by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EST] | PDF

Our Comment today opens with notes from the Ronald Reagan Presidential Institute’s annual National Defense Forum over the weekend.  We next review a range of other international and U.S. developments with the potential to affect the financial markets today, including more risky Chinese moves in the South China Sea and a new intraday record high for gold prices.

United States-China:  At the Reagan Institute’s annual National Defense Forum over the weekend, Commerce Secretary Raimondo delivered a passionate, aggressive call for even stronger efforts to keep U.S. advanced technology from the Chinese military.  As we’ve noted before, many U.S. business elites continue to resist Washington’s new restrictions on trade, investment, and technology flows to China, including Raimondo’s move in October to clamp down on semiconductors with artificial intelligence capabilities.  However, Raimondo offered no apologies, saying, “I know there are CEOs of chip companies in this audience who were a little cranky with me when I did that, because you’re losing revenue. Such is life.  Protecting our national security matters more than short term revenue.”  Ouch!

• One of Raimondo’s goals is to boost the budget for her department’s Bureau of Industry and Security, which works to stop foreign threats to U.S. industry and national security. According to Raimondo, “I have a $200-million budget. It’s like the cost of a few fighter jets. Come on.  Let’s go fund this operation like it needs to be funded so we can . . . protect America.”
• As more U.S. officials and voters become aware of China’s military buildup and the U.S.’s lagging effort to match it, we see a rising chance that domestic political winds could suddenly shift toward something like the “Missile Gap” controversy of the 1950s and 1960s. The result could be a crash effort to hike U.S. defense spending and expand the military, with politicians who oppose the effort pilloried for being “soft on China.”  On that note, the latest Reagan National Defense Survey was released in conjunction with the weekend forum.  Some of its key findings include:
  • Fully 51% of respondents named China as the greatest threat to the U.S. (including 66% of Republicans and 40% of Democrats), up from 21% in 2018.
  • The increased concern about China mostly reflected worries about its military build-up, human rights abuses, and aggressive foreign policy. The survey now shows much less concern about China’s economic policies.
  • Despite concerns about China’s military, the respondents appeared overconfident in the U.S.’s military superiority over China. The respondents’ assessments suggest they still don’t appreciate how far China has developed its naval, air, missile, space, and cyber capabilities.
  • The survey suggests that if or when voters believe the U.S. is falling behind China’s military, they would be prepared to respond. About 77% of respondents support increased spending on the military (including 87% of Republicans and 71% of Democrats).  Fully 69% believe the U.S. needs to increase its defense industrial capacity.

(Source:  Ronald Reagan Institute, 2023)

China-Philippines:  As if to underscore China’s geopolitical aggressiveness, the Philippines yesterday said some 135 vessels from the quasi-military Chinese Maritime Militia are swarming a reef in the South China Sea that is recognized as Philippine territory under international law but is claimed by China.  The incident appears to be the biggest of its kind since the reef was deluged by some 200 Chinese vessels in 2021.  The swarming is particularly risky because the U.S. has a mutual defense treaty with Manila that could be invoked if Chinese forces attack the Philippines.

COP28 Climate Conference:  As the annual international meeting on climate change continues in Dubai, we’ve noted the following chart of global fossil fuel emissions.  The chart clearly shows how emission rates accelerated after China joined the World Trade Organization in 2001 and started its period of rapid economic expansion.  What few people are discussing is how emission growth slowed markedly in the last decade and a half, as Chinese economic growth slowed and much of the world was in a laggard recovery from the Great Financial Crisis of 2008.

• As the Chinese economy continues to slow and as developed countries continue to diversify their energy mix to include more renewable sources and nuclear energy, we wonder what would happen if emissions hit a plateau and even start to decline.
• Since many in the West are already pushing back against the “green transition,” we wonder if flattening or falling emissions could also sap some of the political support for green investment.

Israel-Hamas Conflict:  After restarting its attacks on the Gaza Strip on Friday, Israel now appears to be training its sights on the southern sections of the territory.  The renewed attacks and continued violence between Israelis and Palestinians in the West Bank mean there is still a risk that the conflict could widen.  Indeed, Iran-backed Houthi rebels in Yemen launched retaliatory missile and drone strikes over the weekend against commercial ships and a U.S. destroyer operating in the Red Sea.  At least two commercial ships were hit, while the destroyer shot down the drones sent against it.

