Asset Allocation Quarterly (Third Quarter 2023)

Posted on July 20, 2023 by Amanda Ahne

by the Asset Allocation Committee | PDF

Our three-year forecast still includes a relatively mild recession followed by a recovery and the potential for an economic expansion.
We expect inflation to moderate in the near-term but modestly re-accelerate in the back half of the forecast period given underlying structural influences.
The Fed’s monetary policy is likely to ease as economic conditions slow. Additionally, we expect a measured and careful approach by the FOMC as the presidential elections draw nearer.
The duration posture remains short-term. We anticipate the yield curve will begin flattening from its current inverted state.
In domestic equities, we maintain our value bias as well as large cap cyclical sectors and quality factors within lower market capitalizations.
International developed markets include an overweight to Japan. We maintain emerging markets exposure in the most risk-accepting portfolio but exclude China.
Gold exposure is maintained for its benefits as a low-correlation asset along with its potential to act as a haven during economic turmoil and as a hedge against geopolitical risk.

ECONOMIC VIEWPOINTS

The economy has generally remained resilient despite the Fed’s tightening actions and a widely anticipated recession. While fiscal spending has supported the economy, consumer spending has carried the expansion on the back of strong household balance sheets. However, we are seeing the first signs of slowdown in consumer sentiment. As this chart indicates, household non-mortgage debt-to-cash ratios have crept higher recently, indicating weakening balance sheets which could negatively affect spending. Savings that were bolstered by stimulus payments have now been depleted by strong discretionary spending and inflationary pressures on the overall consumer basket. Early signs of slowing consumer spending are emerging from the Consumer Staples and Discretionary categories, which we believe are due to price elasticities of demand in response to higher inflation. It is significant to note that we are seeing household balance sheets deteriorate even before the resumption of student debt payments. An estimated 37 million borrowers had a three-year reprieve in student debt payments and reports indicate this primarily supported consumption and did not accrue into savings. We expect these debt payments to further suppress spending.

At the same time, labor markets have remained strong with unemployment near cycle lows. The unemployment rate may be artificially understated as employers are hoarding labor in fear of labor shortages even when consumer demand is slowing. Here, again, we are seeing early signs of a slowdown in hours worked and falling rates of wage growth.

Macro headwinds combined with monetary policy tightening reinforce our forecast for a mild recession, which is likely to be uneven among different segments of the economy. For example, the increased cost of capital is likely to weigh more heavily upon more highly leveraged companies and those embarking on new projects or expansionary efforts. The overall recession is not expected to be severe since it has been widely anticipated and elevated levels of liquidity on the sidelines should provide support to risk markets. As this chart shows, we continue to see historically high levels of money market and ultra-short bond fund assets. These levels are high for two main reasons. First, the inverted yield curve is offering attractive yields in the short end of the curve with low levels of risk. Second, accruing this yield is attractive for investors waiting on the sidelines for a dip in the market, providing support to risk markets.

Inflation is already showing signs of slowing. We believe this is primarily in response to the short-term smoothing of the supply-chain problems and is only secondarily affected by slower demand caused by tightening monetary policy. Our expectation is that inflation will return toward the end of the forecast period due to underlying structural issues, such as deglobalization and aging demographics. We also expect the new inflation regime to be higher than during the ZIRP epoch but lower than it has been since the pandemic.

One of the mega-trends supporting domestic economic activity longer-term is the re-shoring of manufacturing capacity and generally shortening supply-chains. Geopolitical tensions are likely to remain elevated and further support international polarization into regional blocs. Reliability of supply is now prioritized over the absolute lowest cost of manufacturing. Capacity buildouts are multi-year endeavors, which will place increasing demands on construction labor and materials initially and skilled labor to operate in the long-term. We believe these pressures, alongside general supply-chain complications, will further reveal inflationary bottlenecks in the economy and could lead to the resurgence of inflation.

We expect the path of monetary policy to be measured and careful over the forecast period, especially as we head into the 2024 presidential elections. Fed fund rates are likely to settle higher following the recession as the FOMC attempts to control a systemically higher inflationary regime.

STOCK MARKET OUTLOOK

A mild recession is generally discounted into current equity fundamentals, especially lower capitalization stocks. Domestic large cap stock valuations remain near cycle highs, with the expansionary cycle extended by excitement around AI and machine learning. We remain cautious regarding large cap exposure as concentration remains at historic highs. For example, the top 10 names in the S&P 500 accounted for roughly 30% of that index at quarter end. To guard against concentration risk, we lean our style tilt toward value over growth. Additionally, we retain our Aerospace & Defense position and cyclical sector overweights as we project that deglobalization and re-militarization of foreign countries is a sustainable long-term trend. We maintain our sector overweights to Mining, Energy, and Industrials in most strategies. The Mining and Energy sectors are likely to benefit from electrification/green energy policies as electrification is metals heavy.

We believe small and mid-capitalization stock valuations remain attractive, while fundamental earnings power remains healthy. Mid-cap stocks, specifically, remain at historically wide valuation discounts to large cap stocks. Last quarter, we introduced a quality factor in our mid-cap exposure. Similarly, we remain in a quality-screening vehicle on the small cap side. The quality factor screens for profitability, leverage, and cash flows, which should support the group through economic volatility.

We continue leaning into the value bias across all market capitalizations. We view the sustainability of earnings growth as more attractive in equities categorized as value and the fundamental valuation multiples are modest compared to historical data. In addition, value style has a lower exposure to sectors that we view as overpriced. Although growth has vastly outperformed value year-to-date, we anticipate that we are in the early stages of a value outperformance cycle.

International developed equities remain attractively valued, while their earnings potential remains healthy. This quarter, we added a country-specific overweight to Japan as shareholder-friendly reforms are starting to take hold in the country and as capital flows are moving out of the rest of Asia and into Japan, which could potentially lead to earnings multiple expansion. We also forecast positive returns from emerging market stocks on the back of U.S. dollar weakness, although exposure to this asset class is limited to only the most risk-accepting strategy. Given the potential economic slowdown and geopolitical risks stemming from China, we have directed our exposure to an emerging market ex-China investment vehicle.

BOND MARKET OUTLOOK

With the anticipated decline in the fed funds rate (the Fed’s reaction to the recession) and a more docile near-term level of inflation, the most attractive segment of the Treasury curve is in short duration. While our base case is for a flat yield curve to reign by the end of the three-year forecast period, we harbor concerns regarding intermediate-term bonds and especially long-duration bonds. Should inflation reassert itself within the forecast period, yields on long-term debt could rise, exerting downward pressure on prices and resulting in a traditionally shaped yield curve. Consequently, the duration posture of the strategies with income as a component remain short-duration with a concentration in one-year Treasuries.

