by Bill O’Grady, Kaisa Stucke, and Thomas Wash

[Posted: 9:30 AM EDT] The news over the weekend was fairly quiet, although there were several things we noted:

The first leg of the president’s trip went rather well: President Trump offered support to authoritarians in Egypt and the Gulf State which was well received.  Iran was isolated as the problem state in the region, a shift from the Obama administration.  Military and other sizeable investments were announced.  And, the president delivered a speech on Islam that was well crafted and delivered.  There was a significant break in policy from the previous administration.  First, the arms sales were three times larger than what was done over two terms of the previous president.  Second, the partial thaw with Iran that President Obama had started is over.  So, all in all, the first part of the trip was a success.

The second leg could be a bit more challenging: Israeli leaders are not pleased with President Trump’s decision to share intelligence with Russian diplomats.  The massive arms deal with Saudi Arabia will also raise concerns.  Although Israel and the Gulf States share a common enemy, Iran, the Israelis rightly fear that arming the Arab states may present a problem for them at some point.  Finally, the administration’s apparent decision to at least slow the move of the U.S. embassy from Tel Aviv to Jerusalem is a disappointment to parts of PM Netanyahu’s conservative coalition.

Grants to loans: The Trump administration’s budget proposal will end some of the foreign military grants, converting them to loans.  The State Department believes this would affect about $1.0 bn in aid to various nations.  Although this proposal is consistent with the platform Trump campaigned on, it may lead some of these nations to cancel the purchase and seek equipment from other nations.  It will also make them less amenable to “strings attached” to the use of the equipment if they are buying it rather than receiving it as a gift.  This is an old conundrum—if you rely on allies to do your bidding in foreign policy, they may not be easy to control.

U.K. polls are tightening: A week ago, the Tories were holding a 20% point lead over Labour; that lead has narrowed to 9% in the latest polls.  The most recent gaffe was a proposed tax on the elderly which would require them to pay most of their support costs until they reach a net worth of £100k.  Dubbed the “Alzheimer tax,” it was slammed in the press; PM May has retreated on the policy only to now face criticism that “the lady is for turning” in comparison to Lady Thatcher, who was not for turning.  We still expect the Conservatives to win but the mandate to manage Brexit will be compromised if the victory is narrow.

Rouhani wins: Hassan Rouhani won a second term in convincing fashion, taking 57% of the electorate.  Although we doubt he will be able to make major changes to liberalize Iran, his win does act as a bulwark against more hardline policies.  However, Rouhani may have to move in the hardline direction if the Sunni coalition is able to contain Iran’s regional ambitions, as noted above.

Pedro Sanchez returns: Eight months ago, Spanish Socialists ousted Sanchez when he refused to compromise on the vote to allow PM Rajoy to form a minority government.  Sanchez’s return to leadership likely means the previously center-left Socialists will lean left to retake votes from the radical Podemos Party.  The polarization of the Spanish electorate is reflected, to greater or lesser extent, across Europe.

Another North Korea missile test: The Hermit Kingdom launched another ballistic missile into the Sea of Japan, flying around 300 miles.  Although this was a shorter test than what we have seen previously, the cycle of tests is accelerating which means the country is probably moving up the missile-learning curve faster.

An OPEC deal?  Saudi oil officials suggest they have gotten agreements from other cartel members, although there is some trepidation over extending it past six months.  There are two factors at play; first, the longer this agreement is in place, the harder it will be to maintain output cuts.  If Saudi Arabia wants to keep the price propped up, it will need to continue to make the largest production cuts.  Second, the ECB and the Fed may play a bigger role in oil prices; a weaker dollar would be bullish for oil and likely overshadow anything the cartel does in terms of output restrictions.

Thinking about narratives: Earlier this year, Robert Shiller wrote a paper[1] suggesting that data and theory can only carry analysis so far.  In addition, it’s useful to understand what people were thinking, in other words, the “narrative” they were using to explain phenomena around them.  Since Shiller is an economist, he examines such narratives with reference to markets and economics.  In the Sunday NYT,[2] he notes that mere economic data about housing really didn’t do a good job in forecasting the housing bubble.  In his report, he notes that pervasive reports about “flipping,” where real estate investors would buy a home, make cosmetic improvements and sell the property quickly to make scads of money, became part of the “narrative” about the strong housing market.  The early success of flipping led more investors to get into the market and use increasing leverage to further magnify the gains.  Of course, when home prices stopped rising, the leverage became a serious problem.  Shiller’s op-ed is related to a similar one in the review section of the same paper reporting that psychologists are beginning to conclude that one of the factors that separates human mental activity from animals is that we project into the future.  In fact, it’s almost impossible for us to be “in the moment.”[3]  The article suggests that the primary function of memory is to project into the future.  We have seen this in the narrative people have about markets; when we go through something painful, like the burst of the tech bubble, we are on guard for that event continually, almost guaranteeing it won’t happen the same way again.  This practice, sadly, makes us vulnerable to other “unexpected” outcomes.

