by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Good morning! Today’s Comment begins with a discussion about the Bank of Japan’s latest policy decision. Next, we will provide an in-depth analysis of the GDP report, including why we believe that the warm weather may hurt economic growth in the third quarter. Finally, we end with our thoughts about the underlying tensions within the Western bloc.

New Day for BOJ: The Bank of Japan has left its policy rate unchanged but made a tweak to its yield control

• The Bank of Japan (BOJ) has made a surprise move to relax its yield curve control policy, allowing 10-year Japanese government bond yields to rise to 1.0%. The BOJ had previously capped yields at 0.5%, but it now says that the limit will no longer be rigid but rather a reference rate. This signals that the BOJ is planning to get less involved in anchoring the yield curve. The move comes after reports showed that consumer prices excluding fresh food rose 3% in Tokyo in June, well above the BOJ’s 2% target.
• Traders viewed the Bank of Japan’s (BOJ) decision to relax its yield curve control policy as a sign that the central bank was moving away from its ultra-accommodative monetary policy. Yesterday’s reports that the BOJ was considering such a move led to a drop in all major indexes in the U.S., with the S&P 500 falling 0.62%, the NASDAQ slipping 0.64%, and the Dow Jones Industrial Average dropping 0.67%. The dollar also slipped against the yen (JPY), from 144 per dollar to 139. The move is a sign that the BOJ is preparing to normalize monetary policy.

• The BOJ’s decision to relax its yield curve control policy marks a significant shift in financial markets, particularly in the yen carry trade. The trading strategy involves borrowing JPY at low-interest rates and investing in assets that offer higher yields. Low rates and a weak currency have made the JPY an attractive funding currency for this strategy. However, if interest rates in Japan rise, the yen carry trade will become less profitable and hurt traders who will have to repay loans with a stronger currency. Additionally, the move will cause investors to reassess their risk appetite, especially as the global economy shows signs of slowing.

Keep on Surprising: Strong GDP growth in the second quarter of 2023 has bolstered hopes that the U.S. economy may be able to skirt a recession, but we have doubts.

• The American economy expanded at a faster-than-expected pace in the second quarter of 2023, according to the Bureau of Economic Analysis (BEA). GDP grew at an annualized pace of 2.4% from April to June, up from a revised 2.0% in the first quarter. The figure was also above the consensus estimate of 1.8%. A rebound in investment spending boosted the growth, as it offset deceleration in both government spending and consumption. Although it is unclear whether we are out of the woods, the report does provide reassurances that the economy is more resilient than many suspected.
• A deeper dive into the investment GDP numbers shows that much of the increase came from private investment, particularly in transportation. Purchases of transportation equipment accounted for more than half of the growth in fixed investment and more than a fifth of the rise in overall growth. Although it is unclear where the rise has come from, there is speculation that it may have something to do with the government infrastructure bill passed in 2021. Additionally, steps made toward reshoring manufacturing may have also played a role. If this is true, it suggests that investment may be able to support a longer expansion.

• That said, hotter-than-normal temperatures and El Niño conditions could lead to an unexpected drop in growth in the third quarter. These factors could make it harder for workers to perform outside jobs and deter consumers from engaging in outdoor activities. There are signs that the heat is leading to a decline in consumer spending and business investment. On Thursday, President Biden instructed the Department of Labor to ramp up enforcement of on-the-job heat hazards. At the same time, theme parks such as Disney World have experienced a sharp decline in attendance. The extent of the economic impact of high temperatures on economic activity is unclear, but it is likely to weigh on GDP.

Let’s Be Friends: NATO allies are vying for support in the Oceania region as geopolitical tensions in the Indo-Pacific heat up.

• As geopolitical tensions rise in the Indo-Pacific, Western leaders have traveled to Oceania to build ties with countries in the region. French President Emmanuel Macron is currently on a week-long tour of the Polynesian islands, where he warned of a “new imperialism” threatening the sovereignty of numerous states in the South Pacific. On the same day, U.S. Defense Secretary Lloyd Austin gave a speech in Papua New Guinea, reassuring government officials that the U.S. was not planning to set up a permanent base in the country, and the U.S. Secretary of State Antony Blinken invited New Zealand to join AUKUS.
• Western overtures in Oceania are part of a strategic pivot toward Asia to counter China’s growing influence in the region. In April 2022, the Solomon Islands authorized the Chinese navy to make routine port visits, raising concerns that Beijing could establish a permanent military base in the region. In response, the United States and European countries have increased their engagement with Oceania. This year, the U.S. has signed defense agreements and reopened embassies after decades of closure. France has also sought to improve ties with Australia and position itself as an alternative to China and the United States in the Oceania region.

