by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Our Comment today opens with some notes on the China/Russia bloc’s military buildup and increasingly aggressive military operations. We next review several other international and US developments that could affect the financial markets today, including Chinese General Secretary Xi’s visit to Europe this week and a couple of notes on the US labor market.

China: The Fujian, China’s third aircraft carrier and its first domestically-built one, reportedly left the port of Shanghai last week for her maiden sea trial. According to press reports, the initial trial will focus on testing Fujian’s propulsion, navigation, and communications systems. Other systems, such as her state-of-the-art electromagnetic catapults, will be tested in other trials over the next year, before a planned “experimental” cruise in late 2025.

• Reports suggest the People’s Liberation Army Navy (PLAN) wants to eventually maintain round-the-clock carrier coverage in both the western Pacific Ocean and the Indian Ocean. To account for vessels out of action for maintenance, training, transit, etc., that implies the PLAN will ultimately need at least three more carriers.
• As we’ve noted before, the Communist Party continues working to boost China’s “comprehensive power” in diplomacy, economics, technology, culture, and military capability. China’s surging economic heft was long the main source of its power. However, now that the country has begun to hit big, structural economic headwinds, its rapidly increasing military force is becoming the main threat to the US and its allies.
• As we’ve also noted before, many US voters and policymakers have become tired of the costs of global hegemony. The resulting populism and isolationism have probably helped encourage China and other authoritarian powers to assert themselves. A key question now is whether Beijing’s growing carrier force, rapidly expanding nuclear arsenal, and other aspects of the Chinese military threat might convince Americans to coalesce again and recommit to international leadership in the name of national defense.

Fujian embarking on her maiden sea trial. (Source: South China Morning Post)

China/Russia Geopolitical Bloc: In addition to building up their armed forces, China and other members of its bloc keep launching aggressive military and intelligence operations against US treaty allies. For example, Chinese forces continue to harass Philippine ships trying to resupply the country’s marines at an outpost in the South China Sea. Russian intelligence services are also reportedly ramping up their sabotage against infrastructure and defense industry facilities in NATO countries, including an apparent arson attack against a German defense firm last week.

• As we’ve noted in the past, Chinese and Russian attacks on US treaty allies are especially dangerous. If such attacks are deemed serious enough, the US could come under pressure to help defend the targeted country per their mutual defense agreement.
• Given their aggressiveness, China’s military operations against the Philippines and Russia’s sabotage attacks on NATO soil are probably more dangerous than most observers realize. Beijing and Moscow clearly feel emboldened, and they appear to be probing the West’s willingness to defend itself. That presents a risk that they could cross a red line and potentially touch off a conflict.

China-European Union: General Secretary Xi today began an important visit to Europe, where he is expected to try to break US-European unity against China on international issues such as Beijing’s backing of Russia in its invasion of Ukraine and its dumping of low-cost exports onto the world market. Xi today met with European Commission President von der Leyen and French President Macron, who have taken a hard line against China’s actions. However, the more conciliatory German Chancellor Scholz declined to join the meeting.

• The recent Chinese and Russian military buildups, provocative military actions, and spying have already prompted the US and its allies to start boosting their defense budgets and rebuilding their armed forces, but the progress to date has been slow and spotty.
• Notably, Prof. Steve Tsang, director of the SOAS China Institute in London and author of a new book on Xi’s political thought, has argued that the general secretary is too bent on global domination to be deterred militarily. Tsang argues that Xi is more afraid of being cut off from Western markets, capital, and technology, which could destabilize China’s domestic economy and political environment. If true, a united European threat to freeze out China economically could help bring Beijing to heel.

United Kingdom: In local elections late last week, the ruling Conservative Party of Prime Minister Sunak lost about half the municipal council seats it was defending, likely portending a significant loss in the national parliamentary elections this fall. Election observers are warning that the projected results could result in a hung parliament, in which neither the Conservatives, Labor, nor any other party can cobble together a majority. The political uncertainty is likely to be a headwind for UK equities in the coming months.

Israel-Hamas Conflict: The Israeli military today warned Palestinians around the southern Gaza city of Rafah to evacuate ahead of its planned offensive against Hamas fighters in the area. The warning comes as the latest Israeli-Hamas negotiations for a peace deal appear to have faltered. Any Israeli attack on Rafah is likely to again raise concerns about the conflict broadening and potentially further isolate Israel on the world stage.

Panama: In national elections yesterday, pro-business conservative José Raúl Mulino won the presidency, putting him in a position to carry out his agenda of reinvigorating the economy. Mulino has vowed to focus on infrastructure investment, such as building a train line across the country to complement the Panama Canal. However, it isn’t clear how he will approach the sudden closure of the Cobre Panama copper mine, which accounted for about 1% of global supply before it was suddenly shuttered last year amid protests over environmental damage.

US Labor Market: Although our Comment on Friday included our initial reaction to the April labor report, we want to add one more observation. Specifically, when calculated using our preferred method, the year-over-year rise in average hourly earnings slowed much more sharply than indicated by the financial press’s measure. Press reports say average hourly earnings in April were up 3.9% from the same month one year earlier, slowing from a rise of 4.1% in the year to March. Our measure shows the growth rate slowed all the way to 3.2%.

• The press typically calculates annual wage growth using seasonally adjusted figures. Since both the current figure and the year-earlier one could be distorted by bad adjustments, that raises the risk of an inaccurate growth calculation. We prefer to use non-adjusted figures for year-over-year changes. We think our approach reduces the risk of inaccuracies from bad adjustment factors.
• In any case, as we noted on Friday, the report included several indicators pointing to softer labor demand, i.e., much more moderate growth in payrolls, a rise in the unemployment rate, and a contraction in the average work week. The apparent cooling in labor demand doesn’t necessarily point to a big economic contraction. Still, it could well keep the Federal Reserve on track to start cutting interest rates by late summer.

US Stock Market: In another development that touches on both the labor market and stocks, Chipotle Mexican Grill has proposed a massive 50-to-1 stock split to make it easier for small investors, including the firm’s own workers, to buy the stock. At Chipotle’s recent price of about $3,155 per share, the split should bring the price down to about $63. Shareholders are due to vote on the proposed split on June 6. Chipotle officials say easier access to the stock aims to improve employee retention amid labor shortages for lower-skilled workers.

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