recession or are already in recession.

China: The November consumer price index was down 0.5% from the same month one year earlier, worse than expectations that the CPI would decline 0.2% as it did in the year to October.  The November producer price index was down an even sharper 3.0%.  The figures are further evidence that the Chinese economy is continuing to losing steam in the face of problems such as weak consumer demand, high debt, poor demographics, disincentives from government policies, and de-coupling by foreign countries—all of which bode poorly for the global economy.

India: With parliamentary elections expected in spring 2024, officials in recent days have banned onion exports, restricted the use of sugar for ethanol production, and cut the size of wheat stocks that traders and retailers are allowed to hold.  The moves are apparently aimed at ensuring robust domestic supplies and low prices to keep voters happy with Prime Minister Modi.  However, the moves have also roiled some international commodity markets, such as the market for sugar.

U.S. Monetary Policy: The Federal Reserve opens its latest policy meeting today, with its decision due on Wednesday at 2:00 pm ET.  The policymakers are widely expected to keep their benchmark fed funds interest rate at today’s range of 5.25% to 5.50%.  The question is what they’ll say about future policy moves.  While many investors are hoping for a signal of near-term rate cuts, we think officials remain focused on rebuilding their inflation-fighting credentials and are more likely to repeat their “higher for longer” mantra.

U.S. Economic Growth: Accounting and consulting giant Ernst & Young is reportedly laying off dozens of highly paid partners across all its businesses in response to a failed merger earlier in the year and weakening demand from companies as U.S. economic growth slows.  The job cuts follow a previous big round in April and are seen as larger than the usual annual cull of relatively underperforming professionals.  The layoffs provide further evidence of moderating economic activity in the U.S., which puts the economy at greater risk of recession in 2024.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EST] | PDF

Our Comment today opens with tantalizing signs that the Israel-Hamas conflict could be inching closer to its end game.  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 Philippines, the surging market capitalization of India’s stock market, and various points on the U.S. economy.

Israel-Hamas Conflict: As the Israeli Defense Forces continue to press their attacks against Hamas fighters in southern Gaza, evidence over the weekend suggested Hamas may be starting to collapse politically and militarily.  Arab television networks Al-Arabiya and Al-Jazeera aired interviews with Palestinians in Gaza who criticized Hamas and its leaders over the dire situation there, and Israeli television showed large numbers of Palestinian men surrendering in northern Gaza.  IDF officials confirmed that Hamas’s military organization is starting to collapse.

• To accelerate a Hamas military collapse, the IDF is now redoubling its effort to find and kill the group’s leaders, who are believed to be hiding in the group’s tunnels in the south. If the IDF can take out the Hamas leadership, Israel’s offensive could end relatively soon.
• As long as major combat operations continue, there will still be a risk of the conflict spreading to other parts of the region and threatening oil supplies.
  • Since Hamas touched off the conflict with its October 7 attacks on Israel, Brent crude oil has fallen from roughly $90 per barrel to about $75 per barrel, reflecting rebounding output from the U.S. and elsewhere and weakening demand as global economic growth moderates.
  • Nevertheless, those prices probably include some risk premium to account for the chance that the Israel-Hamas conflict could spread. When and if the conflict ends and that risk premium goes away, near-term oil prices could fall further.

China-Philippines: In at least two incidents over the weekend, Chinese coast guard vessels again harassed Philippine coast guard and civilian supply vessels operating near disputed shoals in the South China Sea.  In the confrontations, the Chinese once again apparently used acoustic weapons to disorient the Philippine sailors, fired water cannon at them, and collided with at least one of the Philippine vessels.

• China continues to aggressively assert its expansive territorial claims from the Himalayas to Taiwan and throughout the East China and South China seas. According to General Secretary Xi, taking control over the disputed areas is a key part of his goal to achieve “the great rejuvenation of the Chinese people.”
• Given the mutual defense treaty between the U.S. and the Philippines, Beijing’s increased aggressiveness in the South China Sea is especially risky as the sinking of a Philippine vessel or the killing of Philippine sailors could potentially require the U.S. to confront China.