• Along with security agreements, the U.S. is also looking to increase trade ties with Australia
• While the West agrees on the need to stand up to China in the Indo-Pacific, there are signs that the two sides are not completely aligned. Europe’s focus on strategic autonomy is one example of this, as it suggests that the bloc is seeking to avoid putting all of its eggs in the U.S. basket. France has been particularly vocal in this regard, with President Macron stating that he wants to maintain a “constructive relationship” with China, despite U.S. calls for de-risking. Although we do not expect the Western allies to have a major fallout over this dispute, we do foresee a less cooperative relationship, especially if the war in Ukraine ends.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Good morning! Today’s Comment begins with a summary of the Federal Open Market Committee’s policy rate decision and our views on the path of rates going forward. Next, we provide an overview of the European Central Bank’s monetary policy decision. Finally, we give an update on the war in Ukraine.

Close to the Vest: The Federal Reserve has kept its options open on future rate hikes after lifting rates to a 22-year high but has explicitly ruled out any cuts in 2023.

• The Federal Open Market Committee (FOMC) raised its policy target range by 25 basis points to 5.25%-5.50%. In a press conference following the decision, Chair Jerome Powell said that the committee would take a data-dependent approach to future rate hikes. While the committee welcomed the recent progress in declining price pressures, Chair Powell noted that he did not believe inflation would return to its target of 2% until 2025. Last month, the overall Consumer Price Index (CPI) rose 3.0% from the previous year, while core CPI rose 4.8%.
• Markets were relatively muted following the Federal Reserve’s policy decision on Wednesday, as traders were unsure of the central bank’s future plans. The S&P 500 closed down 0.02%, while the yield on 10-year Treasuries declined by a mere 3 bps. Chair Powell’s reluctance to commit to further rate hikes weighed on the dollar, as it reaffirmed investors’ belief that the European Central Bank (ECB) and Bank of England may be more aggressive in tightening monetary policy over the next few meetings. As a result, the U.S. Dollar Index (DXY) ended the day down 0.32%.

• The Fed’s rate-hiking cycle is nearing its end. The committee has already pushed rates into restrictive territory, and it is unlikely that every member will be able to tolerate further increases in 2024. Real interest rates, which measure the interest rate after inflation has been removed, are currently at their highest level since the end of the financial crisis. According to former Richmond Fed President Jeff Lacker, a real fed funds rate between 2% and 4% is needed to bring inflation down to the Fed’s 2% target. The real fed funds rate was around 2.1% before the July FOMC meeting, which suggests that the interest rates may already be sufficiently high.

No Surprises: Similar to its American counterpart, the European Central Bank has stated that it will keep its options open when deciding further rate hikes.

• The ECB’s governing council voted to increase its benchmark interest rates for the ninth consecutive time, by 25 basis points. It has raised interest rates by 425 basis points since last July, as it seeks to bring inflation under control. The hikes have come even as the eurozone economy is showing signs of slowing, with growth expected to be around 1% in 2023. During her press conference, ECB President Christine Lagarde insisted that the bank is still dedicated to achieving its mandate of price stability, while acknowledging that the committee will be data dependent going forward.
• The European Central Bank faces a difficult balancing act as it tries to raise interest rates to combat inflation without tipping the eurozone into recession. The region narrowly avoided a technical recession in the previous quarter, and there are signs that tightening credit conditions are already having an impact on consumption. According to the ECB bank lending survey, demand for loans by firms and households slowed in the second quarter of 2023. Additionally, manufacturing activity has stagnated showing no signs of improving, and the energy outlook continues to look uncertain. El Niño weather conditions are expected to bring more extreme weather events as well as lower temperatures in the winter months, which should hurt household budgets.

• As the chart above shows, there has clearly been a shift in sentiment regarding European assets. Expectations of slower economic growth and higher inflation in the eurozone have contributed to the outperformance of U.S. equities relative to European assets. Given the uncertainty regarding the state of the global economy as well as the possibility of a weaker dollar, it is still unclear whether this trend will continue throughout the year. The current environment shows that international equities still offer relative value, especially given that the recent rally in large-cap assets has pushed stock valuations to near-cycle highs.

