Daily Comment (November 14, 2022)

by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Our Comment today opens with an update on the Russia-Ukraine war, including a discussion of what comes next following Ukraine’s dramatic recapture of the southern city of Kherson late last week.  We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today, much of which is focused on developments in China and in U.S.-China relations.

Russia-Ukraine:  Now that Russian forces have abandoned the southern Ukrainian region around Kherson, they appear to be redeploying their forces northward to launch new offensives in the province of Donetsk.  That will likely force the Ukrainians to reinforce their units in that area, but they are also expected to send some troops from Kherson northward to bolster their offensive in the northeastern Luhansk region.  In any event, it appears that Ukraine’s recapture of Kherson has set the stage for intensified fighting, rather than less fighting, in the coming months.

Turkey:  An apparent terrorist bombing in central Istanbul killed six people yesterday, prompting the government to vow vengeance on the Kurdish militants that it suspects planted the device.  Because of U.S. support for Kurdish rebels in Syria, the attack and any Turkish retaliation is likely to worsen U.S.-Turkish relations.  Potentially, that could mean that Turkey will become even less cooperative in supporting Ukraine as it tries to defend itself against Russia’s invasion.  It could also prompt Turkey to dig in its heels against Sweden and Finland joining NATO.

United Kingdom-France:  Today, negotiators from the U.K. and France struck a deal in which the U.K. will provide additional resources to France so it can halt additional migrants from illegally crossing the English Channel to the U.K.  The agreement is an early sign that Prime Minister Sunak’s government may be able to work more constructively with France and the rest of the EU than other recent Conservative governments.

China COVID Policy:  The Communist Party has ordered that the country’s Zero-COVID policy be “optimized and adjusted” to minimize its impact on economic growth, people’s lives, and foreigners’ ability to visit China.  Along with the news of easing inflation in the U.S., the announcement helped give a big boost to stocks in China and Hong Kong on Friday.

  • However, it’s important to note that the order didn’t change the overarching policy goal of completely stamping out COVID-19. Many Western observers assessed the move to be merely fine-tuning, rather than easing, the Zero-COVID policy.
  • That’s especially the case given that new infections in China have now surged to more than 10,000 per day, marking their highest level since Shanghai was forced to shut down its economy in March. Since so many Chinese citizens remain unvaccinated or vaccinated only with China’s relatively less effective indigenous vaccines, especially among the elderly, a large breakout of new infections could spark a big increase in deaths.  In turn, that would probably prompt the government to tighten restrictions again, with negative implications for the Chinese economy and financial markets.

China Real Estate Policy:  In the country’s second major move to accelerate economic growth, the People’s Bank of China and the China Banking and Insurance Regulatory Commission released a broad support program for the real estate industry on Friday.  One of the biggest policy changes in the notice is to allow a “temporary” easing of restrictions on bank lending to real estate developers.  In addition, developers’ outstanding bank loans and trust borrowings due within the next six months could be extended for a year, while repayment on their bonds may also be extended or swapped through negotiations.  To reduce the risk of popular unrest over developers’ failure to deliver finished homes after buyers made down payments, the new policy also calls on banks to negotiate with homebuyers on extending mortgage repayment and emphasized that buyers’ credit scores should be protected.

  • The regulatory adjustments for the real estate market come on top of other, more limited measures issued in recent months, including cutting interest rates, urging major banks to extend 1 trillion yuan ($140 billion) of financing in the final months of the year, and offering special loans through policy banks to ensure property projects are delivered.
  • The eased property restrictions probably also fed into the surge in Chinese stocks on Friday. However, it is important to remember that the regulatory easing flies in the face of President Xi’s desire to rein in real estate developers’ debt, so it’s not entirely clear how far the measures will be taken.  It therefore remains to be seen whether Chinese stocks will continue to rebound.

United States-China:  President Biden and Chinese President Xi held their first in-person meeting as national leaders today on the sidelines of the Group of 20 summit in Indonesia.  According to U.S. National Security Advisor Sullivan, Biden used the occasion to warn China about U.S. red lines as the two countries’ rivalry intensifies.  He also suggested that Xi should help rein in North Korea’s belligerent nuclear missile program.

U.S. Mid-Term Elections:  Based on updated vote tallies released over the weekend, Nevada Senator Catherine Cortez Masto now appears to have won re-election, ensuring the Democratic Party will retain control of the upper house of Congress with Vice President Harris’s tie-breaking vote.  If the Democrats win Georgia’s senatorial run-off vote on December 6, they will improve their position in the Senate to an outright majority of 51-49.

  • Nevertheless, for investors, the key story is simply that the Republicans have probably taken control of the House of Representatives.
  • If confirmed by final vote tallies in the coming days, Republican control of the House means that the federal government will again be split between the parties. Historically, that has been a positive environment for U.S. stocks.

U.S. Monetary Policy:   At an event in Australia today, Federal Reserve board member Christopher Waller warned that investors shouldn’t be lulled by last week’s report showing cooler inflation.  According to Waller, the monetary policymakers “have a ways to go yet” to boost interest rates high enough to get inflation truly under control.  The statement should be a reminder that the Fed is still desperately keen to rebuild its inflation-fighting credentials, so it is likely to keep raising interest rates in the near term even if doing so pushes the economy into recession, as we expect.

U.S. Economy:  The freight unit of FedEx (FDX, $175.61) said it is furloughing some workers in select U.S. markets in response to slowing demand.  Since transportation services can often be a bellwether for the overall economy, the action provides concrete evidence that U.S. economic activity is slowing sharply, consistent with our view that it will slip into recession sometime in the first half of 2023.

  • Because of slowing demand and purchasing mistakes amid the pandemic’s disruptions, many retailers have already started offering big “Black Friday” discounts to clear out excess inventories. The drop in prices could help bring down inflation but will probably also weigh on retailers’ profits and stock prices.
  • In other potential good news for inflation, wetter weather in Brazil and Indonesia is promising to bolster coffee supplies which will prompt a big decline in prices. Futures prices for the Arabica variety have fallen approximately 22% in just the last month.

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