Venezuela-Guyana:  In Venezuela’s “consultative” referendum yesterday, the government said more than 95% of the 10 million citizens who participated voted in favor of claiming sovereignty over Guyana’s oil-rich region of Essequibo.  Although it appears that authoritarian President Maduro has pushed the issue mostly to stoke nationalism and help his party in next year’s general election, the vote could potentially provide an excuse for more concrete steps to seize Guyana’s territory.  That risk could buoy oil prices to some extent in the coming months.

Japan:  As the U.S. and other developed countries deal with falling birth rates and population aging, Japan may offer lessons about how the labor market may evolve.  Now that Japan has faced those issues for decades, one new trend to deal with labor shortages is “spot workers,” who work during their free time, separate from their primary jobs and household responsibilities.  Unlike traditional gig workers or part-time workers, spot workers only work when they want to and have no on-going relationship with the employers.  They work for companies on a one-off basis, aided by apps that help them find openings, which offer streamlined on-boarding processes that allow them to get productive on an expedited basis.

U.S. Monetary Policy:  In a speech Friday before the blackout period ahead of the Fed’s next policy meeting, Chair Powell said interest rates are now “well into restrictive territory.”  He also said the policymakers would only hike rates further “if it becomes appropriate to do so.”  The statements suggest the Fed is unlikely to hike its benchmark fed funds rate further.  All the same, Powell also tried to dissuade investors from thinking the Fed would cut rates in the near term, saying it’s still too soon “to speculate on when policy might ease.”  We continue to think investors should believe the Fed policymakers when they say they intend to keep interest rates “higher for longer.”

• Nevertheless, many investors continue to have visions of rate cuts dancing in their heads. One result of that has been continuing downward pressure on the U.S. dollar.
• Earlier today, the prospect of falling U.S. interest rates and further dollar weakness boosted intraday gold prices to an all-time record of $2,135 per ounce before pulling back.
• Over the longer term, we also think gold is being buoyed by increased geopolitical tensions as the post-Cold War period of relative peace and globalization gives way to the new era of Great Power competition and U.S.-China rivalry.

U.S. Retirement Economics:  New analysis from Harvard University’s Joint Center for Housing Studies finds that nearly 70% of older people will eventually need long-term care services, but few will be able to afford it.  The study finds that more than half of older Americans live alone.  Among those living in metro areas, only 13% of adults 75+ could afford assisted living without diving into assets.  Only 14% could afford a daily visit from a home health aide along with their housing costs.

U.S. Momentum Investing:  New research suggests that momentum stock investing stopped performing well early this century in large part because of a change in the way rating firm Morningstar (MORN, $284.30) assigns “stars” to mutual funds.  Prior to 2002, Morningstar assigned its top 5-star rating to the funds posting the best recent returns versus all other stock funds.  The researchers believe that incited investors to pile into those funds, creating momentum.  Beginning in 2002, however, the firm started assigning stars based on how a fund performed against others using the same investment style.  The researchers believe that diluted the impact of performance chasing and took much of the wind out of momentum investing.

U.S. Quantum Computing:  We write a lot about artificial intelligence, autonomous vehicles, green energy, and other rapidly advancing technologies that have the potential to transform the global economy and create new opportunities for investors, but one technology we’ve neglected so far is quantum computing.  In a report today, IBM (IBM, $160.55) is expected to unveil 10 projects demonstrating how quantum calculations can be used to speed up scientific research and business decision-making.  The announcements aim to reassure investors that quantum computing still offers opportunities even if progress has come slower than anticipated.

• In a nutshell, quantum computing leverages the properties of sub-atomic particles that make it possible for them to be in many different states at the same time. This enables quantum machines to carry out large numbers of calculations simultaneously— potentially solving problems beyond the scope of traditional computers.
• One main challenge, however, is that the “qubits” on which the systems are based are unstable and only hold their quantum states for very short periods, introducing errors, or “noise,” into the calculations.  IBM is hoping to show progress in dealing with that problem.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EST] | PDF

Good morning! Equities are trading lower as investors seek to liquidate some of their holdings ahead of Fed Chair Powell’s speech, and the Dallas Cowboys’ defense failed to live up to the hype on Thursday. Today’s Comment starts with our thoughts about changing interest rate expectations. We then examine the continued stability of oil prices and the potential challenges of providing military aid to other countries. As always, our comprehensive report encompasses the latest domestic and international data releases.

