by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Good morning! The market is currently assessing the implications of Republican control over both chambers of Congress. In sports news, the Cleveland Cavaliers are experiencing their best start to an NBA season since 2015-2016. Today’s Comment will cover the impact of the so-called “Trump trade” on cryptocurrency, provide our insights on why the recent market rally could indicate an equity market bubble, and discuss European defense spending. As always, the report will end with a roundup of international and domestic data releases.

Trump Trade Resumes: Risk assets continue to rally as investors price in the impact of a second Trump term.

• The news of a Republican sweep has sparked a surge in risk appetite, especially among retail investors, with cryptocurrencies leading the charge. According to the latest results, Republicans now hold 53 Senate seats compared to 46 for the Democrats, and the Republicans have surpassed the 218-seat threshold for a House majority, with nine races still undecided. This strong showing has fueled investor optimism, as the Trump administration is expected to face minimal obstacles when pursuing favorable tax policies and regulatory reforms. Bitcoin, the world’s leading cryptocurrency, surged past $88,000 following the result.
• Crypto is emerging as a potential competitor to gold as the preferred hedge against dollar debasement. While concerns over rising debt and inflation have traditionally driven investors toward gold, bitcoin has surged 20% since the election, while gold has dropped around 4%. This shift reflects growing confidence in bitcoin as a safe haven, especially as trust in government-backed assets wanes. With key figures in the incoming administration likely to champion broader crypto adoption, optimism is mounting that bitcoin could reach $100,000 by year’s end.

• While Trump’s recent victory is viewed as a win for cryptocurrency, it’s too early to gauge how effectively he will champion digital assets. Despite bitcoin’s growing popularity, its usage remains limited, and benefits of the increased adoption of bitcoin are unclear, particularly with the US dollar still acting as the global reserve currency. Given this uncertainty, investors may be wise to wait and see how the administration approaches the cryptocurrency, as its current valuation appears somewhat inflated.

Bubble Brewing: Market euphoria continues to drive equities higher, but concerns about future inflation have led to rising bond yields.

• The S&P 500 and Dow Jones Industrial Average have scaled new heights, surpassing 6,000 and 44,000 points, respectively. This milestone is likely to attract increased investor interest in equities, potentially shifting funds from money markets to the stock market. However, the surge in market optimism has led to a flattening of the yield curve. The two-year US Treasury yield has climbed nearly 10 basis points since the Federal Reserve’s 25-basis-point rate cut last Thursday, while the 10-year Treasury yield has declined 12 basis points.
• Concerns about a potential market bubble have resurfaced as the Magnificent 7 tech giants have been the primary drivers of the S&P 500’s performance over the past two years. This trend has continued over the last five days, with these mega-cap tech stocks significantly outperforming the broader market index. This outperformance has led the S&P 500 market cap index to its widest premium over its equal-weight counterpart since the dot-com bubble. The high market concentration has also led to concerns of a potential bursting of the tech-stock bubble.

• We remain optimistic about the US economy’s ability to avoid a recession absent a major external shock. However, we believe the market remains overweighted in a few sectors. The recent flattening of the yield curve is a concern, as it has historically been associated with economic downturns. Nonetheless, as long as inflation continues to moderate and corporate earnings remain robust, we expect market concentration to gradually normalize. As a result, we suspect that investors may begin to shift their focus toward sectors offering better value and solid fundamentals over the coming weeks.

European Defense: Trump’s win of the US presidency has forced the European Union to accept that it will have to drastically increase its defense spending.

• European defense stocks rallied after the European Union opted to relax spending restrictions in anticipation of rising costs related to the Ukrainian conflict and NATO spending following the return of Donald Trump to the White House. The EU intends to reallocate funds previously earmarked for reducing income inequality among member states to directly support defense purchases and military funding. Moreover, these investments will be used to bolster critical infrastructure in Germany, given its geopolitical importance, and in Eastern European countries bordering Ukraine.
• This policy shift has boosted the pan-European Stoxx 600, which closed up 1.1% on Monday, marking its best day in six weeks. Investors are optimistic that increased spending will benefit European defense companies which have already been on a strong run. Many of these defense companies have already reaped record profits from supplying equipment and services to support the war effort in Ukraine. A significant portion of these windfall gains has been used to reward shareholders through share buybacks.