Next Stage: Ukraine forces are switching tactics, while Moscow is doubling down on its war efforts.

• Ukraine is in the midst of its much-vaunted counter-offensive, but so far it has not been as successful as officials had hoped. The group has already lost almost a fifth of the NATO kit provided to help the operation. The Ukrainian forces have made much needed changes to improve military efficiency, such as focusing on attacking using heavy artillery fire instead of crossing Russian minefields. However, it is still too soon to tell whether these changes will be enough to break through enemy lines. Western officials are closely watching the situation, and they may decide to send more weapons to Ukraine to help its war effort.
• Meanwhile, Moscow is still looking for new recruits as it seeks to protect its hard-fought gains. The government has introduced a bill that would raise the age of conscription eligibility from 27 to 30. This change, which would not take effect until January 2024, could potentially increase the pool of conscripts by more than 2 million. Russian President Vladimir Putin’s push for more recruits is a sign that he is not ready to give up the war in Ukraine, and it also highlights the growing manpower challenges that Russia is facing.

• All signs point to a protracted war in Ukraine, as both sides battle for leverage. Despite a few setbacks, Kyiv has shown that it is capable of winning this war with the continued support of Western allies. Moscow, on the other hand, has shown that it is willing to continue sacrificing its own people in the hopes of wearing down its opponent. It is likely that it will take an outside power, such as China or the West, to bring this war to an end. As a result, the conflict will continue to present a risk to commodity prices.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Our Comment today opens with news that China is making new progress toward developing a network of naval facilities in the waters of the Indo-Pacific region.  We next review a range of other international and U.S. developments with the potential to affect the financial markets today, including continued political unrest in Israel and a discussion of today’s upcoming decision on U.S. interest rates from the Federal Reserve.

China-Cambodia:  New commercial satellite imagery shows China has made considerable progress in its construction of naval facilities at Cambodia’s Ream Naval Base.  The imagery shows the Chinese have now nearly completed a pier that is strikingly similar in size and design to one the Chinese military already uses at its only official overseas naval base in Djibouti.  Importantly, both piers are big enough to berth Chinese aircraft carriers.

• The report provides more evidence of China’s large-scale, if secret, effort to build a network of dual civilian-military port facilities it could access in time of international conflict. Other such Chinese facilities include the Port of Hambantota in Sri Lanka and the Port of Gwadar in Pakistan.
• China continues trying to hide the extent of its military build-up, including by masking the military potential of the ostensibly civilian infrastructure it is helping to build. All the same, as Western leaders increasingly appreciate the scale of the Chinese build-up, we suspect it will worsen China’s tensions with the West and make it even harder to maintain trade, investment, and technology flows.

Russia-Ukraine-European Union:  Following Russia’s pullout from the deal in which it allowed Ukraine to export grain from its southeastern ports, both Poland and Hungary are threatening to block Ukrainian shipments to the West unless the European Union extends restrictions on selling the Ukrainian products in their territory.  The actions threaten to weaken Ukraine’s economic resilience in the face of Russia’s invasion and further complicate the EU’s effort to support Ukraine.

Spain:  As expected, Alberto Núñez Feijóo and his center-right Popular Party have been left with no apparent route to forming a government after two key regional parties rejected his invitation to form a coalition.  Even though the PP won the most seats in Sunday’s elections, and even though it has the support of the controversial hard-right Vox Party, it looks like it will be unable to control parliament.  The most likely scenarios now would be for incumbent Prime Minister Sánchez and his Socialist Party to form a government with left-wing and regional parties, or for Spain to hold new elections in August.

Israel:  Protests and strikes continue to disrupt the economy and push stock prices lower following this week’s passage of a measure that would limit the supreme court’s ability to block Knesset legislation.  Ironically, the supreme court itself said today that it would hear a case challenging the constitutionality of the law.  Obviously, the optics of the court striking down a law limiting its powers would not be good, so it’s unclear whether the court would really do so.  In any case, the political and social instability in Israel looks set to continue in the near term.

U.S. Monetary Policy:  Officials at the Federal Reserve will wrap up their latest two-day policy meeting today, with their decision due to be released at 2:00 PM EDT.  Fed Chairman Powell will also hold a news conference at 2:30 PM EDT.  Along with most other analysts, we suspect that continued strong wage gains and price pressures will prompt the officials to hike their benchmark fed funds interest rate further after pausing last month.  All the same, some other analysts think recent signs of modest economic slowing could convince them to hold rates steady again and simply signal the potential for more rate hikes later.