Inflation Cooling: While central bankers unanimously agree on the need for prolonged rate hikes, certain countries are better equipped to withstand the economic implications of this policy stance.

• Inflationary pressures remain pervasive across the developed world, yet price increases have moderated at a rate exceeding most analysts’ forecasts. The latest eurozone data indicates that headline inflation has climbed 2.4% since November 2022, substantially lower than the consensus forecast of 2.7%. Notably, Portugal and Italy have both reported annual price increases well below 2%. Concurrently, the Federal Reserve’s preferred inflation measure rose 3.4% from the prior year, well below consensus estimates of 3.5%. This progress has emboldened central bankers, who are now signaling their intent to maintain current interest rates while pursuing measures to address underlying price pressures.
• Despite concerns about a resurgence in inflation, several areas, including the eurozone, the U.K., and Canada, may find it untenable to maintain elevated interest rates without jeopardizing their economic growth prospects. These countries have all experienced economic contractions in the third quarter of 2023, highlighting the delicate balance between curbing inflation and fostering economic growth. In stark contrast, the U.S. economy surged at its fastest pace since 2021 from July to September. This divergence in growth prospects has fueled speculation among investors that other developed economies may be forced to loosen monetary policy ahead of the U.S.

• The chart depicted above showcases the shift in implied policy rates since August. Implied policy rates refer to market-derived forecasts of future interest rates. During this period, investors adjusted their anticipated policy rates downward for the U.K., Canada, and the eurozone for the next few years. Notably, the U.S. has bucked this trend, with investors revising their expectations for the upcoming year. This divergence in policy paths should be supportive of the U.S. dollar against its major counterparts.

Crude Prices Under Pressure:  Despite lingering supply concerns, oil prices have remained subdued, falling short of the previous year’s level.

• Oil producers’ efforts to achieve a sustainable rise in crude prices faced a setback due to supply cuts. In an attempt to bolster prices, OPEC+, which includes Russia, reached an agreement on Thursday to deepen production cuts by an additional 1 million barrels per day. While the agreement was nonbinding, it was meant to convey the oil-producing nations’ resolve to collaborate. Despite an initial surge, Brent crude prices closed the day lower, partly due to concerns that producers might not be able to implement the agreed-upon cuts fully. As a consequence, oil prices ended the day down 2%.
• The stability of oil prices has been partially attributed to weaker demand from China, which is grappling with internal economic challenges, and the looming threat of a global economic downturn. Notably, last year it was expected that oil demand would surge in 2023 as the lifting of China’s Zero-COVID policy was anticipated to increase energy consumption significantly. These expectations were dashed as the country’s low consumer confidence and industrial output have led to a sluggish economic recovery. Furthermore, the Organization for Economic Co-operation and Development (OECD) has forecast a slowdown in GDP growth for member countries to 1.4% in 2024, which will further contribute to weakened demand.

• This year, energy has been a major headwind for inflation. The base effects from last year’s energy price surge have largely dissipated, narrowing the gap between core inflation and headline inflation. The lack of drag from energy will put pressure on other components of inflation as central banks look to bring inflation back to their 2% target next year. Hence, a possible reversal of oil prices could force central banks to rethink the path of interest rates. If oil prices remain relatively stable in the coming year, policymakers may be encouraged to stand pat.

Wars Far From Over: Conflicts in Central Asia and the Middle East show no signs of waning, putting Washington in a difficult position.

• Ukrainian President Volodymyr Zelenskyy has pivoted strategically amidst the evolving conflict with Russia. Acknowledging the constraints of recent counteroffensives, Zelenskyy has redirected attention toward expediting the construction of robust military fortifications along the eastern front line. This shift in focus emphasizes a defensive stance aimed at fortifying Ukraine’s defenses against a potential resurgence of Russian aggression during the winter months. Additionally, there are concerns about Moscow’s preparations, including the accumulation of missiles, which could potentially target Ukraine’s power grids. The actions taken by both Ukraine and Russia signal a readiness to persist in the conflict, indicating that neither side is inclined to cease hostilities.
• At the same time, Israel has stated that it is preparing for a prolonged conflict with Hamas. The remarks come after a seven-day cease-fire ended and the two sides resumed fighting early Friday morning. Although the timing may vary, Israel is expected to maintain its ground offensive until at least early 2024. The objective of the attack will be to kill three of the top Hamas leaders—Yahya Sinwar, Mohammed Deif, and Marwan Issa—and dismantle the group’s capacity to govern effectively in Gaza. Israeli officials caution that the resolution of the conflict won’t be sudden, emphasizing their commitment to prevent the group from regaining influence.