Thoughts about trade: This week’s “Odd Lots”[4] podcast interviewed Dave Donaldson, the recent winner of the John Bates Clark medal for the best economist under the age of 40.  He conducted a massive study of the Indian railway system under British rule to measure how trade within India changed with better infrastructure.  He discovered that once trading expands, specialization develops.  This is true of both international and intranational trade.  Although this specialization makes the economy more efficient, the improvement from trade is much less welcome to those who used to supply a local market and are then eliminated by a distant competitor.

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[1] http://cowles.yale.edu/sites/default/files/files/pub/d20/d2069.pdf

[2] https://www.nytimes.com/2017/05/18/upshot/how-tales-of-flippers-led-to-a-housing-bubble.html?ref=business

[3] https://www.nytimes.com/2017/05/19/opinion/sunday/why-the-future-is-always-on-your-mind.html?src=me

[4] https://itunes.apple.com/us/podcast/odd-lots/id1056200096?mt=2&i=1000385614557

by Bill O’Grady, Kaisa Stucke, and Thomas Wash

[Posted: 9:30 AM EDT] After a week of tumult, things appear rather quiet this morning.  Equities have a bullish tone after a drop midweek.  Oil prices are up as OPEC officials meet to prepare for next week’s policy setting meeting.  There are hopes that the broader cartel can follow Saudi Arabian and Russian lead and extend production cuts into Q1 2018.  The dollar is continuing to fall this morning and this factor may be the most bullish fundamental for oil prices.

The president is about to embark on his first foreign policy trip.  On its face, this exercise should be a cakewalk.  He is meeting with allies who should be mostly supportive.  His first stop is in Riyadh for two days (Saturday and Sunday), where he is meeting with King Salman and giving a speech on Islam.  This is a risk area for the president.  In theory, he should craft a non-descript talk about Islam being one of the world’s great religions and focus on the good works it performs.  However, we note that this speech is being drafted by Stephen Miller[1] who also crafted the first travel ban.  Any talk about religion requires nuance.  Making broad statements about any religion in a policy speech is ripe for creating tensions.  Thus, the potential for a stumble here is high.  On the other hand, the Saudis didn’t care for President Obama and are looking forward to a “reset” with President Trump.  Accordingly, expect the Saudis to do everything possible to make this leg of the trip a rousing success.

On Monday and Tuesday, the president visits Israel.  This should be an easy visit.  However, there are a couple of issues that could present a problem.  First, we will be watching to see if PM Netanyahu presses Trump on moving the U.S. embassy to Jerusalem.  Second, will the president’s sharing of intelligence with the Russians that apparently could have revealed sources and methods of Israel’s intelligence on ISIS become an issue?  We doubt either will, but it’s possible.  In addition, on Tuesday, the president meets with Palestinian President Abbas; the hope here is that the visit will restart peace talks.  Next, on Wednesday, the president meets Pope Francis.  We expect both men to be gracious and avoid difficult conversations, at least in public.  The pope finds many of Trump’s policies offensive and private discussion of these disagreements is probably unavoidable.  Nevertheless, as long as Trump isn’t publically dressed down, this visit should go well.

The president leaves Rome and spends the rest of Wednesday and Thursday in Brussels at the NATO meetings.  Look for Trump to praise the alliance and call for more defense spending.  We are hearing rumors the Merkel government is making “inquiries” about the F-35.  If so, this may be a precursor to a sale and allow the president to get a “win.”  Finally, on Friday and Saturday, the president flies to Taormina, Italy for the G-7 summit.  There are potential risks here.  He has differences with Chancellor Merkel and clearly supported Le Pen in the French elections.  And, the president reportedly doesn’t like to travel and could be fatigued by the end of the trip.  Thus, there could be some awkward moments.

Will anything here be market moving?  Probably not.  The market most sensitive to gaffes is probably forex.  The dollar is already rolling over and if the president stumbles it will likely add further bearish sentiment to the greenback.

There are two other news items we are watching.  First, Julian Assange of Wikileaks may be a free man soon; Swedish prosecutors are reportedly ending the sexual assault investigation without charges.  It will be interesting to see where he goes once released.  He has an outstanding warrant in the U.K. for not appearing in court and the U.S. would like to prosecute him on his role in several incidences of gaining U.S. classified information.  If he ends up in Moscow, it will severely undermine his argument that he is just trying to make the world aware of what governments are doing.  Second, the U.S. executed airstrikes on Syrian military assets operating near the Jordanian border where U.S. forces are training opposition fighters.  We will be watching to see if anything escalates.