• The push to bolster European defense companies is likely to encounter significant political obstacles. Public sentiment generally opposes profiteering from war, and this could lead to increased scrutiny and potential backlash against defense companies. While the sector is poised to benefit from rising government defense spending, this could also trigger calls for greater corporate responsibility. As a result, these companies may face pressure to contribute a portion of their increased revenue back to society through higher taxes or other forms of public investment.

In Other News: Tesla CEO Elon Musk has started the push to end the Fed following Fed Chair Jerome Powell’s decision not to step down, in a sign that the central bank is becoming more politicized. Germany agreed to hold snap elections on February 23, as the country readies for a no-confidence vote.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Our Comment today opens with a preview of tonight’s presidential debate and the latest major economic policy statement from former President Trump. We next review several other international and US developments with the potential to affect the financial markets today, including new European court decisions against major US technology companies and the broadening impacts from the re-industrialization of the US.

US Politics: Presidential candidates Donald Trump and Kamala Harris are scheduled to have their televised debate tonight on the ABC network, starting at 9:00 pm ET. Former President Trump and Vice President Harris have never met in person, so the battle could be as interesting as two unbeaten prize fighters meeting for the first time. The Wall Street Journal last night published a useful overview of the likely strategies the two candidates will use in their meeting.

• Separately, Trump made a confusing vow over the weekend to impose a 100% import tariffs against any country “leaving” the dollar. Based on the context of the statement, Trump was apparently saying that he would impose the tariffs against countries reducing their use of the dollar in international trade or investment.
• Many people are fearful that if other countries reduce their use of the dollar, its value will decline, undermining its purchasing power and boosting consumer price inflation. But Trump and his aides have previously indicated that they want to depreciate the dollar in order to bolster US exports and discourage imports. The contradictory statements suggest Trump wants to both keep demand for the dollar high and drive down its value.
• Tracking and measuring all the different ways that the greenback is used in trade and investment is difficult, so economists look at the dollar’s share in global central bank foreign exchange reserves as a proxy. The dollar’s share in those reserves has actually been declining gradually for two decades, and yet the currency has been in a bull market and is now close to a record high.
• In our latest Bi-Weekly Geopolitical Report, published yesterday, we look at the prospects for the dollar as the world fractures into relatively separate geopolitical and economic blocs. The report notes that strong economic growth and better investment prospects in the US continue to draw in foreign capital, boosting the dollar’s exchange rate despite its reduced share in global trade and investment flows. For the time being, those factors could continue buoying the dollar.

European Union-United States: The European Court of Justice today overturned an appeals court decision and reinstated a 2016 court ruling that Ireland provided US tech giant Apple with illegal subsidies. The ruling today subjects Apple to 13 billion EUR ($14.3 billion) in back taxes. The ECJ today also affirmed a 2.4-billion EUR ($2.6 billion) fine against Google for antitrust violations. The rulings are likely to worsen US-EU economic tensions, especially if Trump is re-elected. The rulings also illustrate the growing regulatory risks for large US tech firms operating around the world.

Germany: Interior Minister Fraser yesterday said the government will extend and strengthen its border controls to reduce “irregular” migration and lower the risk that Islamist terrorists could enter the country. The move is likely a response by the centrist coalition government to the recent surge in political support for populist, anti-immigrant parties. It also illustrates how illegal immigration has become a political issue for many developed countries around the world.

United Kingdom: During the three months ended in July, average earnings excluding bonuses were up just 5.1% from the same period one year earlier, marking the weakest wage gains in two years. Average earnings in the service sector alone were up just 3.8%. The figures suggest the Bank of England’s tight monetary policy is continuing to wring price pressures out of the economy, although the policymakers are still expected to cut interest rates only slowly.

Russia-Ukraine Conflict: New polling shows the share of Ukrainians who want to compromise with Russia to end the war has risen to 26%, with younger people more inclined to negotiate. However, those in the military are least likely to want compromise. According to the report, enlisted personnel, who are influential in Ukrainian society, see any talk of compromise as an affront to those who have died resisting the Russians. They also argue that the Kremlin would only use a truce to rearm and prepare for a new attack.