• Facing mounting fiscal pressures, U.S. lawmakers will likely face heightened scrutiny when justifying foreign military aid, particularly for prolonged conflicts. While Americans generally support limited assistance to other nations, their tolerance may dwindle, especially when faced with persistent domestic challenges. These concerns likely explain the recent instances where lawmakers have conditioned military aid for Israel and Ukraine on the inclusion of funding for border security. Hence, we may be moving toward a world in which countries will be forced to be less reliant on the U.S. for protection. This scenario should lead to greater trade and supply chain uncertainty, which should favor commodity prices in the longer term.

Other News: Oil prices are also being impacted by the use of bot traders. This highlights technology’s growing influence on markets and raises questions about potential risks. In a separate event, Florida Governor Ron DeSantis’ one-on-one debate with California Governor Gavin Newsom fell short of expectations. While DeSantis hoped the debate would reinvigorate his campaign, he failed to clearly differentiate himself from Republican frontrunner Donald Trump.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EST] | PDF

Good morning! The day is off to a lively start, with equities surging and Arkansas pulling off an upset victory over Duke. In today’s Comment, we delve into the reasons behind investor rate expectations that may be amiss, explore the waning influence of the Magnificent Seven, and provide our insights into how the world might respond to a reduced U.S. presence. As always, our comprehensive report encompasses the latest domestic and international data releases.

Investor Deja Vu? Ignoring the lessons of the previous year, investors have eagerly embraced riskier and longer-duration assets in anticipation of a Fed pivot.

• The fed futures market has signaled investor anticipation for a rate cut in early 2024, with estimates indicating an almost 80% likelihood by May. This optimism stems from recent progress in inflation and Fed commentary, which have bolstered expectations that the current rate-hike cycle is nearing its end. On Wednesday, 2024 voting member and Atlanta Fed President Raphael Bostic stated that price pressures could subside as the economy slows. However, some Fed officials, including Richmond Fed President Thomas Barkin, Fed Governor Michelle Bowman, and Minneapolis Fed President Neel Kashakari, have all advocated the possibility of another rate hike if inflation resurges.
• As 2023 draws to a close, the stock market is displaying a pattern reminiscent of the year’s beginning. In 2022, inflation exhibited persistent signs of easing after reaching a peak of 9.1% in June, followed by a 140-basis-point decline four months later. Similarly, investors had been anticipating a potential recession in the first half of 2023. While inflation has continued its downward trend this year, investor optimism proved to be premature. A resilient labor market and improved household balance sheets supported economic growth, giving the Federal Reserve more leeway to raise interest rates further.

• Without a substantial economic downturn, it is prudent to trust the Federal Reserve’s commitment to maintaining elevated interest rates for an extended period. The latest Atlanta GDPNow estimate suggests the economy likely expanded at an annualized seasonally adjusted pace of 2.1% in the fourth quarter, indicating that economic momentum remains. Additionally, central bankers have shown a growing interest in incorporating anecdotal evidence into future policy decisions. Although the latest Beige Book indicated signs of economic moderation, policymakers remain vigilant about future price developments, seeking early signs of a potential resurgence in inflation. As a result, government data may have less of an impact on Fed rate decisions going forward.

Down With the Kings? The Magnificent Seven have been the market’s top performers in 2023, but their continued dominance into the new year is uncertain.