Among investment-grade corporate bonds, it is notable that spreads have not compressed beyond historic averages, underscoring the absence of investor concern even in the face of the much-anticipated recession. Moreover, corporate debt issuance has been subdued over the past few years and has not led to excessive debt levels on most corporate balance sheets. Nevertheless, it would be consistent with our thesis for spreads to widen modestly as the recession takes hold and the maturing of low coupon debt to be refinanced with bonds reflecting higher rates than what prevailed during the years prior to 2022. As a result, corporate bond exposure in the strategies represents a lower proportion than popular market indices.

In the speculative-grade corporate bond category, we find caution is warranted due to the sizable increase over the past 15 months in the cost of capital for highly leveraged companies that are refinancing debt. As with investment-grade corporates, spreads have been relatively contained. However, an uneven recession is likely to cause spreads on lesser rated corporates rated B or lower, especially those in the distressed category, to widen markedly. Accordingly, all exposures to speculative-grade bonds in the strategies are exclusively in BB-rated debt.

OTHER MARKETS

Allocations to REITs are absent as our forecast for the sector over the near-term calls for continued headwinds and low levels of demand for office and retail space, compounded by the difficulty in arranging financing. Although the strategies similarly avoid broad-based commodities owing to recession-induced pressure on prices, we maintain the allocation to gold across the strategies. We favor the continued gold exposure as it can act as a haven during economic contractions and as a hedge against geopolitical risk. Furthermore, gold can be beneficial due to the potential strength it offers during periods of U.S. dollar weakness and its use as a reserve asset for global central banks.

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Asset Allocation Fact Sheet

Weekly Energy Update (July 20, 2023)

Posted on July 20, 2023July 19, 2023 by Amanda Ahne

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

On Monday, oil prices spiked on reports that the Kingdom of Saudi Arabia (KSA) was going to extend its voluntary production cuts until year’s end. The report was incorrect but does show the power that the news has on the oil markets.

(Source: Barchart.com)

Commercial crude oil inventories fell 0.7 mb, less than the 2.5 mb draw forecast. The SPR was unchanged.

In the details, U.S. crude oil production was steady at 12.3 mbpd. Exports rose 1.7 mbpd, while imports increased 1.3 mbpd. Refining activity rose 0.6% to 94.3% of capacity.

(Sources: DOE, CIM)

The above chart shows the seasonal pattern for crude oil inventories. After accumulating oil inventory at a rapid pace in the first quarter, stockpiles have moved into a pattern consistent with the seasonal. Current inventories are in line with seasonal levels.

Fair value, using commercial inventories and the EUR for independent variables, yields a price of $59.94. Commercial inventory levels are a bearish factor for oil prices, but with the unprecedented withdrawal of SPR oil, we think that the total-stocks number is more relevant.

Since the SPR is being used, to some extent, as a buffer stock, we have constructed oil inventory charts incorporating both the SPR and commercial inventories.

Total stockpiles peaked in 2017 and are now at levels last seen in 2002. Using total stocks since 2015, fair value is $92.96.

About the Heat: We have been commenting on the unusually warm temperatures currently in the Northern hemisphere. Europe, unaccustomed to such heat, is having a very difficult time adjusting. In the U.S. the southern tier of states has experienced extreme heat, especially in the Southwest. China is seeing hot weather as well. Temperature reporting is now front and center in the media. Although climate change is being blamed for much of it, our experience with climate is that it’s complicated. There are two complications that are important to mention:

Sunspot cycles: The sun plays a major role in the earth’s climate. Sunspots are the result of magnetic activity on the sun that causes flares and ejections from the sun’s surface. The scientific community is divided on the impact of sunspots on climate. Some argue that it is an important factor, others dismiss the activity as negligible. We are not climate scientists but interested observers. Our take is that the cycles likely amplify the normal variation. That means that sunspot cycles probably don’t drive climate by themselves but do play a role.
- Sunspot cycles run 22 years, from trough to trough. The current cycle will peak in 2025. In general, increased activity tends to lead to higher temperatures. Thus, we are in the part of the cycle that should lift global temperatures. The current cycle isn’t unusually amplified, but its current readings exceed the peaks observed in the last cycle.

(Source: NOAA)

ENSO cycles: The ENSO cycle has three phases—El Niño, La Niña, and neutral. In recent years, we had experienced a set of La Niña events. We are currently in an El Niño event, and current projections suggest it will be moderate to strong. El Niño events often lead to hot North American summers, especially across the south. It has also coincided with mild winters.

The combination of elevated sunspot activity and an El Niño ENSO cycle indicates that hot weather will continue. In the developed world, this climate condition tends to be bullish for summertime natural gas prices, as it boosts air conditioning demand and consequently, electricity consumption. So far, U.S. natural gas production has been robust enough to keep injections on par with seasonal norms. This factor has kept natural gas prices low. If winters are mild, it could be bearish for natural gas prices going forward. There have been other effects as well:

Hot, dry weather in parts of Europe have caused the water levels of the Rhine River to decline, forcing shippers to lighten barges by shipping less product. Mississippi River water levels are also low.

High river temperatures are limiting nuclear power production in France.
Hot weather in Spain has sent (olive) oil prices soaring.
Temperature and rainfall changes have created situations where it is hard to find any part of the U.S. that is unaffected.

Market News:

The IEA’s oil market report increased oil demand by 2.4 mbpd to 102.3 mbpd, a new record. Most of the demand will be met by non-OPEC+ suppliers. Meanwhile, we note that the KSA is losing its spot as top oil producer within OPEC+. In the early 1980s, something similar occurred which led the Saudis to aggressively retake market share, tanking oil prices in the mid-1980s.
- As the KSA reduces output, Kuwait is aggressively lifting productive capacity. We doubt that the Saudis will tolerate this absorption of market share indefinitely.
The global natural gas market is experiencing a generational adjustment in the wake of the war in Ukraine. The IEA’s recent global natural gas report details how the world market for gas has changed.
The recovery in oil prices has lifted the Russian Urals price to the G-7 cap of $60 per barrel. The breach will begin triggering financial sanctions for traders and the financiers of these oil purchases. We will be watching to see if Russian oil sales are affected.
The Biden administration is planning modest injections into the SPR, but in no way is this going to replace all the oil that was sold.
California, once a major oil producer and still the 7^th largest oil producing state, has essentially stopped new oil well approvals.
Turkey has suspended oil flows from Iraq over a dispute over payments. So far, there has been little progress in freeing up these flows.
One of the surprises of the past year has been the rather modest increase in U.S. oil production despite elevated prices. As we have noted in the past few months, higher costs for drilling and financing issues have stifled output. Now, there are reports that drilling rig counts are fading, suggesting that production may decline in the coming months.