U.S. Labor Market:  Yesterday, United Parcel Service (UPS, $184.69) and the Teamsters Union reached a tentative deal on a new contract.  If approved by the firm’s 340,000 union workers in a vote on August 3, the agreement will avert a massive strike that could have noticeably affected the economy.

• Under the deal:
  • Full-time workers will get wage increases that will bring their average top rate to $49 per hour, making them the highest-paid delivery drivers in the U.S.
  • New part-time hires would start at $21 per hour, up from $15 in the previous contract.
  • A much-hated two-tier worker classification system, where some were paid less for doing essentially the same work, will be ended.
  • For the first time, union workers would get Martin Luther King Day off as a paid holiday.
• The agreement is likely to encourage other unions to strike a hard bargain in their negotiations with employers, potentially increasing average wages across the economy and helping boost consumer price inflation.

U.S. Artificial Intelligence Market:  New reporting indicates investors are snapping up shares of small biotechnology companies that are using artificial intelligence to aid in drug discovery.  Some of those stocks have doubled or even tripled in value this year, even as the broad healthcare sector has lagged the overall market.  For investors who worry they’ve missed the initial run-up in AI stocks, this development is a reminder that specialized, proprietary AI models and tools for specific industries or uses could well be the source of huge value creation in the coming years.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Our Comment today opens with China news, including signals of economic support from a meeting of the Communist Party’s Politburo.  We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today, including a discussion of the U.K.’s high interest burden and a new survey on the attitudes of U.S. retirement investors.

China:  At its monthly meeting yesterday, the Communist Party’s powerful Politburo took a number of key decisions that could have sweeping impacts on the Chinese economy and foreign relations.  Most important for investors, the Politburo acknowledged the headwinds holding back economic growth, announced its intent to address them, and signaled several measures related to key sectors.  The measures did not include the major fiscal stimulus that many investors have come to expect in China, but they did include promises to increase the number of affordable housing units built and signaled that the government will loosen its restrictions on buying homes for investment purposes.  Even though the announced measures were modest, the positive tone of the announcement has given a strong boost to stocks in China and Hong Kong so far today.

• Separately, Pan Gongsheng was named as the new chief of the People’s Bank of China, less than a month after being named as the central bank’s Communist Party chief. The appointment of Pan, who was previously the head of the State Administration for Foreign Exchange, will further solidify President Xi’s control over the institution.
• Finally, Chinese state media said top party foreign affairs official Wang Yi would reclaim his prior job as foreign minister, replacing Qin Gang, the fast-rising protégé of President Xi who was China’s ambassador to the U.S. until he was named foreign minister this spring. Qin hasn’t been seen in public for about a month, so speculation has been high that he might be in trouble.  The announcement merely said that he had been replaced for “health reasons.”

China-United States:  After CIA Director Bill Burns said in a speech last week that his agency was making progress in rebuilding its spy network in China, the Chinese foreign ministry yesterday issued an angry statement denying that China spies on the U.S. and vowed to protect itself from the CIA’s efforts.  The Burns statement referred to a catastrophic loss of CIA agents in China between 2010 and 2012 due to a mole at the agency.

China-India:  The Indian government has rejected a bid by leading Chinese electric-vehicle maker BYD (BYDDY, $68.55) to build a car and battery factory in Hyderabad, citing security concerns.  The rejection reflects India’s tough stance on trade with China following the two countries’ Himalayan border skirmishes three years ago.  The rejection also throws a wrench in BYD’s effort to rapidly build up its foreign sales under Beijing’s “Made in China 2025” industrial plan.  In response, Chinese Foreign Minister Wang criticized New Delhi and called for the two countries to “enhance strategic mutual trust.”

Pakistan:  The national election commission issued a new, non-bailable arrest warrant for Former Prime Minister Imran Khan, who was ousted last April and arrested on corruption charges in May before being bailed.  The new warrant suggests the country will continue to face political instability and mass demonstrations for the foreseeable future.

Israel:  As we flagged in our Comment yesterday, Prime Minister Netanyahu and his right-wing coalition pushed a key plank of their judicial reform through the Knesset yesterday.  The law, which limits the grounds on which the supreme court can nullify acts of parliament, has sparked mass protests, strikes, and warnings that key businesses will relocate out of the country.  In recent years, Israel and Israeli stocks have become investor darlings, but the new political instability and concerns about Israeli democracy threaten to undermine the country’s asset values in the near term.