• These titans of the S&P 500, including Apple (AAPL, $189.37), Amazon (AMZN, $146.32), Alphabet (GOOGL, $134.99), Meta (META, $332.20), Microsoft (MSFT, $378.85), Nvidia (NVDA, $481.40), and Tesla (TSLA, $244.14), stand as the dominant forces within the index. Collectively, these behemoths account for nearly 30% of the S&P 500’s value, eclipsing their 493 counterparts. While the broader market has gained 19% this year, the Magnificent Seven have surged by an astounding 80%. However, this remarkable growth has been accompanied by a concerning rise in their P/E ratios from 29 to 45, prompting questions about potential overvaluation.
• Maintaining the remarkable performance of the Magnificent Seven in 2023 could be challenging. Their exponential growth was fueled by investor optimism in their ability to capitalize on artificial intelligence advancements that would translate into exceptional future returns, which is offsetting the risk of sacrificing higher-yielding safe-haven assets today. Their ascent has drawn parallels to the Nifty 50s of the 1970s and the dot-com boom of the 1990s, leading to speculation that these companies could face a correction if expectations are not met. The latest earnings reports show that Amazon and Microsoft may still have some momentum, while the remaining companies are seeing less favorable attention.

• As the prospect of higher interest rates diminishes, investors may redirect their focus to stocks that were largely neglected throughout 2023. This sentiment shift is evidenced by the recent performance of the S&P 400, an index that tracks mid-cap companies. Despite starting November down nearly 2% for the year, the index surged by an impressive 7.7% during the month, indicating a renewed interest in these often-overlooked companies. This improved performance can be attributed to a resurgence of bargain hunting among investors seeking opportunities to reenter the market. If favorable conditions persist, this trend could extend into the coming year.

A More Hostile World: With the United States gradually relinquishing its mantle as the world’s preeminent superpower, the global community faces the daunting task of navigating a world without a global hegemon.

• The United Nations and NATO have urged Western nations to address the growing influence of fringe powers in Eurasia and the Middle East. The director general of the International Atomic Energy Agency emphasized the need for renewed engagement with Iran to avert its nuclear ambitions. Meanwhile, NATO’s secretary-general has cautioned that Russia has amassed a significant stockpile of missiles specifically aimed at disrupting Ukraine’s power grid and energy infrastructure during the harsh winter months. India’s brazen assassination attempts in foreign nations (see below) also underscore the potential for escalating geopolitical tensions in the absence of a robust global authority.
• The intensifying global conflicts have prompted non-U.S. nations to reevaluate their approaches to addressing these challenges. The European Council president has advocated for the issuance of defense bonds within the economic bloc. This proposed legislation would facilitate the expansion of Europe’s defense capabilities. Meanwhile, to counter Iran’s nuclear ambitions, UN officials have urged the West to abandon the current Iran nuclear deal and negotiate a new one, considering the situation has deteriorated significantly since the initial agreement in 2015.

• The world’s fracturing into regional blocs is likely to unfold over the next few years. While the U.S. shows no immediate signs of relinquishing its superpower status, political currents are clearly nudging Washington in a different direction. This shift is evident in the growing congressional gridlock over aid packages for Israel and Ukraine. The geopolitical transformation is likely to trigger an upsurge in global military spending, which should bode well for the aerospace and defense industry for the foreseeable future. Furthermore, the burgeoning political uncertainty is poised to render commodities as an attractive haven, since intensifying competition will compel nations to drive up resource prices.

Other news: The U.S. charged an Indian official with plotting to assassinate a Sikh separatist. The incident underscores the challenges the U.S. faces in aligning India with its interests, as India has repeatedly asserted its autonomy as a rising power. Meanwhile, the U.S. and China are poised for a clash of influence in Micronesia, a reflection of their intensifying competition for global influence. On a somber note, political mastermind Henry Kissinger passed away at the age of 100. Renowned as the architect of U.S. foreign policy for decades, his legacy will continue to shape how people view international relations even after his death.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EST] | PDF

Our Comment today opens with new projections of global interest rates from the Organization for Economic Cooperation and Development.  We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today, including potential territorial aggression by Venezuela against its neighbor Guyana and an important case being heard today by the U.S. Supreme Court that could potentially dismantle much of the modern U.S. regulatory system.

Global Monetary Policy:  In its latest economic outlook, published today, the OECD warned that both the European Central Bank and the Bank of England may need to keep interest rates high until early 2025—much longer than investors are expecting—to guard against stubborn inflation pressures.  In contrast, the OECD projected the Federal Reserve will start cutting U.S. interest rates by the second half of 2024.

• The prospect of earlier rate cuts in the U.S. is probably a key reason why the euro (EUR) and pound (GBP) have appreciated so far this quarter, while the dollar has declined. As of early this morning, the EUR is valued at a nearly four-month high of $1.0984, up 3.9% from the end of September.  The GBP is trading at $1.2696, up 4.1% for the quarter.
• If the dollar continues to weaken, it could provide a boost to foreign stocks and some commodities.