Geopolitical News:

India has been a major buyer of Russian crude oil, but the two nations have struggled to establish payments. India has been paying in INR, but the Russians have discovered that the usefulness of INR is limited due to the lack of deep Indian financial markets and capital controls. And so, to facilitate further sales and avoid USD transactions, Russia and India have agreed to transact in CNY. It’s unclear how much is being done in the Chinese currency and what India’s CNY reserve status is at the moment. However, if this continues, then at some point India will need to run a trade surplus with China to acquire CNY. We doubt China will support that outcome.
Israel is working to improve relations with Azerbaijan. The Israeli defense minister has visited the country recently. At the same time, Azerbaijan is working to improve relations with Iran as well.
Russia recently suggested that the UAE had the rightful claim to the Greater and Lesser Tunbs and Abu Musa, three islands in the Persian Gulf that are controlled by Iran. The Iranians were not pleased. Although Iran and Russia have seen relations improve recently, there have been notable differences over the years that still affect the relationship.
As part of the thaw in Saudi/Iranian relations, the KSA, Kuwait, and Iran may be working to jointly develop offshore natural gas in the Persian Gulf.
In response to Iran’s interdiction of Persian Gulf shipping, the U.S. is increasing its deployment of F-16s to the region. The U.S. has also moved F-35s and a destroyer to protect shipping. There is also talk of boosting air defense systems in Iraqi Kurdistan as Iran has also been threatening that region.
The morality police in Iran were sidelined during last year’s headscarf protests. The police have apparently returned, along with a crackdown on women not wearing the hijab.
Although sanctions on Russian energy sales have affected global oil supply, they haven’t really prevented Russian oil from entering the market. The sanctions have reduced the Russian revenues from oil sales (evading sanctions costs money), but the Russian economy continues to muddle through, although there is increasing evidence that economic conditions are deteriorating. Essentially, Western nations really didn’t want to shut off the flow of Russian oil, but they just didn’t want to pay high prices due to sanctions. The real goal was to reduce Russian revenue, and in those terms, sanctions have been generally effective.
- Saudi Arabia is increasing its imports of Russian petroleum products. We suspect these are for reexport. Exporting product to friendly nations is one way Russia is evading sanctions.
- Sanctions on Russian oil have benefited Venezuela and Iran, who have both seen sanctions on their respective nations ease. Dubai has benefited by becoming the place where Russian oil deals are consummated. The role of busting sanctions used to belong to Switzerland; that has changed.
- Interestingly enough, the U.S. has also benefited from sanctions. The shift from coal to oil disadvantaged Europe, which had plenty of coal but lacked oil. The U.S. has attempted to use oil as a diplomatic tool to gain European compliance to American policy goals. Europe, obviously wanting to avoid this pressure, and against American opposition, bought Russian oil. The U.S. was open to Europe buying oil from the Middle East as well, but Europe’s goal was diversity of sources. The war in Ukraine has exposed the risks of being dependent on Russia, which has led to a boom in U.S. oil and gas sales to Europe.
Schlumberger (SLB, $56.41) has finally ended sales to Russia.
Relations between the UAE and the KSA leaders have deteriorated recently. Mostly, it appears to be driven by the goal of both leaders to project power in the region.

Alternative Energy/Policy News:

Solid state EV batteries could be the technology that moves transportation to electricity. The batteries promise not only to recharge in a time frame similar to filling a car with gasoline, but also to have a range that may exceed 700 miles per charge. Nio (NIO, $10.48) announced it will start using these batteries. The current technology is still emerging, but the more the industry moves to solid state, the quicker the transition is likely to be.
- We continue to monitor the progress in not just solid state batteries, but cheaper materials to make batteries. Lithium prices have soared as EV production rises, so replacing such metals with cheaper alternatives would be another form of progress.
The European heatwave, noted above, is boosting solar power output.
The EU is trying to use trade policy to secure critical EV metals. Mercosur and the EU have been in trade negotiations for some time, but now the EV buildout is increasing European’s interest in getting a deal done. However, for the Mercosur nations, the echoes of colonialism continue, prompting resource nationalism.
- The U.S. Senate has approved a tax treaty with Chile, which could support lithium imports.
- The Economist magazine notes that the process of energy conversion may not be possible without buying such products from China.
Chinese GDP data was disappointing, but two bright spots are EVs and solar panels. China is aggressively building out battery storage which is critical to the expansion of solar power.
According to reports, China is aggressively hacking the U.S. energy grid and could use cyberattacks on the grid in case of a war.
One of the paradoxes of the energy transition is that environmental concerns about mining key metals is hampering the expansion of supplies needed to replace fossil fuels.
- As the world scrambles for critical EV minerals, mining the deep sea is being considered. Concerns about environmental damage are being raised.
- Maine has deposits of lithium, but the state prohibits commercial mining of the resource.
Clean hydrogen offers the promise of clean energy using the existing infrastructure. However, it isn’t clear if that promise will ever materialize.
A new deal to build and deploy small modular nuclear reactors in the Northwest shows the steady growth and interest in this new technology.
The CFTC is drafting guidance for the eventual creation of a carbon market. Economists hold that the fastest way to address carbon reduction is to properly price it. Having this trading done on exchanges is one way to create a market for carbon credits.

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Asset Allocation Bi-Weekly – Are Higher Interest Rates Bearish for Risk Assets? (July 17, 2023)

Posted on July 17, 2023July 13, 2023 by Amanda Ahne

by the Asset Allocation Committee | PDF

Orthodox finance and economics rests on the idea that higher interest rates reduce economic activity and lower the attractiveness of risk assets. We have no real quarrel with the part about reducing economic activity as higher borrowing costs will tend to slow investment and consumer durable spending. The effect on risk assets seems rather straightforward as well. Higher rates should divert funds to fixed income and away from equities and commodities.

However, when debt levels are elevated, rising interest rates could increase interest income. Current debt levels are high.

This chart shows private sector debt (household plus non-financial business sector) scaled to GDP along with general government debt. Although the total is down from the pandemic peak of 304.1%, it is still 262.0% of GDP. Combine that debt level with rapid policy tightening, and interest income would be expected to rise. In fact, in raw terms, it is.

Interest income is about 8% of total personal income, which is lower than the peak of 18% in 1984. Thus, in looking at the overall data, there isn’t a strong case that interest income is all that significant yet.