United Kingdom:  In a report on government debt burdens around the world, bond rater Fitch said the U.K. will face the highest debt interest burden among major developed countries this year.  Because of the central bank’s interest-rate hikes to bring down inflation, high debt levels, and a large proportion of that debt in inflation-protected bonds, the U.K. government will spend an estimated 110 billion GBP on interest in 2023, equal to 10.4% of government revenue.

United States-Russia:  The Defense Department said a Russian fighter jet deliberately released flares close to a U.S. drone flying over Syria, causing damage to the U.S. craft.  The incident is the latest in a series of moves that suggest Russia is trying to pressure the U.S. into reducing its activity in Syria.  In any case, the incidents are further raising U.S.-Russia tensions.

U.S. Monetary Policy:  Officials at the Federal Reserve today begin their latest two-day policy meeting, with their decision due to be released at 2:00 PM EDT on Wednesday.  Along with most other analysts, we suspect that continued strong wage gains and price pressures will prompt the officials to hike their benchmark fed funds interest rate further after pausing last month.  All the same, some other analysts think recent signs of modest economic slowing could convince them to hold rates steady again and simply signal the potential for more rate hikes later.

U.S. Investment Markets:  A new survey by BlackRock (BLK, $756.58) found that the share of U.S. retirement savers who feel they are “on track” has fallen to 56%, down from 69% in 2021.  The share of savers who feel they are “off track” has more than doubled to 24% in the same period.  The changing attitudes reportedly reflect concerns about high inflation and volatile markets. In response, almost 30% of survey respondents said they now plan to work longer than they previously expected to.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Our Comment today opens with several notes on China’s worsening relations with the U.S. and other members of the U.S. geopolitical and economic bloc.  We next review a wide range of other international and U.S. developments with the potential to affect the financial markets today, including news of an inconclusive election in Spain, growing protests against a judicial reform in Israel, and a blockbuster weekend at the movies in the U.S.

China-United States:  The Chinese government has opened an anti-dumping investigation into U.S. propionic acid, an important preservative for products ranging from foods to medicines.  The probe will last for one year, but it could be extended to as late as January 2025, at which point the government could take steps to block or reduce U.S. sales of the chemical in China.

• The anti-dumping investigation follows fast on the heels of the government’s recent move to require a license for the export of gallium and germanium, key metals for the production of high-technology goods such as semiconductors. It also follows an enforcement action that limited the Chinese sale of products from U.S. technology firm Micron Technology (MU, $65.65).
• Along with those actions, the anti-dumping probe appears to be retaliation for last year’s U.S. clamp down on sending advanced semiconductor technology to China.
• In any case, the Chinese move is just the latest evidence that U.S.-China tensions continue to worsen, presenting challenges and risks for investors.

China-Canada:  The Canadian government on Friday charged a retired Royal Canadian Mounted Police officer with foreign interference, saying he helped China “identify and intimidate” someone in Canada at the behest of the Chinese government.  The case appears to be another example of China trying to secretly extend its policing power and Communist Party discipline against Chinese people living abroad, sometimes through secret foreign police stations.

• Just as China’s Ministry of State Security often pressures ethnic Chinese abroad to spy for it, the latest Canadian case also involved an ethnic Chinese.
• The charged RCMP officer reportedly emigrated to Canada from Hong Kong.

China-Taiwan:  New satellite imagery of Chinese military bases and defense industry factories shows the country has been rapidly replacing its short-range missile arsenal on the southeastern coast facing Taiwan with much more capable medium-range missiles.  The new missiles being deployed include the DF-17 and DF-24, which can not only travel more than 1,000 miles, but are also fitted with hypersonic glide vehicles that could evade U.S. air defense systems.

• If the Chinese military launches an effort to take control of Taiwan, analysts suspect its first step will be to send waves of these missiles to take out U.S. and allied bases in places like Guam and Japan. The missiles could also be used to take out capital warships, such as aircraft carriers.
• The reports also indicate the new medium-range missiles are sometimes being deployed in close proximity to China’s strategic nuclear bases. That likely aims at discouraging the U.S. from any effort to destroy the missiles preemptively, since any such attack might damage Chinese strategic forces and increase the risk of a counterattack against the U.S.
• As with China’s aggressive build-up of its inter-continental ballistic missile force, which looks set to give China as many strategic nuclear weapons as the U.S., the roll-out of more medium-range missiles is likely to increase the bipartisan U.S. effort to address China’s growing military threat.