Russia-Kazakhstan-China: Meirzhan Yussupov, chief of Kazakhstan’s state mining company Kazatomprom, said in a Financial Times interview that Western sanctions after Russia’s invasion of Ukraine have forced his company to favor uranium exports to Russia and China, even though it would prefer to maintain a more diversified customer base. The company, which is now the world’s largest uranium producer, earlier warned that its output would be crimped by supply shortages and delays in building new mining facilities.

• Yussupov’s effort to blame Western sanctions for crimped uranium exports, along with the firm’s statement about production challenges, may aim to mask Russian and Chinese pressure to reserve Kazatomprom’s low-cost uranium for themselves.
• As we noted in our Bi-Weekly Asset Allocation Report from April 15, 2024, the Chinese government is likely using enormous volumes of uranium as it works to massively expand its arsenal of strategic nuclear weapons. We suspect Chinese weapons demand has been a significant reason for the run-up in spot uranium prices since 2022. Beijing would want to hide where it’s getting its uranium supplies, and the statements by Yussupov and his company could be a part of that effort.
• To the extent that Russia and China can sew up Kazakhstan’s low-cost uranium ore, the result would be increased upward pressure on spot uranium prices in the West. That’s one reason why we are currently maintaining our exposure to uranium and uranium miners in Confluence’s Asset Allocation Strategies.

US Re-Industrialization: As the US-China rivalry and global fracturing continue to spur re-shoring and a boom in US factory construction, new data shows the long-awaited secondary effects are also becoming noticeable. The data, from real estate analytics firm Green Street, shows that investors are ramping up their plans to acquire or build warehouses, hotels, office buildings, and apartments near coming factories across the Sunbelt and Rust Belt, where most of these so-called onshoring projects are under way.

• The planned real estate development around emerging factories are an example of the “multiplier effect” of new investment.
• Although parts of the real estate sector, such as office buildings, are still broadly challenged by today’s high interest rates and the work-from-home trend, the multiplier on re-industrialization is a reminder that other types of real estate and particular localities continue to have good prospects.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Our Comment today opens with an important new speech by former Australian Prime Minister Kevin Rudd, who warns that Chinese leaders are more ideologically driven than most in the West realize and also more apt to use military aggression. We next review several other international and US developments with the potential to affect the financial markets today, including an important new report on European competitiveness and a note on last week’s record-breaking corporate bond issuance in the US.

China: Kevin Rudd, the former Australian prime minister and Canberra’s current ambassador to the US, warned in a must-read speech in Washington last week that Chinese leaders are more driven by ideology than most Westerners believe. Rudd, a Mandarin speaker with an extensive background dealing with Beijing, emphasized that because of Chinese leaders’ Marxist-Leninist view of the US and their conception of deterrence, they could soon launch what they would view as a “small war” to deter the US and its allies from further efforts to contain China.

• In Rudd’s view, Chinese General Secretary Xi has fully embraced the Marxist-Leninist view that China is at the vanguard of historically determined social revolution, and that the “East is rising, while the West is falling.” According to Rudd, this makes Xi prone to over-confidence in dealing with the US and its allies.
• Although we have been warning for some time that the worsening US-China rivalry could potentially spill into military conflict of one sort or another, it hasn’t happened yet. Rudd’s warning suggests that investors should remain aware of the risks. That mindset is consistent with our current positioning in our asset allocation strategies of keeping exposure to gold, commodities, and defense firms, which are designed to act as hedges against a potential conflict.

China-Southeast Asia: As the US and other developed countries rush to impose tariffs against the new wave of subsidized Chinese exports, new reporting shows many cheap Chinese goods are being diverted to the relatively poor, developing countries of Southeast Asia. With prices kept extremely low by Beijing’s subsidies and the massive excess capacity in China’s industrial sector, the flood of Chinese goods is putting companies out of business and destroying jobs in countries such as Thailand, Malaysia, and Indonesia.

