Daily Comment (January 3, 2024)

by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EST] | PDF

Our Comment today opens with recent reports suggesting U.S. and European leaders are shifting their focus from helping Ukraine expel the invading Russians to simply helping it defend the territory it still holds.  We next review a range of other international and U.S. developments with the potential to affect the financial markets today, including an Israeli strike on a Hamas leader in Lebanon that raises the risk of escalation and new private-sector data confirming the recent slowdown in U.S. labor demand.

Russia-Ukraine War:  Now that Russian and Ukrainian forces have fought to an apparent draw and many U.S. and European politicians staunchly oppose further aid to Kyiv, President Biden and allied leaders have reportedly begun to shift their focus toward bolstering Ukraine’s ability to defend the territory it still holds, rather than pushing the Russians out of the country.  Their aim is to bolster Kyiv’s bargaining position when peace negotiations eventually come about.

  • In our view, the U.S. and European resistance to further aid for Ukraine is essentially political and strategic, rather than economic.
    • The officials who support Ukraine are often traditional center-left or center-right establishment elites. Those who oppose more aid to Ukraine are often on the far left or the far right.  U.S. and European far-right populists have been especially energized by working class anger over post-Cold War globalization, migration, de-industrialization, and income and wealth inequality.  Those populist isolationists are often strongly opposed to more assistance for Ukraine.
    • Some of international relations theorists also argue that while the U.S. and Europe might face an existential threat if Ukraine lost its independence to Russia, the West wouldn’t face much additional risk if Russia merely holds on to the territory it has already conquered.
  • In contrast with the very real political pushback and strategic disagreements, the U.S. and European aid to Ukraine so far in the war is small from an economic standpoint. For example, the U.S.’s total assistance of $75.4 billion to date equals:
    • About 0.16% of the estimated $46.116 trillion in U.S. gross domestic product from the start of Russia’s invasion until late 2023;
    • Roughly 0.65% of the U.S. government’s total spending of about $11.689 trillion over the same period;
    • About 5.1% of the U.S.’s defense spending of $1.491 trillion over that period; or
    • Approximately the same amount that the U.S. spent on health research in that period, and well below what it spent on disaster relief.
  • For investors, the longer-term strategic implications of reduced Western aid for Ukraine may be most important.
    • Recent research from the Institute for the Study of War notes that if the conflict is frozen with Russia retaining the almost 20% of Ukrainian territory it now holds in the east and south, President Putin would almost certainly use the freeze to rebuild his forces for a new invasion in the future.
    • That would likely require the U.S. and NATO to drastically bulk up their defenses in Europe, further bolstering our thesis of higher future defense spending and new investment opportunities in the defense sector.

Israel-Hamas Conflict:  In an apparent Israeli drone strike, a top Hamas political leader and at least two of the group’s military commanders were killed in an explosion in the suburbs of Beirut yesterday.  Since the assassinations took place in an area dominated by the Iran-backed Hezbollah militant group, which previously warned against any Israeli strikes in Lebanon, the incident further ratchets up the risk of the conflict spreading beyond the Gaza Strip.

European Union:  José Manuel Campa, head of the European Banking Authority, said in an interview that the regulator is launching an investigation into the relationship between banks and non-bank financial institutions (NBFIs) such as hedge funds, private equity firms, and cryptocurrency groups.  The goal is to determine if there is any risk that financial stress in the NBFIs could spread to banks.  Importantly, the initiative may encourage similar scrutiny in the U.S., with the possibility of new regulations down the road.

United Kingdom:  According to a union leader representing the junior physicians who yesterday launched a planned seven-day strike against the National Health Service, the doctors would accept a 35% pay hike spread over several years, rather than all at once.  The statement could potentially diffuse the strike, which would be the longest in NHS history.  It could also help bring an end to the U.K.’s year-long labor unrest.

United States-Netherlands-China:  ASML (ASML, $716.92), the world’s top manufacturer of fabricating equipment for advanced semiconductors, yesterday said the Dutch government has revoked some of its licenses to export deep ultraviolet lithography systems to China.  Under U.S. pressure to help constrain China’s ability to make advanced chips, the Dutch government already bans ASML from selling its top-of-the-line extreme ultraviolet lithography systems to China.  Revoking the licenses for less advanced systems shows the U.S.-China tech war is expanding.

  • The U.S.-China geopolitical rivalry, and especially the U.S. clampdown on technology flows that could help China’s military, continue to present risks for investors who own Chinese assets or have positions in companies that depend on Chinese capital or markets.
  • As proof of that, ASML’s depository receipts in the U.S. fell 5.3% yesterday, as the loss of DUV export licenses convinced investors that even more of the company’s China revenue could be at risk.

United States-China:  Reflecting China’s growing competitiveness in making electric vehicles, Shenzhen-based BYD (BYDDY, $53.70) for the first time delivered more all-electric cars than U.S. rival Tesla (TSLA, $248.42) in the fourth quarter of 2023.  While China still lags in some advanced technology industries, in part because of Western restrictions, it continues to come on strong in EVs.  As Chinese EV exports increasingly threaten other countries’ auto industries, the question is whether, when, and how those countries might clamp down on the Chinese cars.

  • On a related note, the Financial Times this morning carries an article in which top officials from General Motors (GM, $36.05) and Nissan (NSANY, $7.80) warn against former President Trump’s plan to gut the Inflation Reduction Act’s subsidies for EVs made substantially in the U.S.
  • The officials warn that if the subsidies are revoked, the recent U.S. investment boom in EV-related factories will end, inward foreign investment will weaken, and consumers will be tempted to buy vehicles from China and elsewhere.

U.S. Energy Regulation:  Oil giant Chevron (CVX, $149.48) yesterday warned that it will book impairment charges of $3.5 billion to $4.0 billion in the fourth quarter, in part to reflect the impact of tough regulations in California.  The California issue is a reminder of the regulatory drag that can hit energy firms operating in the U.S.  In addition, Chevron said the charges would also reflect hiccups in the disposal of certain assets in the Gulf of Mexico.

U.S. Labor Market:  Recruitment site Indeed has released data showing that its total job postings at the end of 2023 were down 15% from one year earlier.  However, the data shows that the pace of decline slowed in the second half of the year, and that overall postings remain more than one-quarter higher than before the pandemic.  In sum, the report helps confirm that labor demand slowed markedly in 2023, especially early in the year.  As we argued in our outlook, slowing momentum will leave the economy more susceptible to a recession in 2024.

U.S. Stock Market:  On the year’s first day of trading yesterday, the NASDAQ Composite price index dropped 1.6%, as some large, growthy technology stocks sold off sharply.  The stodgier Dow Industrials rose marginally to a new record high of 37,715.04.  In fact, the Dow has now risen for nine straight weeks.

  • Of course, one day does not make a trend. Nevertheless, we note that recent action and yesterday’s trading in particular were consistent with the arguments we made in our recent Outlook for 2024.
  • In our Outlook, we argued that the run-up in large-cap tech and artificial intelligence stocks last year has left them richly priced. Going into the new year, we think investors are likely to see better opportunities in value and small-cap equities.

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