However, there is a distributional factor that may affect risk assets.

In this chart, we estimate the flows of interest income by wealth distribution. As the chart shows, over the past 18 months, interest income to the top 10% of households has increased significantly. The middle 40% has seen modest gains, while the bottom 50% has seen small increases.

In terms of asset allocation, the top 10% hold around 50% to 60% of their wealth in equities. Increased income flows to this wealth bracket, paradoxically, means that more liquidity is available for other purchases. As long as interest rates stay elevated, we would expect fixed income and cash balances to remain high. Although once policy starts to ease, this additional income will likely look for other alternatives; put another way, the bounce to stocks from policy easing could be higher than expected.

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Weekly Energy Update (July 13, 2023)

Posted on July 13, 2023July 13, 2023 by Amanda Ahne

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

Falling U.S. inflation is raising hopes that the Fed’s tightening cycle is coming to an end. That has lifted oil prices, triggering a breakout above the recent trading range.

(Source: Barchart.com)

Commercial crude oil inventories rose 5.9 mb, well above the 0.1 mb draw forecast. The SPR fell 0.4 mb, putting the total build at 5.5 mb.

In the details, U.S. crude oil production fell 0.1 mbpd to 12.3 mbpd. Exports fell 1.8 mbpd, while imports fell 1.4 mbpd. Refining activity rose 2.6% to 93.7% of capacity.

(Sources: DOE, CIM)

Fair value, using commercial inventories and the EUR for independent variables, yields a price of $59.77. Commercial inventory levels are a bearish factor for oil prices, but with the unprecedented withdrawal of SPR oil, we think that the total-stocks number is more relevant.

Since the SPR is being used, to some extent, as a buffer stock, we have constructed oil inventory charts incorporating both the SPR and commercial inventories. With another round of SPR sales set to happen, the combined storage data will again be important.

Total stockpiles peaked in 2017 and are now at levels last seen in 2002. Using total stocks since 2015, fair value is $94.27.

Market News:

China has made a concerted effort to improve energy security. Increasing its imports from Russia and making aggressive diplomatic and investment actions in the Middle East are all part of this goal. It should be noted that domestic production is also increasing.
- China has increased residential natural gas prices in a bid to reduce demand.
Hot weather continues. In the U.S., 6 million Americans are in areas of extreme heat. Phoenix is threatening to break its previous record of 18 days with 110+ F temperatures. Miami has also seen temperatures near that level and has suffered through 30 consecutive days of heat indexes over 100 F.

Geopolitical News:

As sanctions erode on Iran, Tehran is boosting exports, thwarting the Kingdom of Saudi Arabia’s efforts to lift prices.
- Iraq is becoming increasingly important in Tehran’s sanction busting.
Venezuela has seen sanctions gradually erode as the world adjusts to the war in Ukraine. The country is using expanding oil exports to pay down debt.
Russia tends to view Central Asia as its near abroad. We have noted that recently China has been challenging Russia for this region. Reports suggest that the Prigozhin mutiny has led the “stans” to further distance themselves from Moscow.
Rob Malley is a long-time diplomat that specializes in Iran. He was the Iranian envoy (the U.S. doesn’t have formal relations with Iran) for the Biden administration and was involved in the JCPOA talks. He has been relieved of his duties as the FBI investigates his handling of classified materials. However, there is growing speculation he may be a spy for Iran.
Last week, we noted that the U.S. Navy had thwarted efforts by Iran to seize vessels. Apparently, this action wasn’t enough to keep Iran from trying again as the IRGC has now seized a tanker in the Persian Gulf. Meanwhile, Indonesia has seized an Iranian tanker thought to be engaged in an illegal oil transfer.
Iran is said to be increasing cyberattacks against Western targets.
There is increasing evidence that Iran is trying to attack Israel directly via Hezbollah.

Alternative Energy/Policy News:

Although car dealers are tending to hold less inventories these days, reports suggest that EV inventories are becoming rather bloated. Current inventories are at about a 92-day supply, twice the industry average. Sales have picked up, but supply is outpacing demand with probably the biggest issue being price. Also interesting is that hybrid inventories are only 44 days.
Chinese automakers are targeting the U.S. Chinese EVs are a threat to the U.S. market due to their lower costs.
Mercedes-Benz (MBGYY, $19.86) is the latest automaker to adopt the Tesla standard for charging connectors. The company joins five other firms, including General Motors (GM, $39.77) and Ford (F, $15.10), in adopting this standard.
The IEA has released its first report on minerals critical to the energy transition. There is an expanded race to secure key metals involving governments, commodity firms, and automakers.
The energy transition can’t occur without mining and smelting. Although such activities are generally acceptable in the abstract, they become problematic when they occur close to home.
The IEA has published an update on the progress made toward zero emissions.
The seabed is a controversial region for gathering these critical minerals. Island nations and China are keen to develop this source, while European nations are trying to restrict the effort. Meetings on this issue are underway in Jamaica.
Climate problems are becoming a challenge for insurers. The U.S. system of state regulation may not be suited to respond.
Biofuel makers are starting to consider bamboo as a source. The plant grows rapidly and could become a reliable source for ethanol. We note that on the West Coast biofuels are displacing distillate fuels.

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Asset Allocation Bi-Weekly – The Green Shoots of Re-Industrialization (July 3, 2023)

Posted on July 3, 2023June 23, 2023 by Amanda Ahne

by the Asset Allocation Committee | PDF

In a little-noticed report last month, total construction spending in April was up a modest 6.1% from one year earlier, but private nonresidential construction spending was up a whopping 30.2%. That marked the fourth straight month in which private, nonresidential construction, a proxy for commercial construction, was up more than 20.0% year-over-year. In contrast, outlays on public works (such as roads, bridges, and sewer systems) rose 15.1% in the year to April, while private residential construction spending fell 9.7%. We believe these figures confirm an important new trend in the U.S. economy that will have big implications for certain asset returns going forward.

The strength in commercial construction may seem surprising, given today’s high vacancies and the pessimism regarding properties such as office buildings and shopping malls. Those sectors continue to face major headwinds, and they certainly were not responsible for this recent rise in commercial construction. The jump in commercial building has primarily come from new factory construction, especially manufacturing facilities for electronics and information-processing goods. Total outlays on factory construction in April were more than double their level in the previous April, with a year-over-year rise of 104.4%. Expenditures on just the subsector of electronics and information-processing factories nearly quadrupled, showing an astounding increase of 271.8% on the year. Of course, some of this increased spending simply reflects the high inflation in prices for construction inputs ranging from labor to cement. Nevertheless, the spending increases far exceed any reasonable estimates of inflation for construction inputs. The spending figures, therefore, confirm a huge rise in real factory construction.