• Just as in the developed countries, several Southeast Asian nations have responded by imposing new tariffs and other trade barriers against Chinese goods, but the effort is constrained by regional free-trade agreements and fear of retaliation from China.
• Importantly, Chinese firms are also undercutting local logistics companies, such as trucking and warehouse firms. Once Chinese competition has driven a Southeast Asian manufacturer or logistics firm into bankruptcy, a Chinese company will often swoop in to buy the business at fire-sale prices. The Chinese buyer will sometimes use a local front company to hide its ownership, and it may leverage funds from Chinese organized crime groups (a very underappreciated problem throughout the region).
• As Chinese firms take over more local producers and logistics firms, they are reportedly forming “zero dollar” supply chains in which both imports from China and exports to China and beyond are warehoused and carried by Chinese firms with no reliance on the US currency.
• This growing Chinese influence over Southeast Asia is consistent with our view that Beijing will seek to control its evolving geopolitical and economic bloc using a form of neo-colonialism, as discussed in our Bi-Weekly Geopolitical Report from January 9, 2023. In this system, Beijing will offer the countries in its bloc the opportunity to export commodities, basic materials, and low-value factory components to China, but it will treat those countries as a captive market for Chinese exports.

Japan: After stripping out price changes and seasonal impacts, second quarter gross domestic product grew at a robust annualized rate of 2.9%, just enough to offset the 2.4% decline in the first quarter. Japan’s GDP in April through June was still lower than in the same period one year earlier, but the rebound, which was driven by consumer spending and corporate investment, is an encouraging sign that the economy is regaining momentum. The rebound will probably also keep the Bank of Japan on track to keep raising interest rates later this year.

European Union: Former European Central Bank chief Mario Draghi, who was tapped by the European Commission last year to study the EU’s lagging economy, today issued his analysis and recommendations. According to Draghi, the EU needs a massive increase in public and private investment, financed in part by joint EU debt. To spur private investment and innovation, he calls for aggressive industrial policies and subsidies, financial market deregulation, and easier competition rules to let companies grow bigger and more powerful.

• Reporting so far suggests Draghi’s recommendations are consistent with the growing trend toward industrial policies around the world, including measures such as protectionist tariffs and tax breaks or other subsidies for favored industries.
• All the same, it is unlikely that Draghi’s entire list of recommendations will be implemented. At the very least, EU countries that are smaller and more open to trade for growth will likely resist those policies that favor bigger countries and companies or threaten trade wars that could hurt their exports.

Greece: In the latest pushback against tourists in Europe, the Greek government has proposed a series of measures to reduce visits from foreigners, including limits on cruise ship dockings, hefty increases in cruise ship disembarkation fees, and increases in lodging taxes. The moves follow similar restrictions put in place by Italy and Spain as post-pandemic wanderlust and a strong dollar encouraged waves of tourism in recent years. According to locals, excess tourism has driven up prices and disrupted communities in certain areas.

United Kingdom: Prime Minister Starmer’s government today admitted it is mulling ways to soften the blow from Starmer’s plan to reduce fuel subsidies for millions of Britons this winter. Although the government hasn’t yet decided how to soften the impact, any modification to the original plan would likely mean more spending and make it harder for the prime minister to rein in the UK’s expanding budget deficit.

Venezuela: Opposition presidential candidate Edmundo González, whom the US and other key countries consider the rightful winner of July’s election, left Venezuela on a Spanish military plane over the weekend after a Venezuelan court issued a warrant for his arrest. Venezuelan security forces have also surrounded the Argentine embassy’s residential compound, where six Venezuelan opposition leaders have decamped to avoid arrest.

• The developments show President Maduro is consolidating his power again after falsely claiming he won re-election.
• If Maduro retains power, as now looks likely, US sanctions on Venezuela’s petroleum industry are likely to remain largely in place. In turn, much of Venezuela’s oil resources will remain off the global market.

US Politics: As presidential candidates Donald Trump and Kamala Harris prepare for their televised debate tomorrow night, the Wall Street Journal today carries a detailed and useful comparison of their positions on key issues ranging from taxes to healthcare. The debate on the ABC network is Tuesday, September 10, at 9:00 pm ET.