Venezuela-Guyana-Brazil:  Venezuela’s National Assembly, dominated by the ruling party, has recently approved a national referendum on the status of the Essequibo territory—the western two-thirds of oil-rich Guyana that Venezuela has claimed for more than a century.  The planned referendum may simply be a ploy to help the government of Nicolas Maduro in Venezuela’s coming elections, but it could also be an example of Chinese- and Russian-style “lawfare” ahead of an attempt to seize Essequibo.  Since Venezuelan forces would likely have to traverse Brazilian territory for any such invasion, the Brazilian military has reportedly been put on alert and is massing troops along its border with Venezuela.

• Over the last decade, dozens of new oil fields have been discovered in Guyana, setting it up to be a key source of new energy in the coming decades. The country is currently estimated to have the equivalent of more than 11 billion barrels of oil deposits, similar to the number of deposits in Kuwait and the United Arab Emirates.
• If Venezuela did try to invade Guyana, the potential damage to its oil fields and the risk that they would fall into Venezuela’s hands could spark a significant jump in global oil prices.
• If Venezuelan forces traversed Brazilian territory to reach Essequibo, such an invasion could also spark a broader conflict, potentially drawing in more South American countries or even the U.S.

 (Source:  New York Times)

China-Lithuania:  In another sign that Beijing is trying to ease tensions with the West, at least temporarily, Lithuanian Foreign Minister Gabrielius Landsbergis said China has now lifted most of the economic sanctions it imposed on the Baltic country in 2021 in retaliation for its approval of a de facto Taiwanese embassy in Vilnius.  Separate data from Beijing shows Lithuanian exports to China in the first 10 months of 2023 were up 54% from the same period one year earlier.

India:  Despite Beijing’s recent efforts to ease its international relations and rekindle stronger economic growth, its ongoing military buildup continues to spur reactions in neighboring countries.  According to recent reports, Indian officials on Friday plan to formally approve the construction of their country’s second indigenous aircraft carrier.  Along with India’s first indigenous carrier and a Russian-built vessel, that would lift New Delhi’s total carrier force to three, enough to eventually ensure a continuous power projection capability throughout the Indian Ocean.

Vietnam:  The government announced it will raise its income tax on multinational firms to 15%, in line with an OECD-led effort to set a minimum rate on companies to avoid tax evasion and tax-rate shopping.  The move threatens to slow the recent surge of foreign direct investment into Vietnam as more multinational firms look to diversify their production out of China.

United States-Argentina:  The newly elected president of Argentina, populist libertarian Javier Milei, has announced that he held fruitful meetings with U.S. officials in Washington yesterday, as he tries to set the groundwork for restructuring his country’s troubled $43-billion loan from the International Monetary Fund.  In addition, Luis Caputo, a former Argentine finance minister considered the frontrunner to lead Milei’s economy ministry, met U.S. Treasury and IMF officials.

• Milei has said he will postpone his controversial reform, which would replace the Argentine peso (ARS) with the U.S. dollar.
• On the other hand, he plans to send a package of “shock therapy” reforms to Argentina’s congress on December 11, including spending cuts to balance the budget in 2024.

U.S. Regulatory Policy:  In a case that could undermine administrative courts in multiple sectors, the Supreme Court today will hear a challenge to the Security and Exchange Commission’s use of such panels.  The courts, which are presided over by administrative law judges, are being challenged on grounds that the judges aren’t impartial and that the courts rob defendants of their right to a trial by jury.  A decision is expected by next July.

U.S. Investing Pantheon:  Investing legend Charlie Munger, vice chairman of Berkshire Hathaway (BRK-B, $360.05) and key lieutenant of Warren Buffett, died yesterday in a California hospital at the age of 99.  Munger is often credited with convincing Buffett to abandon his early-career focus on cheap “cigar butt” investments and instead focus on buying great businesses at reasonable prices, an approach we largely share here at Confluence!

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EST] | PDF

Our Comment today opens with hints of further tightening in the eurozone’s monetary policy, despite the continuing slowdown in the region’s economic growth.  We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today, including an extended ceasefire in the Israel-Hamas conflict and positive remarks on the U.S. labor market by popular former Federal Reserve economist Claudia Sahm.