The frenzy in building new electronics factories provides some of the first statistical evidence of U.S. re-industrialization, i.e., the rebuilding of the nation’s manufacturing, construction, and mining sectors as companies shift production back home from Asia or elsewhere abroad. We suspect that a lot of the new factory construction reflects the recently announced, high-profile projects for electric-vehicle batteries, semiconductors, and other green-energy or info-technology goods. However, we doubt that the recent spending uptick includes much of the hundreds of billions of dollars in subsidies provided by last year’s Inflation Reduction Act or the CHIPS Act. Slow bureaucratic and administrative procedures would suggest that most of those subsidies will only kick in later. In addition, higher military budgets have not yet had their full impact on the defense industrial base. The recent increase in factory construction, therefore, is probably only the beginning of a much larger, longer-lasting uptrend.

As geopolitical tensions between China and the West worsen, and as Chinese economic growth slows, we think the U.S. will be a key beneficiary of companies “near shoring” or bringing production back home. New data suggests even Europe will see some re-industrialization. The data shows that global businesses acquired or leased 9.6 million square feet of industrial space in the European Union during 2022, marking a 29% increase over the previous year. The uptake of factory buildings comes even as weak consumer demand in the region pushes down contracts for retail and warehousing space. Re-industrialization in the EU could accelerate even further if its member states adopt U.S.-style subsidies or if their defense spending increases spur an expansion in their defense industrial bases.

As the world fractures into relatively separate geopolitical and economic blocs, we have been arguing that re-industrialization will take root in the U.S. and, to a lesser extent, in Europe. The data discussed here shows re-industrialization has indeed started to take root and is now pushing up green shoots that are likely to grow further. Over the long term, this re-industrialization will be a mixed bag for Western societies. It will likely make the West more resilient to external supply shocks and provide more opportunities for workers without a four-year college degree, but these new facilities and the shortened supply chains they represent will be less efficient than under the extreme globalization of the last few decades. The result will likely be persistently higher inflation and interest rates.

Fortunately, shorter-term prospects are more positive. The building boom will likely support demand even as the overall economy slips into recession. The new, highly modern factories being built could also quickly boost worker productivity when they come on line. Finally, since rebuilding the nation’s factory sector will require repairing and expanding roads and other infrastructure, it could also help reverse the recent fall in state and local government investment that we recently wrote about. For these reasons, we believe this re-industrialization will provide a short-to-medium term boost to several different stock sectors, such as broad industrials, construction companies and the service providers that serve them, providers of construction materials and equipment, and perhaps even real estate investment trusts (REITs) that focus on industrial properties.

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Bi-Weekly Geopolitical Report – Distinguishing My Wife From a Hat, an AI Story (June 26, 2023)

Posted on June 26, 2023June 26, 2023 by Amanda Ahne

Thomas Wash | PDF

In his book, The Man Who Mistook His Wife for a Hat and Other Clinical Tales, Oliver Sacks, a neurologist, details his experience with patients suffering from varying neurological disorders. In one such case, he dealt with a man who had lost the ability to recognize faces. The patient was a university music teacher who had always been known for his calm and collected demeanor but had suddenly began behaving strangely. He would sometimes fail to recognize his students and was often seen patting the top of water fountains and parking meters as if they were small children. His antics were widely regarded to be jokes since he didn’t have trouble communicating, and his musical ability was as good as it had ever been.

It wasn’t until the patient was diagnosed with diabetes that he sought professional help. Aware of the disease’s impact on his eyesight, he visited an ophthalmologist, who reassured him that his vision was fine but referred him to see Dr. Oliver Sacks for a neurological exam.

During the visit, Dr. Sacks noticed something was off about the patient. The man seemed to be having trouble perceiving Dr. Sacks fully. Instead of looking directly at Dr. Sacks’ face, the patient fixated on certain parts. He gazed at Dr. Sacks’ nose, chin, right ear, and right eye, but never his face as a whole. After telling the patient the exam was over, the man attempted to find his hat but instead reached for his wife’s head and tried to lift it as if he were about to put it on. To Dr. Sacks’ surprise, the patient’s wife treated this as if it were an everyday event.

The case of the man who mistook his wife for a hat is a great illustration of how artificial intelligence (AI) neural networks process information. Like the patient, neural networks do not have the ability to look at an entire image to judge what it is. Instead, they break down images into parts, specifically into an array of numbers called pixels. AI models (neural networks) see images by recognizing patterns in the numbers that represent the image. They can make distinctions between different objects through training which then teaches them to associate certain patterns with specific objects. Just like the patient who needed to see an eye, nose, and mouth to know that he was looking at a face, AI models need numbers to achieve the same task.

This report provides a beginner-friendly introduction on how AI learns and processes information. We will begin by discussing the similarities between AI and our brains. Next, we will explain how AI works and explore some of its most important applications. We will then discuss some of the challenges and limitations of AI. We end the report with market ramifications. While this is not intended to be an exhaustive summary of AI, readers should come away with a stronger understanding of the technology and why it is such a big deal.

Read the full report

Don’t miss the accompanying Geopolitical Podcast, available on our website and most podcast platforms: Apple | Spotify | Google

Weekly Energy Update (June 22, 2023)

Posted on June 22, 2023 by Amanda Ahne

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

Oil prices may be establishing a new trading range between $67 and $75 per barrel.

(Source: Barchart.com)

Commercial crude oil inventories fell 3.8 mb when compared to the forecast build of 0.5 mb. The SPR fell 1.7 mb, putting the total draw at 5.6 mb.

In the details, U.S. crude oil production fell 0.2 mbpd to 12.2 mbpd. Exports rose 1.3 mbpd, while imports declined 0.2 mbpd. Refining activity declined 0.6% to 93.1% of capacity.

(Sources: DOE, CIM)

The above chart shows the seasonal pattern for crude oil inventories. After accumulating oil inventory at a rapid pace into mid-February, injections first slowed and then declined. This week’s draw is consistent with seasonal norms. The seasonal pattern would suggest that stocks should fall in the coming weeks, but this pattern has become less reliable due to export flows.

Fair value, using commercial inventories and the EUR for independent variables, yields a price of $58.21. Commercial inventory levels are a bearish factor for oil prices, but with the unprecedented withdrawal of SPR oil, we think that the total-stocks number is more relevant.

Total stockpiles peaked in 2017 and are now at levels last seen in 2002. Using total stocks since 2015, fair value is $93.15.