Russia-Ukraine War:  Following fast on Russia’s withdrawal last week from the deal allowing Ukraine to export grain from its southern ports, Russian forces have redoubled their missile attacks on Ukraine’s grain storage and export facilities.  The Russian strikes today hit a key terminal close to the border with NATO member Romania, raising the risk of escalation.  Meanwhile, the Ukrainians apparently launched a number of drone strikes against targets in central Moscow and in Crimea.  So far this morning, the result has been a further boost to global grain prices.  At this writing, U.S. wheat prices are up 5.2% to $7.34 per bushel.  Corn prices are up 4.0% to $5.56 per bushel.

European Union:  Hamburg Commercial Bank said its “flash” HCOB purchasing managers’ index for the eurozone fell to an eight-month low of 48.9, well below the expected reading of 49.7 and the June reading of 49.9.  Like all major PMIs, the HCOB index is designed so that readings below 50 indicate contracting activity.  Today’s release showed that the main weakness in the eurozone is in the manufacturing sector.  The subindex on factory activity fell all the way to a 38-month low of 42.7.

• The reading points to worsening recessionary conditions in the eurozone in the coming months. In turn, that could convince the European Central Bank to halt or pause its interest-rate hikes following an expected 25-basis point increase this Thursday.
• Reflecting that, European bond yields are dropping today, and the value of the euro has declined 0.3% to $1.1088.

Spain:  In elections yesterday, Alberto Núñez Feijóo and his center-right People’s Party won the most seats in parliament, but not enough to give it a clear shot at forming a governing coalition even if it teams up with the far-right Vox Party.  In contrast, Prime Minister Pedro Sánchez and his Socialist Party out-performed expectations and won enough seats to give it a fighting chance at a forming a majority grouping.  The results are an unexpected setback for right-wing populism in Europe and will set the stage for a period of inter-party wrangling and potential new elections in Spain.

Israel:  Prime Minister Netanyahu and his right-wing coalition in parliament will press ahead with a vote on a controversial judicial reform today.  The renewed push to limit the supreme court’s power to nix legislation has sparked mass protests and strikes.  The potential for political unrest and economic disruptions could weigh on Israeli assets in the coming days and weeks.

U.S. Monetary Policy:  Officials at the Federal Reserve will hold their latest two-day policy meeting this week, with their decision due to be released at 2:00 PM EDT on Wednesday.  Along with most other analysts, we suspect that continued strong wage gains and price pressures will prompt them to hike the benchmark fed funds interest rate further after pausing last month.  All the same, some other analysts think recent signs of modest economic slowing could convince them to hold rates steady again and simply signal the potential for more rate hikes later.

U.S. Stock Market:  After an 18-month drought in initial public offerings, a wildly successful IPO last week is raising hopes for a revival of deals in the coming months.  Based on last week’s strong performance of Oddity Tech (ODD, $52.56), the parent of direct-to-consumer beauty brand Il Makiage, it appears that investor demand for new companies is strong.  Moreover, the group of companies looking to come to market appears to be stronger than usual, since the hiatus in deals allowed many small firms to focus on consolidating their business and cutting costs.

U.S. Movie Theater Industry:  Despite ongoing concerns that the movie theater industry may never recover from the pandemic, the latest data suggests Barbie generated gross revenues of $155 million and Oppenheimer grossed $80 million over the weekend.  That would mark the first time in history that a three-day weekend has seen one movie open to $100 million or more and another to $50 million or more. It would also mark the fourth-biggest weekend of all time at the domestic box office.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Good morning! Today’s Comment begins with an explanation of why today could be a rocky day for markets. Next, we will discuss two major developments that may reshape international finance. Finally, we will share our thoughts on the Spanish elections occurring on Sunday.

Triple the Effect: A trifecta of events will weigh on market activity on Friday: a reshuffling of a popular tech index, the expiration of option contracts, and the release of corporate earnings.