Eurozone:  In a hearing at the European Parliament yesterday, European Central Bank President Lagarde said her policymakers are likely to consider an early end to the reinvestment of maturing bonds related to the ECB’s pandemic stimulus efforts, rather than continuing them to the end of 2024 as currently planned.  Allowing the ECB’s bond holdings to mature without reinvesting the proceeds would effectively soak up liquidity and further tighten eurozone monetary policy even if the ECB stops raising interest rates.  However, it’s entirely possible the policymakers will keep reinvesting the proceeds if the eurozone economy continues to slow.

United Kingdom-Greece:  The British and Greek governments are embroiled in a bitter feud over the “Elgin Marbles” held at the British Museum in London.  The Greek government has long wanted to repatriate the 2,500-year-old, fragmentary sculptures from the Parthenon in Athens after they were taken to Britain in the 18^th century, but Prime Minister Sunak and many others in Britain believe they are an essential part of the British Museum’s permanent collection.

Russia-Ukraine-Turkey:  New data shows that Turkish imports and exports of certain dual-use, civilian/military goods needed for Russian military production have surged this year, suggesting Ankara is playing both sides in the showdown between Russia and Western-supported Ukraine.  As the world fractures into relatively separate geopolitical and economic blocs, we would expect to see exactly this kind of behavior among countries situated on the borderlands between rival camps.  On the other hand, the move is risky for Turkey, as it could invite a backlash from its Western allies and complicate the trade and investment relations it needs to make the most of its economic potential.

Israel-Hamas Conflict:  The Israelis and Hamas agreed to extend their ceasefire and hostage exchanges for an additional two days, rather than letting them expire yesterday as originally planned.  If implemented, the extension should lead to Hamas releasing another 20 of its Israeli hostages, while Israel will release 60 of the Palestinians it holds in its jails.  More important for investors, the extended ceasefire may further reduce the risk of the conflict spreading, although we don’t think it would eliminate the risk.

• Egyptian and Qatari officials say the current ceasefire is helping build trust that could be turned into a longer-term ceasefire and perhaps even negotiations toward a truce that would end the fighting.
• However, given the compromises Israel and Hamas would likely need to make for such a truce, it’s probably much too soon to look for such a development.

United States-China:  David Solomon, CEO of Goldman Sachs (GS, $337.71) said this week that the worsening U.S.-China rivalry has prompted his firm to abandon its previous China strategy of “growth at all costs.”  According to Solomon, “Today, it’s a more conservative approach [in China] and we’ve probably pared back some of our financial resources there, simply because there’s more uncertainty.”  The statement is consistent with our view that the U.S.-China competition has raised risks for investors, whether they’re direct investors like Goldman or portfolio investors holding assets exposed to China.

U.S. Labor Market:  In one of her “Stay-At-Home Macro” posts over the weekend, popular former Fed economist Claudia Sahm offers a comprehensive argument that most U.S. workers are better off now than they were before the coronavirus pandemic.  While few of her individual observations are groundbreaking, the overall picture she paints probably helps explain the current resilience in U.S. economic growth and the possibility that the country will avoid a recession outright or have only a modest dip in the coming year.

U.S. Pharmaceutical Industry:  President Biden announced yesterday that he will invoke the Defense Production Act to allow government investment in pharmaceutical supply chains as a way to help ensure the availability of key drugs and related medical supplies such as insulin, morphine, vaccines, and ventilators.  The move will allow the Department of Health and Human Services to provide about $35 million for capital investments and other needs in the medical supply chains.

• The move is consistent with similarly modest DPA investments in the traditional defense industry.
• With many reports showing defense firms are having trouble ramping up their output of advanced weapons, ammunition, and other supplies, a key question is why the government isn’t making even stronger use of the DPA.

U.S. Green Technology Industry:  As governments around the world keep pushing policies to cut the amount of carbon in the atmosphere, they’ve mostly focused on cutting carbon emissions.  Now, a rising new set of technologies aims to take the carbon out of the air after it’s been emitted.  For example, a start-up firm called Graphyte has developed a product that uses agricultural waste products such as sawdust or tree bark to naturally absorb carbon dioxide.  The product can reportedly remove carbon from the air at a cost of about $100 per metric ton, well below the main competing technology, direct-air capture, which costs about $675 per metric ton.

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