Daily Comment (January 18, 2023)

by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EST] | PDF

Our Comment today opens with an upward revision in the International Energy Agency’s forecast for global oil demand this year, which is giving a boost to oil prices so far this morning.  We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today, including an unexpected decision by the Bank of Japan that has given a boost to Japanese stocks but has driven down the JPY.

Global Oil Market:  In its monthly forecast, the IEA stated that the end of China’s strict pandemic shutdowns should lead to a further rise in oil demand this year, even though the COVID-19 infections sweeping through China right now are causing widespread economic disruptions at the moment.  With U.S. and European oil usage also looking firmer this year, the agency therefore predicted total global oil demand in 2023 will rise to a record-high average of 101.7 million barrels per day, up 1.9 mbpd from 2022.

  • The news is helping to give global oil prices a further boost so far this morning.
  • Brent crude oil futures are currently up approximately 1.6% to $87.30 per barrel.

China:  In another sign that China is easing up on its economic restrictions and trying to ease tensions with the West, the country’s censors have reportedly cleared two Marvel superhero movies from The Walt Disney Company (DIS, $99.91).  That marks the first Chinese clearances for Marvel movies since 2019, and the films will be allowed to be shown in China next month.

Japan:  The BOJ today kept its monetary policy unchanged, with a yield target of -0.1% for short-term obligations and a cap of 0.5% for 10-year notes.  The decision to hold steady came after a surprise tightening last month.  That disappointed many investors who had bet on a further hike in the 10-year yield and a potential end to the BOJ’s long experiment with yield- curve control.  In response, Japanese bond yields have declined sharply so far today, pushing down the JPY and boosting Japanese equity markets.

European Union:  In her address at Davos yesterday, European Commission President von der Leyen said that the EU will respond to the recent U.S. subsidies for green technologies by easing its restrictions on state aid to industry and pumping cash into strategic climate-friendly businesses.  However, her proposed program would still need a unanimous buy-in across all EU countries, and some national leaders believe a better way to keep investment in the EU is to boost the bloc’s productivity, increase research spending, and bring down energy prices.

  • EU leaders believe the $369 billion in green subsidies under the Inflation Reduction Act will likely draw massive amounts of investment out of Europe and toward the U.S., and they worry that EU countries don’t have the fiscal space to compete with the U.S.
  • However, the Biden administration continues to argue that the EU should adopt similar “complementary” subsidies that would strengthen the EU as a member of the evolving U.S. geopolitical bloc and reduce the EU’s dependence on China and the countries in its bloc.

United Kingdom:  The December Consumer Price Index (CPI) was up 10.5% year-over-year, marking a modest cooling in inflation after the index rose 10.7% for the year to November.  However, excluding the volatile food and energy components, the December Core CPI was still up 6.3%, unchanged from the inflation rate in November.

  • Overall British inflation has now slowed for two straight months, but only modestly, and the wave of strikes now sweeping across the country threaten to buoy wage costs and inflation for months to come.
  • The Bank of England is, therefore, still expected to keep hiking interest rates at its next policy meeting in February.

Russia:  Defense Minister Shoigu outlined a long-term expansion of the country’s military in which total personnel would rise to 1.50 million in 2026 from the current 1.15 million.  The plan would also include the creation of new military districts centered on Moscow and St. Petersburg and the establishment of an army corps in the exclave of Karelia.

  • The expansion of the country’s military will coincide with a likely pullback in economic activity because of factors such as Western sanctions and mass emigration.
  • As a result, Russia is likely edging closer to the day when its defense spending exceeds 10% of gross domestic product – a “defense burden” that has historically created headwinds for economic growth.

Turkey:  President Erdoğan announced that the country’s next presidential and parliamentary elections would be pulled forward by one month to May 14.  Erdoğan’s support in public opinion polls is currently at rock bottom because of soaring inflation, high unemployment, and a currency crisis.  However, he appears to be gambling that a recent spate of public spending programs and his aggressive foreign policy will help him eke out a win and stay in power.

U.S. Labor Market:  As early as today, Microsoft (MSFT, $240.35) is expected to announce another round of layoffs, making it one more in a string of high-profile information technology firms that are shedding workers.  Besides technology, it also appears that rising interest rates and the implosion of the housing market have prompted significant layoffs in the real estate and financial services industries.

  • Nevertheless, with the economy facing an overall shortage of workers, many of those being laid off appear to be finding other jobs quickly. That’s evident in the weekly data on initial jobless claims, which haven’t increased appreciably despite the technology and real estate layoffs.
  • Indeed, one benefit to the layoffs is that the released workers become available to other industries that are growing but have had trouble finding workers, such as defense.

U.S. Bank Regulation:  Acting Comptroller of the Currency Michael Hsu warned that a bank is probably too big to manage effectively and should be broken up if it repeatedly fails to resolve longstanding deficiencies despite reprimands from its regulators and onerous restrictions such as caps on its growth.  The statement highlights the increased regulatory and antitrust risk facing many industries under the Biden administration.

U.S. Investment Strategy:  An interesting article in the Wall Street Journal describes how financial firms are currently in intense disagreement over the future of the “60/40” portfolio, in which 60% of assets are allocated to stocks and 40% to bonds.  Although the 60/40 portfolio largely failed to protect its investors from big negative returns in 2022, its adherents maintain that it was a rare, one-off occurrence.  Others believe a fundamental change may be in order, a viewpoint which we share, given the likelihood of a secular bear market in bonds and unusually good prospects for gold and other commodities.  For example, a decent standard asset allocation going forward may allocate almost half the previous bond allocation of 40% to gold and commodities.

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