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

[Posted: 9:30 AM EDT] | PDF

Good morning.  As the markets wind down before the holiday weekend, U.S. equity futures continue to grind higher.  Hurricane Ida is leaving the U.S. but not before causing flooding in New York City.  Our coverage begins with Afghanistan.  China is up next, followed by economics and policy.  The international roundup precedes our pandemic coverage.

Afghanistan:  The world begins the next phase of the Afghan situation, which is the political fallout and the Taliban’s attempt at governance.

• With the evacuation essentially over, the aftermath begins. The administration will face months of Congressional scrutiny and may find some of it coming from Democrats.  The withdrawal was viscerally opposed by the foreign policy establishment of both parties.  One area of investigation will be who was left behind and what should be done about it.
• Meanwhile, the Taliban, who has proven adept in taking power, now faces the daunting task of governing. Capital flight and aid restrictions have created a cash shortage; remittances have become increasingly difficult as money transfer firms have stopped moving cash.  The Taliban hasn’t established a governance structure yet, although it says it will soon.  The current supreme leader, Hibatullah Akhundzada, is more of a religious figure and has kept a low profile.  It isn’t clear if he intends to rule or play the role of kingmakers.  Groups from Qatar have been sent to Kabul to help reopen the airport, which will be critical for the economy.
• The withdrawal from Afghanistan is yet another example that the U.S. isn’t all that concerned about Europe. EU leaders, for the most part, welcomed Biden’s election, seeing it as a return to normal relations.  But, as is often the case, the focus is improperly on leaders instead of trends.  The simple fact is that the U.S. isn’t all that interested in Europe anymore, as shown by the decision to leave Afghanistan without consulting the EU.  Europe finds itself terribly dependent on the U.S. for security and now isn’t sure if it can rely on that security anymore.  The obvious response is EU rearmament, but the nation most likely to lead that effort is Germany.  Anyone with any knowledge of history should view that outcome with some degree of concern.

China:  There are worries over an unnecessary military confrontation, credit market worries are rising, and Xi continues to portray himself as a decisive leader.

• China has issued a new rule requiring vessels entering the South China Sea to register with Beijing. The U.S. opposes the rule, calling it a “serious threat” to freedom of navigation.  China has claimed almost all of the South China Sea, which the U.S. opposes.  Former military leaders warn that military-to-military communications are inadequate, which creates conditions for an unwanted confrontation.
• China’s credit markets have been an area of concern for some time. Rapid growth in credit has been shown to be a risk factor.  Since 2009, China’s non-financial corporate debt has increased by an average of 12.9% per year, compared to the U.S., at 4.5%.  The collapse of China Evergrande (EGRNF, USD, 0.53) has warned that construction on some projects has been halted, increasing the odds of default.  Although we haven’t seen a clear indication that the stoppages have occurred due to concerns regarding payment, we suspect that this may be the case.
  • China Evergrande isn’t the only company in trouble. Huarong (2799, HKD, 1.02) has released a report on its $16 billion losses from last year.  The report had been delayed by four months, prompting concerns that the firm was failing.  State-owned companies have been drafted into a bailout plan.
  • Problems at these firms have led investors to avoid Chinese high-yield debt.
• We are hearing a steady undercurrent that General Secretary Xi is bringing a “profound transformation” of China. Xi appears to have aspirations of being the next Mao and Deng.  So far, it isn’t completely clear what this change means, although we are getting signs that it likely means slower economic growth with less inequality.  In addition, he is pressing for the centralization of the party; the individual initiative is getting quashed.  There is a recent case of a student being arrested for researching Chinese labor movements, while at the same time, Didi (DIDI, USD, 9.20) JD.com (JD, USD, 80.78) recently agreed to establish unions.  These examples suggest the CPC doesn’t oppose unionization as long as it is led by the party.  It appears Xi is emulating Mao, not Deng.
• Although it is becoming clear that relations with China are deteriorating, multinational firms with supply chains in China are pushing back against the break with Beijing. They want the Biden administration to remove tariffs and provide “clarity” on the relationship.  We suspect they are facing a lost cause.
• The CPC has shut down the tutoring industry with the goal of reducing stress for households. This move has solved little for most households.  If anything, it has made conditions worse, as parents still worry that their children won’t get ahead and now lack the tools to give their offspring a leg up.
• The African Swine flu, a deadly disease for pigs, ravaged China’s pork industry last year. Indications are that in its wake, the supply disruption has changed consumption patterns, leading to what may be lasting demand destruction.