North Korea: Security officials in South Korea last week said they are increasingly considering the possibility that top North Korean leader Kim Jong-Un is grooming his 10-year-old daughter, Kim Ju-ae, to be his eventual successor.  The assessment is based on the girl’s increasingly flattering coverage in North Korean state media and apparent efforts to make her look older than her age.  Since North Korea is a highly conservative and patriarchal society, analysts think Kim would prefer a male heir, but if Kim has a son, he hasn’t shown any public preference for him.

India: The World Federation of Exchanges said the Indian stock market at the end of October had total capitalization of $3.7 trillion, putting it on track to soon overtake Hong Kong, currently the world’s seventh-largest market with capitalization of $3.9 trillion.  We think India’s stocks will keep benefitting from the country’s good economic growth and warming relations with the U.S., but investors continue to sour on Chinese-related investments amid geopolitical and economic concerns.

Argentina: After his official inauguration as Argentina’s president yesterday, populist libertarian firebrand Javier Milei reiterated his general goal of rebuilding the country’s economy and slashing government involvement in it.  However, it appears that the only concrete detail he offered was a promise to cut government spending by 5%.  He is expected to offer further detailed proposals in the coming days.

U.S. Monetary Policy: The Federal Reserve will open its latest policy meeting tomorrow, with its decision due on Wednesday at 2:00 pm ET.  The policymakers are widely expected to keep their benchmark fed funds interest rate at today’s range of 5.25% to 5.50%.  The question is what they’ll say about future policy moves.  While many investors are hoping for a signal of near-term rate cuts, we think officials remain focused on rebuilding their inflation-fighting credentials and are more likely to repeat their “higher for longer” mantra.

U.S. Financial Markets: The Treasury will issue a combined $108 billion of three-year, 10-year, and 30-year bonds today and tomorrow along with $213 billion of shorter-term bills.  Since the 30-year bonds issued in early November were so poorly received, investors will likely focus heavily on this week’s auctions.  If the supply again appears to overwhelm the demand for new U.S. obligations, the result could be a rebound in yields and volatility across asset classes.

U.S. Consumer Spending: As we look out to 2024 and try to forecast where the economy and financial markets will go, we’re paying close attention to consumer spending—by far the biggest driver of U.S. economic growth over the last few years.  We find the chart below to be especially instructive.

• The top line, in red, tracks overall personal income on a per-capita, annualized basis over the last several years. The next line, in blue, tracks per-capita disposable personal income (personal income less taxes) on an annualized basis.  Both measures have been trending up smartly, suggesting consumers have had a lot of buying firepower.
• However, we think the dashed bottom line, in green, is more instructive. It shows how personal income has grown after stripping out both taxes and price inflation.  Essentially, it captures consumer purchasing power from income (excluding borrowing and dipping into savings).  The line shows the big jump in consumer purchasing power when the government released trillions of dollars of stimulus in the middle of the coronavirus pandemic.  However, the line clearly shows how purchasing power fell once price inflation took hold and has only partially recovered since then.  Overall, per-capita purchasing power is flat-to-down since the start of 2021.
  • In 2017 prices, disposable income stands at $50,169 per person. If real disposable income per capita had continued to increase at its growth rate from mid-2017 to the end of 2019, it would now stand at $50,462.
  • The relative shortfall in per-capita purchasing power goes far toward explaining consumer pessimism about the economy and low opinion of President Biden. Since spending has continued to increase, the figures also suggest consumers have been borrowing or spending down their savings to buy.  There is likely a limit to how far they can take that strategy, which suggests consumer demand and the economy could well slow in 2024.

U.S. Oil Industry: Following up on a chart we included in a Comment last week, we couldn’t resist the version below, which shows that not only has U.S. oil production now risen to a record high, but it’s done so while mighty Saudia Arabia and Russia have seen their output decline.  As mentioned above, rising U.S. production and slowing economic growth around the world are key reasons for the recent decline in global oil prices.

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