Daily Comment (August 2, 2021)

by Bill O’Grady, Thomas Wash, and Patrick Fearon-Hernandez, CFA

[Posted: 9:30 AM EDT] | PDF

Good morning and happy Monday!  It’s the first trading day of August (a time of the year often unfriendly to equities), and U.S. equity futures are pointing to a higher open.  Our coverage begins with an incident off the coast of Oman.  Economics and policy are up next.  China news and the international roundup follow, and we conclude with pandemic coverage.

Drone attack:  Over the weekend, an oil tanker, the MV Mercer Street, was attacked by drones and killed two people, a Briton and a Romanian.  Zodiac Maritime, an Israeli company, manages the vessel; it is owned by Taihei Kaiun (1968, JPY, 2723).  According to reports, the drones, which apparently carried explosive charges, crashed into the ship’s bridge, killing two crew members.  The U.S., U.K., and Israel have blamed Iran for the attack.  Tehran denies its involvement.  This attack has been part of a series of strikes between Iran and Israel.  We noted in June that Iran’s largest warship, the Kharg, caught fire and sank under suspicious circumstances.  Market reaction has been mostly non-existent.  Oil prices are lower this morning on pandemic concerns.  However, an attack on oil shipping in the region around the Strait of Hormuz does raise the potential for a supply disruption.

Economics and policy:  The infrastructure bill is now printed, real estate is in the news, and there is a potential strike in Chile.

  • The bipartisan infrastructure bill is now available, all 2,702 pages. Although we are going to have a period to discuss amendments, we don’t expect major changes to occur.  All signs suggest it will pass the Senate.  However, this deal isn’t done yet; the House leadership wants the Senate to pass a larger infrastructure package via reconciliation before the House takes up this bipartisan measure.  If that requirement remains in place, none of this may get passed.  What is our expectation?  The Senate will pass a smaller additional measure, around $1.5 trillion to $2.0 trillion, and force the House to either get nothing or settle for less.  Our bet is that, after much anguish, the smaller measure along with the bipartisan one will make it through the House.
  • Real estate markets have been roiled by the pandemic. We see a global jump in home prices, raising fears of a repeat of 2008.  We believe these fears are overblown; credit standards have held up remarkably well in this cycle.  Calls to raise interest rates to cool the housing market look to us to be misguided.  This isn’t a demand problem but a supply problem.  We need to build more homes and apartments.  While the housing boom is going on, the eviction moratorium appears to have expired, which may soon lead to mass evictions.  It is unclear how this will all work.  Landlords rightly are unhappy with months of unpaid rent and want paying tenants, but if thousands are turned out, it could lead to a situation where rentals are empty because the newly evicted can’t afford to rent out the property.  And, it isn’t just renters; mortgage delinquencies rose during the pandemic, and foreclosures could come next.  There may be enough buyers to purchase foreclosed homes, but you still have the problem of the newly homeless.  The sad part is that Congress has provided massive funding to smooth out the problem; state and local governments have failed to administer the funding.  The area most affected appears to be the South.
  • The global supply chain remains under stress. There are a number of crosscurrents.  At the onset of the pandemic, firms prepared themselves for a long and deep recession.  They cut orders and reduced inventory.  Unfortunately, they were half right; it was deep but the shortest on record.  Demand roared back into lean inventories and canceled orders.  Exacerbating the problem was a rise in goods demand relative to services demand, a legacy of the lockdowns.  We are still months from seeing supplies normalize.
    • One item we are watching is whether we end up with inventory instability. Until the 1980s, inventory recessions were rather common.  Technology has completely changed inventory management.  Before the 1980s, firms would overestimate demand and end up with excessive inventory.  It would lead to layoffs as the inventory was sold off.  With modern inventory technology, the supply chain typically knows where everything is.  That has allowed inventory levels to decline overall as sales and stockpiles are closely matched.  Until now.  We are hearing anecdotal reports of double and triple ordering to ensure that products will be available.  It is quite possible that all this “stuff” will show up at once, and firms will find they have an overstock problem.  Such a situation will scramble economic projections.  We doubt anyone’s economic models have inventory reactions from 60 years ago built into them.
    • Complicating matters further is the administration’s regulation policy toward logistics. Ocean shipping and rail have become concentrated over the past 20 years (unlike trucking, which is remarkably competitive), and the administration is looking to open competition in these areas.  Not a bad idea but doing it at this moment may be difficult.
  • Chipmaking facilities report gas contamination may affect semiconductor production.
  • Workers at Chile’s La Escondida copper mine voted to strike. If a work stoppage occurs, it could constrain already tight supplies for this metal.
  • China became dominant in solar panel production, mostly due to lax environmental standards and the willingness to forgo profit for market share. As a result, Chinese solar panels dominated supply.  In response, in 2018, the U.S. implemented an 18% tariff on the product.  That tariff is scheduled to end next year; U.S. firms are lobbying for an extension.  The extension puts the administration in a bind.  The environmental policy supports the expanded use of solar energy, and one factor in adoption is low cost.  Yet, protecting domestic suppliers is a goal as well.
  • As entry-level wages rise, established workers are finding their pay relative to new hires has declined. This development is creating problems for employers and may encourage established workers to seek new jobs.
  • We continue to monitor news about Chair Powell’s reappointment. He is facing criticism regarding regulatory policy.  Although we expect him to be reappointed, it may mean a populist will get the role of Vice-Chair for regulation.  That position is currently held by Randal Quarles.  His term in this role ends in October.
  • An anti-dumping measure in the fertilizer market may lead to higher prices.
  • Germany’s pork industry is facing a threat from African Swine Virus. The bug is being found in wild boars, and the fear is that these boars will spread it into farms.
  • How do you feel about flying without a pilot? Airlines are considering pilotless aircraft for short flights.

China:  We continue to monitor China’s regulatory policy.

International roundup:  The Philippines renews military relations with the U.S.

COVID-19:  The number of reported cases is 198,425,839 with 4,227,258 fatalities.  In the U.S., there are 35,004,592 confirmed cases with 613,228 deaths.  For illustration purposes, the FT has created an interactive chart that allows one to compare cases across nations using similar scaling metrics.  The FT has also issued an economic tracker that looks across countries with high-frequency data on various factors.  The CDC reports that 400,674,525 doses of the vaccine have been distributed, with 346,456,669 doses injected.  The number receiving at least one dose is 191,498,983, while the number of second doses, which would grant the highest level of immunity, is 164,757,423.  The FT has a page on global vaccine distribution.

  • Over the weekend, information emerged that the Delta variant spreads much more easily than earlier variants, may be more lethal, and could be spread by the vaccinated. The reports highlight a problem that has been in place during this pandemic.  The media reports on what is incomplete scientific information.  Science is an inductive process; as new information emerges, viewpoints change.  However, the public messaging becomes garbled.  Part of the scientific process is to question and review findings and what was thought to be true once changes over time.  The best we can determine is that the Delta variant does spread more easily.  It’s probably too soon to know if it’s worse than earlier variants.  It does not appear that lockdowns are returning, so we expect medical systems will remain under pressure for a while longer.
  • France is seeing massive protests against its new vaccine passport policy. As France opts for sticks, Germany is trying “carrots” or specifically, bratwurst.  That’s right, get a shot, get a brat.
  • China is dealing with a large outbreak of the Delta variant. Beijing has mostly used social measures to control the virus and lags on the vaccination front.  The Delta variant, which is more contagious, is leading to renewed lockdowns.

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