US Bond Market: New data from LSEG show a record 60 corporate bond deals were completed last week for a total of $82 billion in borrowing. According to market participants, the flurry of deals reflects a desire by company managers to sew up their debt issuance ahead of any market volatility that could come as the economy slows, the Federal Reserve starts cutting interest rates, and the presidential election approaches.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Good morning! The market is closely parsing through the latest jobs data. In sports news, Patrick Mahomes of the Kansas City Chiefs surpassed Len Dawson as the team’s all-time passing leader while securing a victory over the Baltimore Ravens. In today’s Comment, we discuss why the recent Services PMI data should relieve recession fears, consider the potential impact of the ECB’s reluctance to address weak GDP figures on the dollar, and explore how the coalition collapse in Canada aligns with a broader trend of dissatisfaction with ruling parties in the West. As always, the report includes a comprehensive overview of domestic and international data.

Good News, Finally! Days after the Purchasing Managers’ Index (PMI) for manufacturing raised concerns of a potential economic slowdown, the services component offered reassurance.

• Both the S&P Global and ISM Purchasing Managers’ Indexes (PMIs) for August showed an increase in service sector activity, challenging the narrative of an impending recession. The S&P Global PMI rose from 55.4 to 55.7, while the ISM PMI increased slightly from 51.4 to 51.5. The stronger pace of new orders, indicating continued demand for firms’ offerings, was the primary driver of the overall improvement. However, both PMIs showed declines in their employment components, reaffirming concerns about the cooling labor market.
• The rise in the PMI services index strongly indicates that the economy remains in expansion. Unlike manufacturing, service consumption represents nearly half of all economic output, making the economy particularly sensitive to shifts in this sector. The ISM services index, specifically, has proven to be a reliable economic predictor, explaining about half of the GDP variation over the past three decades. As a result, the latest reading suggests that, despite market concerns about an imminent downturn, the economy has enough momentum to avoid a recession.

• While recent data suggests slowing growth, it’s important to consider the historical context. The past four recessions were all triggered by unforeseen events: the 2020 pandemic, the 2008 Lehman Brothers collapse, the 9/11 attacks in 2001, and the Gulf War in 1990. Hence, a slowdown doesn’t necessarily foreshadow an immediate downturn. While the economy faces challenges, we remain cautiously optimistic that it can weather these headwinds, absent any major disruptions such as a mass mobilization war, commodity supply shock, or pandemic.

The Flat Dollar: As the global economy anticipates a convergence in interest rate differentials, the US dollar has begun to depreciate against foreign currencies.

• The Eurozone’s second quarter GDP was revised downward to 0.2% from 0.3%, indicating continued economic stagnation. This latest data is likely to fuel concerns that the region’s tight monetary policy is beginning to dampen economic activity. Household consumption and investment spending both declined, with investment spending falling by a more significant 2.2%. Germany, the bloc’s largest economy, contracted by 0.1% as its industrial sector remains under pressure. However, there were some bright spots: France and Italy both grew by 0.2%, and Spain’s economy expanded by a robust 0.8%.
• Despite growing economic concerns, there is skepticism that recent economic data will prompt the European Central Bank (ECB) to accelerate its easing policy. A survey of economists indicates that respondents anticipate the ECB will maintain its current monetary policy stance, even in the face of weakening economic indicators. As growth slowed, the region’s unemployment rate fell to a new low in July, and core inflation has shown signs of stalling. The ECB’s reluctance to respond to the slowdown mirrors the Bank of Japan’s decision to maintain its current policy path.

• The reluctance of central banks to respond to economic changes is likely to accelerate interest rate convergence. Historically, global developed central banks have been hesitant to follow the US Federal Reserve in raising rates and they have also been less willing to cut rates as aggressively. This narrowing interest rate differential, coupled with growing concerns about the US economy, is expected to weigh on the US dollar in the short to medium term. This trend has already begun to manifest itself this year, with the Bloomberg Dollar Spot Index falling from its 2024 peak in June to levels close to its value at the start of the year.

Trudeau in Trouble: As voters across the West express increasing discontent with incumbent leaders, the impending collapse of Trudeau’s coalition threatens to end his party’s nine-year reign.