Economics and policy:  Bitcoin may no longer represent the crypto space and more trouble for tech.

• For a long time, bitcoin was considered a proxy for all cryptocurrencies. That may not be the case much longer.  The expansion of crypto assets is leading to fewer funds flowing to bitcoin.  The lack of price momentum in bitcoin is masking strong price increases in other parts of the space.  We view the entire crypto space as a reaction against currency debasement.  Our expectation is that, over time, governments will snuff out this avenue of debasement protection, similar to the way the Roosevelt administration made it illegal to hold gold.
  • Investors considering this space should note that the area is mostly unregulated. The fraud seen in financial markets in the past, which happened infrequently in regulated markets, is a common occurrence in the crypto space.
• The DOJ is preparing to sue Google (GOOGL, USD, 2904.31) over its dominance in digital advertising. This is the second lawsuit on this issue against the company.
• Major tech firms in the U.S. and China are moving into the chipmaking business, although this effort appears to be more about design than manufacturing. The goal is to make custom chips for their hardware, which will allow them to create better products.
• Modi’s increasing authoritarian tendencies are creating problems for U.S. tech firms

International roundup:  The ECB is considering tapering and the Scots make noise about independence.

• Some ECB members are pushing for tapering. Although the leadership isn’t leaning that direction, we suspect the Europeans will probably, at some point, start following the Fed on this issue.  European bond markets are preparing for the slowdown in buying.
• The new government in Tehran has shown little interest in restarting nuclear talks. However, there are reports that discussions may resume soon.  We still harbor strong doubts the agreement can be revived.
• The Scottish National Party (SNP), which supports independence from the U.K., currently runs a minority government in the region. It recently added two Green party members to the government.  The Greens support independence and this development will be a problem for Boris Johnson.
  • The SNP has indicated it won’t allow nuclear weapons to be stored on its soil if it gains independence. The U.K. may be forced to move its nuclear submarines to the U.S. or France if they can’t remain in Scotland.
  • Brexit-related supply problems are becoming critical; there are reports that beer supplies are running low.
• President Biden met with Ukrainian President Zelensky yesterday. Although Biden attempted to assure the Ukrainian leader of U.S. support, we suspect Zelensky remains concerned.  The U.S. did commit to $60 million of military aid.

COVID-19:  The number of reported cases is 218,516,990, with 4,544,777 fatalities.  In the U.S., there are 39,399,080 confirmed cases with 642,093 deaths.  For illustration purposes, the FT has created an interactive chart that allows one to compare cases across nations using similar scaling metrics.  The FT has also issued an economic tracker that looks across countries with high-frequency data on various factors.  The CDC reports that 443,741,705 doses of the vaccine have been distributed, with 371,280,129 doses injected.  The number receiving at least one dose is 205,527,578, while the number receiving second doses, which would grant the highest level of immunity, is 174,600,017.  For the population older than 18, 63.6% of the population has been vaccinated.  The FT has a page on global vaccine distribution.  Although some of the southern states are seeing a decline in cases, the majority of states are reporting increases.

• Recent polling is showing evidence that vaccine hesitancy is weakening. It appears the combination of FDA approval and vaccine mandates by companies are slowly leading to more vaccine acceptance.
  • Studies from Israel support booster shots.
• Each surge in infections tends to be followed by falling cases. There are multiple reasons behind this outcome.  Rising cases lead to increased caution.  As infections rise, the disease can find fewer victims.  Weather plays a role.  As temperatures cool and crowds move outdoors, the virus has less opportunity to circulate.  We could see a decline in cases in the coming weeks in the U.S. resulting from all these factors.
• Vaccination does not grant complete immunity. Those vaccinated are infected, and some suffer symptoms.  However, there is evidence that these “breakthrough” cases are not as severe.  And, it also appears that the vaccinated are less likely to suffer from “long COVID” cases.
• Although children have been less affected by COVID-19, there are cases where kids suffer inflammatory complications, called MIS-C. A U.K. study suggests that for those children who came down with these complications, there were no long-term medical issues.
• Rising cases in Asia are leading to supply disruptions in factories The surge is threatening the manufacturing of parts for key consumer electronics.

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