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 some of the key air defense and cyberwarfare assistance that the U.S. has provided to Ukraine.  We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today, including an initial take on the U.S. mid-term elections, although it’s important to note that the votes are still being counted and the outcomes of many races are still up in the air.

Russia-Ukraine:  Ukrainian forces continue to make marginal gains in their counteroffensives in the northeastern Donbas region and in the southern region around Kherson.  Reports today indicate that the Ukrainians have entered a key city just north of Kherson.  Meanwhile, the Russians continue to strike back with air, missile, and kamikaze drone attacks.  Additional reporting shows that the Russians continue to struggle with depleted weapons inventories and difficulties with manufacturing replenishment weapons, in part due to Western sanctions.  They are therefore turning to other countries to buy weapons.  The most recent reports suggest Russian National Security Council Secretary Patrushev arrived in Tehran yesterday, probably to discuss the potential sale of Iranian ballistic missiles to Russia.

• Yesterday, the Ukrainian military announced it had received its first two U.S.-supplied National Advanced Surface-to-Air Missile Systems (NASAMS), which should improve the country’s air defense capabilities and reduce the damage to its civilian infrastructure from Russian air, missile, and drone attacks. The U.S. has pledged to provide six more NASAMS over the next year and a half.
  • One benefit of the NASAMS is their use of adapted air-to-air missiles known as Surface-Launched AMRAAMs. Newer NASAMS can also launch other air-to-air missiles, such as the AIM-9 Sidewinder.
  • That’s important because the U.S. and its allies have significant stocks of those types of missiles.
• U.S. Army Gen. Paul Nakasone, head of the National Security Agency, recently explained why Russia has launched only small, ineffective cyberattacks against Ukraine and its allies so far in the war. According to Nakasone, Russia’s cyber capabilities were seriously blunted by U.S. “hunt-forward” teams sent to Ukraine in late 2021.
  • The hunt-forward teams, consisting of U.S. cyber soldiers, conduct defensive and cooperative measures overseas at the invitation of a foreign government. The teams are a part of the U.S. military’s “persistent engagement strategy,” which centers on maintaining constant contact with cyber adversaries and ensuring that proactive, not reactive, moves are made.
  • According to Nakasone, U.S. hunt-forward teams have conducted dozens of operations abroad in recent years, including in Croatia, Estonia, Lithuania, Montenegro, and North Macedonia.

China:  As shown in the data section, the October producer price index was down 1.3% year-over-year, marking China’s first annual drop in wholesale prices since December 2020.  Along with the weak international trade data released earlier this week, the fall in the PPI provides clear evidence that China’s economy is losing momentum, which is likely to be a headwind for the global economy and global risk assets in the coming months.

• The October consumer price index was up just 2.1% year-over-year, below expectations and weak enough to suggest muted consumer demand.
• Amid weak foreign demand, unpredictable and disruptive COVID-19 lockdowns, government crackdowns on whole swaths of the private sector, and other challenges, the reports indicate waves of Chinese manufacturers are closing down or reducing operations, pushing many blue-collar workers into unemployment.

European Union:  The European Commission proposed a loosening of the bloc’s debt rules today that would give highly indebted governments more room to spend money. Until now, the bloc has required governments to keep the budget deficit below 3% of GDP and debt below 60% of GDP, with tight timelines for cutting above-target deficits and debt.  Those rules have been suspended for several years now, but the EU is proposing to replace them with country-specific action plans to cut deficits and debt over longer, more realistic time periods.

• We suspect some version of the proposed rules will be put into place, simply because the prior rules and timelines are unrealistic given that many EU countries have boosted their spending and debt so much in recent years.
• The new rules would likely trade austerity for higher debt, leaving many EU countries at economic risk. High debt among countries in the Eurozone could also lead to widening currency spreads that would complicate ECB policymaking and threaten the euro.

United Kingdom:  To help cut the U.K.’s yawning budget deficit, Chancellor Hunt is reportedly considering a proposal to reduce the income level at which the country’s top personal income tax rate of 45% kicks in.  The move would allow the government to avoid breaching the Conservative Party’s 2019 pledge not to increase tax rates.

U.S. Mid-Term Elections:  Based on the results available so far this morning, the key takeaway from the elections yesterday is that the “red wave” of massive Republican Party gains failed to materialize.  The Republicans are expected to regain control of the House of Representatives, but with a smaller majority than they had hoped and anticipated going into the polls.  The Senate remains up in the air, with votes in several key races still being counted.  At least one important Senate race, in Georgia, could result in a run-off election.

• In any case, the U.S. will now have a divided government again, with Democrats retaining the Executive Branch and Republicans controlling at least one chamber of the Legislative Branch.
• Historically, such divided government has actually been positive for investors. In addition, the U.S. stock market has historically tended to rally over the year following the mid-term elections.  U.S. stock futures are trading lower so far this morning, perhaps on investor disappointment that pro-business Republicans didn’t do better, but the election may have actually helped lay the groundwork for stronger stock markets once the U.S. economy gets through its impending recession.

U.S. Military Power:  Because of the military’s recent shortfalls in recruiting, the U.S. Navy said late last week that it is raising its maximum age for new sailors from 39 to 41.  The policy change means that the Navy is now accepting the oldest enlisted recruits of the four services.  The Air Force’s maximum enlistment age is now 40, and the Army’s maximum is 35, while the Marine Corps’ enlisted age limit is 28.

U.S. Semiconductor Industry:  Taiwanese computer chip giant Taiwan Semiconductor Manufacturing Company (TSM, $65.02) is reportedly preparing to build a second cutting-edge fabrication facility north of Phoenix, Arizona.  The scale of the investment is expected to be similar to the $12 billion or so the firm will spend on its first cutting-edge Arizona fab, announced in 2020.

• The development marks a welcome diversification of TSMC’s production capacity, which currently is heavily focused on Taiwan itself, making the firm’s critical output subject to disruption as China pushes Taiwan toward reunification with the mainland.
• The new plant also reflects the kind of shortened supply chains and “friend shoring” we expect to see as the world fractures into relatively separate geopolitical and economic blocs. Our studies indicate that Taiwan would end up as a key member of the evolving U.S. bloc.

U.S. Cryptocurrency Market:  After suffering a sudden liquidity crunch, major cryptocurrency exchange FTX agreed to be taken over by rival Binance.  The crypto world had already been shaken this year by rising interest rates, investors’ falling risk appetite, and a series of bankruptcies in which FTX founder Sam Bankman-Fried often rode to the financial rescue.  The takeover of FTX, therefore, marks a major power shift from FTX to Binance and a humbling comedown for Bankman-Fried.

• The news has also sparked a new round of weakness in crypto assets. So far this morning, Bitcoin has fallen approximately 4.6% to $17,859.99, while Ether is down 7.6% to $1,229.85.
• FTX’s own token, FTT, has lost some three-fourths of its value so far today.

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