• Jagmeet Singh, leader of Canada’s New Democratic Party, has ended the agreement to support the minority Liberal government, raising the likelihood of snap elections. While this doesn’t technically strip the Liberals of their position, his refusal to uphold the deal could leave PM Justin Trudeau vulnerable to a no-confidence vote, potentially triggering an early election. Additionally, Singh still requires his party’s approval to formally withdraw from the arrangement. That said, federal elections must be held by October 2025, with current polls showing the ruling Liberals trailing the Conservatives by 17 points.
• The Liberal Party is facing increasing criticism over the rising cost of living, particularly housing. While overall inflation is 2.5%, which is within the Bank of Canada’s target range of 1-3%, shelter inflation remains stubbornly high at 5.7%. Unlike in the US, where 30-year fixed mortgage rates are common, most Canadian mortgages are locked in for five years or less. This difference directly impacts inflation as mortgage interest costs account for 13% of Canada’s shelter inflation. In contrast, the US removed housing costs from its CPI measure in 1983, opting instead for owner-equivalent rent.

• One of the key issues facing Western nations as they approach elections in the coming months is public sentiment regarding inflation. While price increases have moderated substantially in recent years, consumers have found it challenging to adjust to current price levels as many had anticipated a decline. This dissatisfaction with prices is likely to influence election outcomes as voters may attribute the problem to their current leadership. As a result, we should not be surprised if opposition parties see a strong performance this election season.

In Other News: The US is growing less confident in a Gaza peace plan and is looking for alternatives, another example of the difficulty of resolving disputes in the Middle East. Republican presidential candidate Donald Trump proposes a 15% corporate tax rate as he looks to bolster his support from big business. The pledge is another sign that neither candidate will be able to solve the deficit matter. Japanese prime minister candidate Yoshimasa Hayashi is holding out hope that the Nippon Steel acquisition of US Steel can be salvaged.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Our Comment today opens with some new research confirming our positive view on the global defense industry going forward. We next review several other international and US developments with the potential to affect the financial markets today, including some notes on the Israel-Hezbollah attacks over the weekend, a shut-off of petroleum exports from Tunisia, and a wrap-up of the Federal Reserve’s conference at Jackson Hole, Wyoming.

Global Defense Industry: New research by Vertical Research Partners suggests the world’s top 15 defense contractors will log total free cash flow of $52 billion by 2026, double the amount they generated in 2021. Half the free cash flow in 2026 will come from five top US defense firms (excluding Boeing), while much of the rest will come from top European producers. The analysis is consistent with our often-stated view that today’s increased geopolitical tensions will prompt higher defense budgets around the world in the coming years.

• Separately, the head of the International Atomic Energy Agency, Rafael Grossi, warned in a Financial Times interview that more countries are feeling pressure to develop their own nuclear weapons. According to Grossi, “There are all these tensions, this possibility of alliances being weakened and countries having to fend for themselves. This is where the nuclear weapon factor, and attraction, comes back in a very unexpected way.”
• Grossi’s analysis echoes our view that factors such as the geopolitical aggressiveness of key authoritarian countries and weakening alliances within the US bloc could spark a new, global nuclear arms race in the coming years. From an investment standpoint, that suggests that there could be opportunities not only in defense stocks, but in commodities such as uranium.

Israel-Hezbollah: On Sunday, after US and Israeli intelligence suggested the Hezbollah militants were preparing a major attack on Israel, the Israel Defense Forces launched a large number of airstrikes against the militant group’s rocket launchers in southern Lebanon. Hezbollah later said it had gotten off about 300 missile launches against Israel, but it tried to signal no more attacks would be coming for now.

• It’s not yet clear if the Hezbollah attack was meant to be the main retaliation for Israel’s recent assassinations of Islamist militants in Lebanon and Iran. If it was, it may suggest that Iran wanted to limit its direct involvement to insulate it from further hostilities with Israel. In any case, reports say Hezbollah’s rank-and-file were disappointed with the relatively small scale of the attack.
• In any case, it’s still impossible to rule out further attacks on Israel by Hezbollah, Hamas, or their Iranian benefactors. With Israel’s war on the Hamas government in Gaza continuing, the risk of dangerous escalation into a broader regional conflict remains.

China-United States: Some artificial-intelligence developers in China are reportedly getting around the US ban on selling advanced AI computer chips to the country by remotely and secretly accessing computer power based on top-of-the-line Nvidia chips in foreign facilities. These “decentralized GPU” services apparently aren’t illegal right now, but the US government may well take steps to clamp down on the practice as the US-China technology rivalry continues.