Market News:

The Netherlands is closing Europe’s biggest natural gas fields due to local concerns about earthquakes. Often oil and gas extraction can lead to earthquakes; Oklahoma has experienced similar issues. This decision, though, will put the EU at risk of supply shortages.
The war in Ukraine has led to a massive restructuring of the global energy market. LNG has become an important fuel, and there has been a clear expansion of its use. This expansion has led to a rapid increase in the infrastructure for the fuel, including gasification plants in the Middle East, Australia, Canada, and the U.S.
- China has embarked on long-term contracts with suppliers, which establish the funding for investment. The EU, likely because of expectations of renewable growth, is less open to long-term contracts. If natural gas usage continues, Europe could find itself isolated.
- Russia’s oil refineries hit new highs in utilization, which may mean that Russia intends to meet its OPEC+ obligations by replacing oil exports with product exports. Russian oil exports have been affected by the war.
- Russia’s oil flows to India have been at deep discounts, helping to improve India’s economy.
- Russian natural gas is still flowing through Ukraine, but the current agreement ends next year, and Kyiv expects Russian gas flows to stop.
There are some unusual actions being taken by the Kingdom of Saudi Arabia (KSA) regarding oil flows. For example, consistent with its decision to reduce oil flows, Saudi oil exports fell to a five-month low in April. However, there are numerous reports that the KSA is storing 20 mb of oil on 10 tankers in the Red Sea. We also note a spike in supertanker rates, which may be tied to the KSA’s decision to float oil storage.
- The Permian Basin is now producing more oil than the KSA’s giant Ghawar field.
- So far, the KSA’s bid to boost prices has failed to work.
The summer solstice came this week, marking the onset of astrological summer (meteorological summer began on June 1). We are seeing a strong heatwave in the South, especially in Texas. Hot weather boosts electricity demand and usually is bullish for natural gas prices. We note Texas degree days are running well above normal.

(Source: Reuters)

- Texas isn’t alone in its drought; Iran is facing a crisis as well.

Mexico has joined several firms in a deep-water oil and gas project.
Guyana is delaying offshore oil-block auctions in a bid to increase the number of participants in its oil exploration.
Ship channel dredging will allow larger oil tankers to directly load oil and products from the Texas coast.
The DOE suffered a data breach tied to Russian hackers.
- DOE Secretary Granholm failed to disclose stock holdings; it is unclear if this fact will lead to her ouster.

Geopolitical News:

The U.S. is still buying uranium from Russia for American power plants. Although nuclear power is an attractive alternative energy, the lack of a non-Russian supplier is a risk.
One of Russia’s long-term geopolitical goals is a warm water port. Although the warming of the Arctic may give Moscow the sea access it wants, it has eyed the Middle East as a possible path to the ocean. As Iranian and Russian relations improve, Russia is looking to build access to the Indian Ocean through Iran. A risk to this path is that the Arab states in the Persian Gulf have tended to side with the U.S. However, as relations fray between Washington and these Arab states, the risks in using Iran for sea access decline. Thus, the recent thaw between Riyadh and Tehran is a benefit to Moscow.
We are seeing a concerted effort by China to secure energy sources. China appears to be deploying an “all of the above” strategy, including both alternatives and fossil fuels. What is important here is that China is most interested in energy security, with less regard for the source.
Central Asia isn’t just the focus of China and Russia. Germany is also looking to secure energy from the region and held talks with Kazakhstan
As we noted last week, we were mostly wrong about an Iran nuclear deal. What we got right was that the JCPOA was dead. What we didn’t expect was that the U.S. would opt for a limited deal in what looks like a bid to reduce regional tensions. We doubt this will increase global oil supplies much since Iranian sanctions are far from tight, but easing tensions will likely make more oil available to the West. We suspect the White House is fully focusing on November 2024, and although there will be a political cost to a thaw, the chances of lower oil prices are probably seen as a greater benefit.
- It isn’t clear what will actually be agreed to in the deal. The U.S. appears willing to accept Iranian uranium enrichment to around 60%, which is less than weapons-grade but still shows that the country can reach the 98% required for bombs. Particles enriched to nearly 84% have already been reported.
- Iran will receive some funds that are currently frozen, and the U.S. will get prisoners freed.
The KSA has invited Iran’s president to Riyadh for an official visit.
China has agreed to build a nuclear power plant in Pakistan.
Here is a cool map of China’s energy infrastructure.

Alternative Energy/Policy News:

One of the emerging themes for the next few years will be the choice Western nations face on EVs. If the goal is extensive adoption, the most effective way of achieving this is to allow Chinese imports. China’s EV industry has improved rapidly and is now producing world-class cars at reasonable prices. On the other hand, if the goal for Western nations is re-industrialization, Chinese cars should be restricted. So far, we have generally expected Europe to be much more open to Chinese EVs compared to the U.S. However, there is evidence that the EU is rethinking that position.
- Tesla (TSLA, $268.75) is rapidly becoming the connection standard for the EV industry as more EV makers adopt its standard. Doing so gives car owners access to Tesla’s charging stations.
In fact, meeting climate goals is often in direct conflict with meeting geopolitical goals. There are serious doubts as to whether the West can move toward carbon neutrality without China.
Solid state EV batteries have the potential to revolutionize the industry. Toyota (TM, $157.40) has a test vehicle it claims has a range of 932 miles with a 10-minute charge. If high range/short charging becomes the norm, ICE vehicles will be much less attractive.
The U.S. is leading a critical minerals partnership in a bid to create a strong supply chain for metals needed for the energy transition. Presently, China holds a commanding position in these metals, but the U.S. and its allies want to build a supply network that prevents China’s dominance.
- It should be remembered that part of the reason for China’s dominance is that it was willing to accept the environmental costs of mining and processing these metals.
- The U.S. is facing calls from nations with key minerals but without free trade agreements with the U.S. to join this partnership. So far, Washington has restricted the subsidies, but if the U.S. doesn’t expand the list, China might become an alternative funder.
- Minnesota may become an important source of nickel, but the permitting process could be daunting.
Chinese regulators approved a thorium reactor. Thorium reactors have some major advantages over uranium reactors. They didn’t get used in the early days of nuclear power because nations wanted the dual option of being able to make nuclear weapons, and thorium can’t be weaponized. In addition, this reactor will use molten salt, which is another significant benefit.
Hydrogen is a fuel that offers promise in providing clean power but tends to fail at gaining traction due to costs. The U.K. is looking to use the fuel for home heating but is struggling with the details. In the EU, there is a program to expand the pipeline network to move hydrogen.
The U.K. has opened its first deep geothermal project in 37 years.
Although there is great hope for fusion power, the reality is that we are a long way from commercial fusion power.
The Biden administration announced an increase in biofuel use, but surprisingly, the ethanol mandate was less than expected. Even with other biofuels, the mandates were less than expected. Biofuels replace fossil fuels to some extent, but also still require fossil fuels in production. In general, biofuels are more about reducing U.S. dependence on foreign oil and are an aid to farmers. Corn ethanol, for example, reduces greenhouse gas emissions by 19% compared to gasoline. The best benefit comes from biomass and cellulosic ethanol. But because neither comes from a cash crop, support for these fuels is lacking.