• The tech-heavy Nasdaq 100 index is undergoing a special rebalance today to address concerns about the weighting of mega tech companies. The index is typically rebalanced quarterly, but an exception was made earlier this month due to the growing dominance of these companies. Boosted by the excitement of artificial intelligence, the top five tech companies now account for over 50% of the index, significantly higher than the 40% cap typically preferred by the providers. The special rebalance will reduce the weightings of these companies and increase the influence of smaller companies. This will likely lead to increased volatility in the market as investors adjust their portfolios accordingly.
• In addition to the Nasdaq 100 rebalance, an estimated $2.4 trillion worth of options tied to stocks and indexes are set to mature. The expiration of these contracts will likely impact trading activity as investors decide whether they would like to roll over existing positions or start new ones. July has been the slowest month of trading in two years, and there is speculation that investors may be sitting on the sidelines until there is more clarity about the future direction of monetary policy. If investors do decide to roll over their options, it could lead to a surge in trading volume and volatility. However, if investors decide to start new positions, it could lead to more sustained performance.

• Finally, the day is likely to be heavily influenced by corporate earnings releases. Several companies are expected to report their results, including regional lenders Comerica (CMA, $52.93) and Regions (RF, $20.35), as well as credit card company American Express (AXP, $177.11). Comerica and Regions are expected to give insights into the deposit market, important information given the fears of disintermediation. At the same time, American Express’s earnings will provide information on the discretionary spending habits of consumers. The results could have a significant impact on the direction of the market in the coming weeks as it may give investors a better sense of the state of the economy.

Institutional Shifts: The World Bank and the Federal Reserve have made major announcements that suggest both organizations are looking to modernize.

• The Chinese-backed Asian Infrastructure Investment Bank (AIIB) has joined forces with the World Bank. The deal with the AIIB will help alleviate the World Bank’s financial constraints. However, this new partnership is likely to raise eyebrows, as it comes weeks after reports that members of the Chinese Communist Party infiltrated the bank. Suspicions of Chinese involvement in the World Bank led Canada to withdraw its membership from the multilateral organization. The move also comes as the two supranational financial institutions look to restructure the debt of emerging market companies.
• The Federal Reserve in the United States has upgraded its payment system to make it easier for Americans to transfer money. FedNow is a much-needed shift in a banking system where people still rely on paper checks and cash to send payments through Automated Clearing House (ACH) transfers, which can take several days to process. Although banks still need to sign up for the new system, its implementation is expected to lead to some disruption. The real-time payment system network should increase competition among credit card companies and offer new opportunities for fintech companies.

• These two developments show how the world is slowly adapting to a new normal. China is one of the world’s largest creditors, and its partnership with the World Bank makes sense given its influence in developing countries. Meanwhile, the U.S.’s current payment system is antiquated and needed to be improved to keep up with the demands of a world that is increasingly dominated by digital transactions. Taken together, these reports reflect how difficult it is for the financial system to keep up with changing trends as one could argue that both events should have happened much earlier.

¿A La Derecha? The upcoming Spanish election is widely expected to result in a rightward shift in the country’s political landscape.

• Recent polls suggest that the Popular Party (PP), led by Alberto Núñez Feijóo, is poised to win the most votes in the upcoming Spanish election taking place on Sunday. This would put the PP in a strong position to form a government. However, there is speculation that Feijóo may seek to form a coalition with the controversial Vox party. The far-right group has been accused of racism, xenophobia, and Islamophobia. If Feijóo were to form a coalition with Vox, it would be a significant shift in Spanish politics, as it would give a far-right party a seat in parliament for the first time since the end of Francisco Franco’s rule in 1975.
• The rise of populist parties in the European Union is linked to the bloc’s encouragement of unpopular reforms. In Spain, for example, the government barely passed a labor reform in order to unlock pandemic funds last year. Similarly, pressure to push through reforms in Italy helped lead to the ouster of Mario Draghi from the premiership. Meanwhile, French President Emmanuel Macron’s controversial pension reforms have boosted support for his political rival, Marine Le Pen. This situation will likely worsen as the European Central Bank plows ahead with rate increases despite signs that inflation is slowing, and the region narrowly avoided a technical recession in Q2 of 2023.

• The European Union’s inability to adapt to each country’s individual needs is a major weakness that could undermine the bloc’s ability to function in the future. This is evident in the fact that Spain will be subject to tighter monetary policy despite the fact that it is making better progress in its inflation fight than other countries. This lack of flexibility could lead to more populist leaders being elected in the EU, who would likely look to protect their countries’ interests, even if it means going against the bloc. As a result, if this trend continues, it could lead to a much weaker euro in the future.

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