China-Philippines: Yesterday, Chinese navy and coast guard vessels again harassed a Philippine government ship bringing supplies to Philippine fishermen near Sabine Shoal, an area inside Manila’s exclusive economic zone claimed by both countries. The Philippine ship may have been intending to bring supplies to one of Manila’s coast guard ships, which has been anchored in the area since April, much to the chagrin of Beijing.

• As we’ve noted previously, Sabine Shoal is developing into another potential flashpoint between China and the Philippines, after the two sides recently agreed to cool tensions over the disputed Second Thomas Shoal.
• To reiterate, any Chinese-Philippine military confrontation has the potential to draw in the US, which has a mutual defense treaty with Manila.

China: New data from Dealogic shows the world’s top private-equity firms have virtually given up on new acquisitions in China as the country hits structural economic headwinds and geopolitical tensions with the West are making such deals riskier. The data is consistent with our view that slowing growth, worsening international tensions, and the world’s fracturing into relatively separate geopolitical blocs will make Chinese investments riskier going forward.

Tunisia: The government controlling Tunisia’s eastern half today said it will stop all petroleum production and exports to retaliate for the rival western government’s effort to take over the country’s central bank. The eastern government has declared force majeure over all oil fields, terminals, and export facilities, closing them down. The news has pushed global oil prices sharply higher today, with near WTI futures currently up 3.0% to $77.06 per barrel and Brent up 2.5% to $80.13.

Canada-China: Canadian Prime Minister Trudeau today said his government will impose new anti-dumping tariffs on a range of imports from China, including a 100% tariff on Chinese electric vehicles and 25% tariffs on Chinese steel and aluminum. The tariffs, which Trudeau said were aimed at “leveling the playing field” for Canadian workers, are another example of how the US geopolitical bloc is decoupling from China and its bloc. The spread of anti-Chinese tariffs is bound to anger Beijing and complicate its effort to re-ignite economic growth.

US Monetary Policy: As we previewed in our Comment on Friday, Fed Chair Powell used his speech at the opening of the central bank’s summer conference in Jackson Hole to confirm the policymakers will begin cutting interest rates in September. In a line for the ages, Powell said, “We do not seek or welcome further cooling in labor market conditions . . . The time has come for policy to adjust.” The most likely scenario is for the Fed to cut the benchmark fed funds rate by a modest 25 basis points to a range of 5.00% to 5.25%.

• Even though investors had long been expecting an interest-rate cut in September, the confirmation by Powell gave a boost to stocks and bonds on Friday. The S&P 500 price index jumped 1.15% to a near-record 5,634.61, while the yield on the 10-year Treasury note fell to 3.8070%.
• Going forward, there is still some question about the pace of any further cuts. Unless there are more signs of real stress in the economy, the policymakers could well prefer a slow, steady series of 25-basis-point cuts extending into 2025. With investors holding massive amounts in money market accounts, an erosion of the yield on those accounts coupled with a soft landing in the economy could potentially prompt a massive rotation back into stocks and a melt-up in equity prices.

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by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Good morning! S&P 500 futures have cooled this morning following favorable inflation data. In sports news, England defeated the Netherlands in the semifinals and will now play Spain in the Euro final. Today’s Comment will begin by examining the significant role that momentum has played in the market rally, followed by a discussion on why uranium remains a commodity with substantial upside potential for investors. We will also provide an update on the UK in the wake of the Labour Party’s recent victory. As usual, the report will conclude with a roundup of international and domestic data releases.

Momentum Propels Large Cap: The S&P 500 leapt past 5,600 for the first time ever on Wednesday, as investors piled into large-cap stocks in anticipation of a Federal Reserve policy shift.

• The market surged following comments made by Fed Chair Powell during his second day of testimony on Capitol Hill. While speaking with lawmakers, Powell stated that although he does not believe the central bank is ready to cut interest rates, Fed officials will not wait for inflation to fall to the 2% target before making a cut and will do so regardless of the upcoming election. Risk assets rose following his remarks, with the S&P 500 climbing 1.0% on the day and the Magnificent Seven stocks increasing by 1.2%.
• The S&P 500’s record high might mask a troubling truth: many underlying companies lack the fundamentals to justify the rally. Bloomberg data confirms this, showing momentum chasing and a focus on large caps have dominated investment returns in 2024. Investors have been relentlessly buying a limited pool of large-cap stocks at any hint of good news, inflating their portfolios. In an uncertain economic climate with rising interest rates and inflation, investors are seeking stability and believe larger, established companies with growth potential will be better positioned to weather these headwinds.