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Asset Allocation Bi-Weekly – The Great Divergence (June 20, 2023)

Posted on June 20, 2023June 15, 2023 by Amanda Ahne

by the Asset Allocation Committee | PDF

The S&P 500 is up 10% year-to-date and briefly reached the 4,200 level in late May. The recent rally in equity markets has been driven by the rise of generative artificial intelligence (AI), which has bolstered tech stocks. In fact, much of this strong performance has come from the five largest tech companies, which now account for 24.7% of the index’s value, a record high. This concentration has led some investors to fear that a bear market similar to the dot-com bubble burst of 2000 may be on the horizon. The pessimistic outlook is related to concerns that the underperformance of the broader index has generally followed previous periods of high market concentration.

The chart above shows the relative performance of the S&P 500 Market Capitalization and Equal Weight indexes over the past 30 years. During times of uncertainty, investors tend to pile into established companies with large market capitalizations. These firms are typically better positioned to weather a downturn as they have more resources and access to capital. In this environment, the Market Cap index generally outpaces its Equal Weight counterpart. However, this outperformance does not usually last long. When the market recovers, investors often go bargain hunting as the lesser names are likely to offer more value. Thus, the Equal Weight index can outperform the Market Cap index over an extended period. That said, the recent unevenness is different than in previous market rallies.

The 2020 tech rally was driven by monetary and fiscal stimulus. The Federal Reserve injected billions of dollars into the financial system, which lowered interest rates and encouraged investors to take on more risk. Additionally, many households had excess savings due to the COVID-19 pandemic stimulus, which increased the number of retail investors. Overall, tech stocks benefited as investors looked for better returns. However, the rally was not sustainable.

As the Federal Reserve began to tighten monetary policy in 2022, interest rates rose and investors became more risk-averse. This led to a sharp decline in tech stocks, which continued until early 2023, when people began to focus on the investments that Microsoft (MSFT, $346.10) had made in machine-learning company OpenAI. The investments signaled the company’s commitment to artificial intelligence and its potential to usher in a new technology wave.

The craze for AI reached new heights in May after chipmaker Nvidia (NVDA, $431.33) forecasted that strong demand for AI chips could help the company generate $110 billion in revenue in 2024. The news led to one of the biggest tech rallies in two decades as the tech-heavy Nasdaq Composite Index rose by more than 7% in May.

Analysts have compared the release of AI-related products such as ChatGPT to the advent of the internet browser, calling it a game-changer. Although still under development, the product has a wide range of potential uses, from content creation to task automation. The technology’s diverse applications have encouraged investors to purchase AI-related stocks at a premium as they are willing to pay for AI-related companies based on their future cash streams as opposed to current earnings.

Unlike the dot-com boom of the early 2000s, many of the companies developing AI technology are not startups. The major movers in AI are established tech giants, such as Microsoft, Amazon (AMZN, $126.50), Alphabet (GOOG, $124.77), Meta (META, $280.34), Baidu (BIDU, $148.19), Tencent (TCEHY, $45.55), and Alibaba (BABA, $92.13). These companies have proven track records of success, and they are unlikely to fail if the AI bubble goes bust. As a result, the recent rally in tech stocks poses significantly less risk than the internet mania of the early 2000s because the firms driving the rally are more stable and have better track records of profitability.

While the Market Cap index has outperformed recently, this outperformance is unlikely to last. Economic growth is expected to slow in the second half of the year, which could lead to a new down-leg in the market. As demand decreases, earnings will likely be negatively impacted, leading to a decline in stock prices. However, we do not expect the repricing of major tech companies to lead to a market crash. Instead, we believe other stocks within the S&P 500 will be less affected. Consequently, the Equal Weight index may recover against the Market Cap index toward the end of the year. Additionally, these companies could be very attractive once economic growth begins to pick up.

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Weekly Energy Update (June 15, 2023)

Posted on June 15, 2023June 14, 2023 by Amanda Ahne

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

Oil prices may be establishing a new trading range between $67 and $75 per barrel.

(Source: Barchart.com)

Commercial crude oil inventories rose 7.9 mb when compared to the forecast draw of 1.5 mb. The SPR fell 1.9 mb, putting the total build at 6.0 mb.

In the details, U.S. crude oil production was steady at 12.4 mbpd. Exports rose 0.8 mbpd, while imports were flat. Refining activity declined 2.1% to 93.7% of capacity.

(Sources: DOE, CIM)

The above chart shows the seasonal pattern for crude oil inventories. After accumulating oil inventory at a rapid pace into mid-February, injections first slowed and then declined. This week’s outsized build puts inventories back at seasonal norms. The seasonal pattern would suggest that stocks should fall in the coming weeks, but the seasonal pattern has become less reliable due to export flows.

Fair value, using commercial inventories and the EUR for independent variables, yields a price of $57.11. Commercial inventory levels are a bearish factor for oil prices, but with the unprecedented withdrawal of SPR oil, we think that the total-stocks number is more relevant.

Total stockpiles peaked in 2017 and are now at levels last seen in 2002. Using total stocks since 2015, fair value is $92.53.

Market News:

The IEA released its forecast for oil demand over the next five years. The group estimates that expanding EV usage will dampen gasoline demand and thus lead to a peak in global oil demand after an almost continuous rise for 80 years.

