Daily Comment (November 4, 2019)

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

[Posted: 9:30 AM EST] The second episode of the Confluence of Ideas podcast is available!

Happy Monday!  Optimism reignseverything is awesome!  Trade optimism, helpful monetary policy, decent earnings and modest economic growth are propelling U.S. equities to new highs.  The Saudi Aramco IPO is on.  Here are the details:

Trade optimism: Commerce Secretary Ross had a number of positive comments on trade over the weekend.  First, the secretary is “optimistic” on the first phase of the U.S./China trade deal.  On November 13, the U.S. is scheduled to decide if it will apply tariffs on European cars; according to Ross, those tariffs may not be necessary.  In addition, Japan reports that the U.S. may be lifting tariffs on its auto exports to the U.S.  Although all this news is positive, there are a couple of issues to note.  First, China is reiterating that its “core concern” is the lifting of all punitive tariffs, which seems highly unlikely.  Second, the American Chamber of Commerce warns that the successful “phase one” of the trade deal is mostly about supporting the farm belt and does little or nothing to bring structural change to China’s economy.  Overall, the trade news appears to be causing a clear relief that conditions aren’t going to get worse in the near term.  However, the longer-term issues are nowhere close to a resolution.

Unrest continues: Hong Kong marks its 22nd weekend of protests and turmoilA pro-democracy politician was brutally attacked by an unnamed assailant.  Protests continued in Iraq; security forces there killed a 17-year-old.  Protestors attacked and temporarily stormed the Iranian consulate in Karbala as well.  Lebanon also saw widespread protests in its northern city of Tripoli.  The protests in Lebanon are putting noteworthy pressure on Iran’s ally in the country, Hezbollah.  For years, Iran’s modus operandi was to support protesters and the oppressed around the region.  For example, it supported Hamas even though it is a Sunni organization.  However, in Lebanon, Hezbollah is pressing to maintain the status quo.  This is what happens when a nation becomes, or desires to be, a regional hegemon; it no longer favors unrest because it prefers stability.

Saudi Aramco: At long last, the Kingdom of Saudi Arabia announced it will begin the process of taking its state oil company, Saudi Aramco, public.  It appears the company will have a valuation of $1.5 trillion, which is less than the royal family had initially hoped.  The IPO prospectus will be issued on November 9, with share trading likely in December.  There are two macro issues worth noting from this IPO.  First, although there is likely a myriad of reasons for the IPO, the fact that the Saudi royal family is selling part of the “family jewel” suggests concern about the long-term viability of oil.  Second, once the sale is made, we could see Saudi oil policy shift to retake market share.  It is possible the Saudis have been trying to prop up the price of oil in order to boost the valuation of the IPO.  Once the sale is made, the kingdom can more easily allow the price to fall to capture market share.  Given the obvious financial vulnerabilities in the shale patch, this might be a good time to boost output and depress prices.

Brexit update: One question that was hanging over the upcoming election was the path the Brexit Party would take.  If Nigel Farage, the party leader, was comfortable with the plan that PM Johnson had negotiated, he could simply stand down and one could reasonably expect Brexit Party voters would drift to the Tories.  If Johnson had managed to get his deal passed, the Brexit Party would have lost its reason for existence.  Over the weekend, Farage made his position clear—he has been pressing Johnson to scuttle his deal to get support of the Brexit Party.  Johnson refused and now Farage has indicated he will contest the election by putting up candidates from his party across the countryRecent polling shows both Labour and the Conservatives are seeing improvement, while the Liberal-Democrats, the Brexit Party and the Greens are all falling.

United States-China-Taiwan: Over the last year, the Trump administration has repeatedly asked Taiwanese President Tsai Ing-wen to help cut the flow of technology to Chinese telecom giant Huawei Technologies (002502.SZ, 2.57).  Specifically, the administration has been pressing Tsai to restrict the amount of semiconductors that Taiwan Semiconductor Manufacturing (TSM, 52.10) can sell to Huawei.  TSM accounts for almost 25% of Taiwan’s stock market, and sales to Huawei account for some 10% of its total sales.  If Tsai succumbs to the pressure, it would likely be negative for TSM and Taiwanese stocks, in general.

China-East Asia: Negotiations have been completed to establish a new free trade deal between China and the 10 members of the Association of Southeast Asian Nations (ASEAN).  The “Regional Comprehensive Economic Partnership” focuses on trade in services, investment, dispute resolution and intellectual property.  Signatories reportedly see it as a way to maintain free trade as the U.S. becomes more protectionist.  Tellingly, the Trump administration only sent lower level officials to the associated U.S.-ASEAN summit being held in Bangkok today.  In response, ASEAN leaders only sent three heads of state to the meeting.

Japan-South Korea: On the sidelines of the big ASEAN meeting today, Japanese Prime Minister Abe and South Korean President Moon held their first meeting since last September, before the countries’ dispute flared up over Japan’s behavior in Korea during World War II.  Reports say the meeting was friendly, and more substantial talks on the dispute could still be scheduled.  Separately, the speaker of South Korea’s legislature said a bill has been drafted to facilitate “voluntary” donations from Japanese companies to South Koreans who had served as slave laborers before and during the war.  It is looking increasingly likely that some such deal could be the way this dispute is resolved.  A resolution of the dispute would likely be positive for both Japanese and South Korean equities.

Odds and ends: The head of the Hungarian central bank had an FT op-ed over the weekend in which he argued that the Eurozone is a failure and that an exit procedure should be established.  Saying such things out loud is generally not done in Europe but, overall, we tend to agree with Mr. Matolcsy.  One of the reasons home prices have been strong is that homeowners are staying in their homes longer than they used to.  A combination of fears of capital gains taxes and the inability to find another affordable property has led to a dearth of new supply.  Increased building activity would help, but the fears triggered by the 2008 Financial Crisis are likely dampening the risk tolerance of builders.  Today marks the 40th anniversary of the storming of the American Embassy in Tehran.  There is a surprising degree of concentration in the electric vehicle battery industry and that concentration is centered in China.  JP Morgan (JPM, 127.80) has indicated that, due to regulations, it has moved $130 billion of excess cash into Treasuries and has sold off loans; this action was done to meet capital rules.  The U.S. and North Korea may resume talks in mid-November.  There are unconfirmed reports that the Turkish Air Force has attacked PPK sites in Iraq; this would be a serious escalation if true.  Bitcoin prices have apparently been manipulated!  Who knew?

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