• The S&P 500’s momentum dependence exposes it to steeper losses in the future. Mega-cap tech stocks, leading the large-cap surge, appear particularly inflated, making them more vulnerable if investor sentiment weakens. This concern is amplified as earnings season approaches and firms such as Nvidia are expected to meet lofty expectations. However, while we remain optimistic about equities overall, mid-cap and small-cap stocks might be better suited for this environment. They offer not only a lower correction risk but also the potential for more upside if interest rates fall.

Uranium Popularity: While renewables gain momentum, nuclear energy from uranium remains a powerful tool for countries transitioning away from fossil fuels.

• On Wednesday, President Biden signed legislation aimed at promoting the development of advanced nuclear reactors. The new law will cut licensing times and processing fees, making it easier for companies to bring these clean energy sources online. While nuclear power currently generates about 20% of US electricity, development has been hampered by cost concerns and unpredictable permitting timelines. The passage of this legislation should make it easier for firms to capitalize on clean energy incentives and offer potential solutions to concerns over the rising energy use of artificial intelligence (AI) technology.
• Fueled by the insatiable energy demands of AI, big tech giants are leading the charge in adopting nuclear power. A Wall Street Journal report reveals that one-third of US nuclear plant owners are in talks with tech firms to discuss the powering of data centers, with Amazon on the cusp of a deal with the nation’s largest nuclear company. This surge in demand is prompting utility companies like Dominion Energy Virginia and Bill Gates’ TerraPower to develop the first of their own commercially viable small modular reactor (SMR) in the US.

• Uranium and nuclear power stocks have skyrocketed this year, eclipsing the broader market. This surge is likely driven by a widening supply-demand gap for uranium. Booming AI and the global push for clean energy are fueling demand, while uranium production capacity lags behind. To bridge this gap, countries are expected to invest heavily in SMRs due to their lower cost and faster deployment timelines. While a near-term correction can’t be ruled out, we believe nuclear companies remain a compelling long-term investment.

The UK Comeback: A surprise surge in economic growth has likely eased concerns about the UK’s debt burden, but also strengthens the case for keeping interest rates high.

• The UK economy defied expectations with a robust 0.4% expansion in May. This is a significant improvement over the previous month’s flat growth and double the forecasted rate for the period. The surge was fueled by a rebound in construction activity, which had been lagging for three months, and an increase in manufacturing production. This positive data strengthens the Labour Party’s position as they navigate economic policy. They can potentially avoid austerity measures while still promoting growth, all within the constraints of fiscal rules that require a balanced budget.
• However, the stronger-than-expected economic data likely diminishes the prospect of an interest rate cut at the next Bank of England meeting. The central bank had previously anticipated a slowdown to 0.2% growth in the second quarter, down from 0.7% in the first. The recent data suggests the quarter will exceed the estimates. Further complicating a rate cut, some voting members, including Huw Pill, have reportedly expressed concerns about high services inflation and wage growth leading to further price pressures.

• Strong economic growth is poised to bolster the attractiveness of UK assets, especially for value investors seeking bargains. British companies currently trade at a discount compared to their US peers, presenting a potential opportunity. Furthermore, the prospect of the Bank of England maintaining higher interest rates for longer than the market anticipated at the start of the year should help stabilize the pound (GBP) against the US dollar. While we remain skeptical of the UK market due to the Labour Party’s proposals, the overall sentiment towards the pound is improving.

Other News: Prominent Democrats and donors continue to urge Joe Biden to step aside, highlighting ongoing uncertainty about the party’s presidential nominee. In other news, Apple will not face fines from the EU after deciding to allow other providers to use its wallet technology for free. This decision underscores the impact of regulations on Big Tech earnings. Meanwhile, US officials are frustrated with India and Saudi Arabia for maintaining relationships with both sides of the conflict in Ukraine. This development illustrates how some countries can avoid aligning exclusively with either the US or China.

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