As the above chart shows, oil demand is forecast to fall dramatically mostly due to negative growth for road transportation. We have serious doubts that this will actually occur, but oil producers, especially those beholden to shareholders, have to be aware of this forecast since it suggests that investment in new production is at risk of being stranded. Therefore, shareholders are likely to demand a shareholder return instead of investment into new production, and it appears this trend is already beginning to happen. This forecast is likely to add to bullish pressure for prices, especially if demand exceeds expectations.
Oil prices continue to mark time in the wake of the OPEC+ announcement. Our take is that the U.S. wants prices around $60 per barrel and the Saudis have a target of at least $80 per barrel. Because of this, we are sitting in a netherworld between these two price points. Worries about Chinese demand are acting as a bearish factor on prices and offsetting the supply cuts coming from OPEC+.
- We note that it’s hot in China, but so far, coal and LNG demand have been remarkably modest. This situation would suggest weak industrial activity.
- OPEC+ production fell last month, with some sources suggesting a 67 mbpd cut while others report a lesser one. In any case, we are seeing a decline in supplies.
- There are reports that the Saudis were targeting bearish oil speculators. Given the market’s reaction, that idea makes some sense. We note that each OPEC+ announcement seems to be having less of a bullish impact.
U.S. crude oil exports have been increasing, but we are starting to get close to capacity at some export facilities.
Natural gas production in the Permian Basin has hit a new record high.
There is always tension between commodity project development and environmental concerns. Oil drilling in the Amazon Delta is pitting oil drillers against environmentalists.
Much to our surprise, it looks like the U.S. will add 3.0 mb to the SPR. Of course, this injection pales in comparison to the sales over the past year. We note the Biden administration wants to purchase another 12.0 mb over this coming year.
Venezuela has suffered falling oil production for years. However, we are starting to see a slow recovery in this area. As Russian sanctions change global oil flows, the U.S. has begun easing sanctions on Caracas.

Geopolitical News:

Although Putin and Xi seem to have a close personal relationship, the geopolitics of China and Russia are often contentious. One reason is that both nations have interests in the same regions, with one area of potential conflict being Central Asia. Russia views this region as part of its “near abroad” as some of these states were part of the Soviet Union. China wants the natural resources of these nations and is making investments in a bid to improve ties. As nuclear power demand rises, China is trying to encourage the Central Asian nations to supply it with uranium. The region is rich with this material. This development is raising tensions between China and Russia.
There are reports that U.S. and Iranian negotiators have made progress in restarting the nuclear deal. We remain highly skeptical of such reports. Although corralling Iran’s nuclear program would be potentially positive, the political costs of helping Iran would be high. Also, we doubt that the incumbent administration could promise any agreement would be binding for future administrations barring an actual treaty agreement, which seems unlikely.
- The U.S. has denied having these reported talks, though that doesn’t necessarily mean they didn’t happen. Israel reported that the U.S. and Iran held talks on what might be a narrowing set of goals. At the same time, the lead Iranian negotiator has been invited to Norway for talks. Overall, we think the Europeans really want access to Iranian oil and may be trying to foster talks. As we noted above, we think the political hurdles are too high for success.
- Furthermore, the U.S. has begun to offload the Iranian oil it seized due to sanctions. If there were serious efforts being made to restart nuclear negotiations, we doubt this would be happening.
- It has been reported that Iran is sending drone parts for assembly in Russia; again, if Iran were really trying to restart talks, the U.S. wouldn’t be issuing this intelligence.
The recent dam rupture in Ukraine has been in the news but the damage done to the Tolyatti-Odesa ammonia pipeline is also important. Ammonia is one of the key building blocks in fertilizer production. This pipeline is the world’s largest but has not operated since the Russian invasion. The attack on this pipeline may make Moscow less likely to extend the grain deal. Natural gas is important to ammonia production, and the loss of this pipeline could have a minor bearish impact on European natural gas.
In the wake of SoS Blinken’s trip to the Kingdom of Saudi Arabia (KSA), Riyadh made it clear that it wants support for a civilian nuclear program. The Saudi foreign minister warned that the U.S. faces competition from other nations. The KSA is pressing for a civilian nuclear program in return for recognizing Israel.
- There are reports that the U.S. and the KSA both threatened each other after the kingdom cut oil production. It appears that recent visits were designed to repair relations.
We continue to monitor the steady flow of leaks concerning the Nord Stream Pipeline sabotage. Reports now suggest the CIA warned Ukraine not to attack the pipeline. It remains unclear who did attack the pipeline as both the U.S. and Ukraine had an incentive to destroy the structure because it more closely tied Germany to Russia. These leaks do suggest the U.S. is trying to distance itself from the attack and pin the event on Ukraine.
- In related news, Dutch intelligence also reportedly warned the U.S. that Ukraine was planning an attack on the pipeline.
Azerbaijan is making diplomatic engagements with regional powers likely in an effort to reduce the risks to oil flows.
As relations between the KSA and China improve, Chinese businesses are “streaming” to the kingdom in search of investment opportunities.
China is rapidly expanding its refining capacity and, according to the IEA, is poised to become the holder of excess refining capacity. Since there is little direct consumption of crude oil, this excess capacity will tend to narrow profit margins for refiners.
Russia has resumed oil exports to North Korea. Given that North Korea has limited capacity to pay for such oil, we suspect that Moscow is swapping oil for military equipment.
The EU is looking to ban all Russian pipeline gas imports by the end of the year. This move would most harm Hungary.

Alternative Energy/Policy News:

EV growth is projected to rise steadily in coming years, but there are serious doubts about the availability of battery metals. The dependence on China for batteries remains a major issue as well.
- It’s arguable that short-sighted U.S. policies for the battery industry helped create China’s dominance.
- Battery metals are critical to the EV transition; the lack of mining talent could boost costs in the future.
- There is a significant price war going on in China’s EV market. A major producer has cut prices, suggesting the price war is spreading.
- BYD (BYDDY, $66.39), the Chinese auto company, is poised to become the world’s largest EV producer. It specializes in low-cost vehicles and makes one for the world market that costs just over $11k. We note BYD is also building the infrastructure to manufacture sodium-ion batteries, which are much cheaper than lithium-ion batteries.
As more investment funds flow into alternatives, we continue to monitor new technological developments. Work being done on plasma drills could expand geothermal power which is nearly emissions-free.
Although nuclear power is often heralded as a solution to climate change and carbon emissions, in reality, the U.S. has allowed its uranium industry to unwind, preferring to acquire the metal from other places. When the world was considered safe for trade and investment, this policy may have made sense; it doesn’t now.
In our 2023 Geopolitical Outlook, we discussed the race for space. Part of the allure of space is the possibility of beaming electricity from orbiting solar panels that would be exposed around the clock. Although seemingly farfetched, a team at CalTech is testing such a program. Obviously, if this works it becomes a game changer for energy.
Back on Earth, the expansion of wind and solar energy is being hamstrung by the lack of grid expansion. This is why there was an interest in Congress to address permitting in the debt ceiling negotiations. Smoke is a problem, too.
Summers are becoming increasingly unpleasant for both coasts but especially for the West Coast. There have been several news items suggesting a rapid warming trend; however, this trend may be due more to non-recurring factors and may not actually signal permanent changes.

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