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[1] Not this Steve Miller: http://www.stevemillerband.com/

by Bill O’Grady, Kaisa Stucke, and Thomas Wash

[Posted: 9:30 AM EDT] One question we have been getting for the past couple of months is, “How can the equity market keep rising in the face of all this political turmoil?”  The standard answer is that financial markets focus on the economy, market fundamentals, etc. and only turn to political events when they become significant enough to affect these factors.  Sometimes the impact is immediate; 9/11 is an example.  Other times, there is a cumulative effect where enough things happen over time to “suddenly” change sentiment.  Equity market action before the S&P downgrade of the U.S. debt rating in 2011 is a good example of the cumulative effect.  That is what yesterday looked like.  It appears financial markets have concluded that the president’s political woes are becoming big enough to stall his otherwise mostly market-friendly agenda and may become serious enough to weaken confidence.

We do note that, based on the history of new GOP presidents, we are approaching a period of weakness.

This chart shows the performance of the S&P 500 on a weekly close basis, indexed to the first Friday of the first trading week in the year of the election.  So far, we have been closely tracking the average for newly elected Republican presidents.  Note that there is general euphoria into roughly August of the year after the November elections; from there, we see weakness, which may reflect disappointment in the fact that all that was promised won’t occur.

Although the chart suggests this pullback is a “head fake,” we are concerned that the rally seen in the average may not occur.  In any case, this initial rally is “aging out” and there is more potential downside than upside.  Thus, a broader decline may be in the offing, perhaps in the 10% range.

Meanwhile, Deputy AG Rosenstein appointed Robert Mueller as special prosecutor to investigate alleged Russian ties to the Trump campaign and its administration.  In the very short term, this is good news for financial markets.  It will shift the focus from the White House to Mueller and, perhaps, allow the administration to move on its agenda.  However, this is only a short-term respite.  Special prosecutors can dig a long time.  Mueller is a friend of Comey; he is considered a dogged investigator and incorruptible.  He will not be cowed by pressure.  And, at 79, he has nothing but his reputation to defend.  According to reports,[1] FBI agents were expressing “jubilation” at the appointment.

The president responded by saying he wants a quick investigation to prove he has no ties to the Russians.  If there are none, Mueller’s confirmation will be accepted by both sides of the aisle.  It should be noted that Rosenstein made this appointment independently of the White House[2] and the decision was not universally appreciated.  We view this as Rosenstein signaling his independence from the administration.  There are reports that Jared Kushner wanted to “counterattack.”[3]  He was overruled by the rest of the staff and the president.  Also yesterday, a potentially damaging report emerged in the WP[4] which indicated that House Majority Leader Kevin McCarthy (R-CA) said in a closed door meeting among GOP Congressmen that “there are two people I think Putin pays, Rohrabacher (R-CA) and Trump.”  This conversation apparently took place a month before the election and Speaker Ryan (R-WI) stopped the conversation and swore members to secrecy.  This comment may have been in jest but, even in humor, this revelation, if true, doesn’t look good.

Political scandal isn’t just a U.S. issue.  In Brazil, it is being reported that President Temer was recorded discussing payments to buy the silence of the former legislative speaker Eduardo Cunha.  Cunha is serving a 15-year sentence for corruption; almost a third of Temer’s cabinet is under investigation for corruption.  Temer has denied the allegations but if the recording is proven to be true then he will be in deep trouble.  The Ibovespa fell 1.7% and the Brazilian real plunged 10% from Tuesday’s high.

U.S. crude oil inventories fell 1.8 mb compared to market expectations of a 2.8 mb draw.

This chart shows current crude oil inventories, both over the long term and the last decade.  We have added the estimated level of lease stocks to maintain the consistency of the data.  As the chart shows, inventories remain historically high but the seasonal withdrawal phase has begun.  We also note that, as part of an Obama era agreement, there was a 0.7 mb sale of oil out of the Strategic Petroleum Reserve.  This is part of a $375.4 mm sale (or 8.0 mb) done, in part, to pay for modernization of the SPR facilities.  International agreements require that OECD nations hold 90 days of imports in storage.  Due to falling imports, the current coverage is near 140 days.  Taking that into account, the draw would have been 2.5 mb, which is fairly close to expectations.

As the seasonal chart below shows, inventories usually are just starting their seasonal withdrawal period.  This year, that process began early.  Although the actual level of stockpiles remains quite high, we are seeing stock declines at a rather rapid pace.  Assuming a similar drop from this year’s peak of 566.5 mb at the end of March, we will end up at 515 mb by late September.

Based on inventories alone, oil prices are overvalued with the fair value price of $34.27.  Meanwhile, the EUR/WTI model generates a fair value of $46.73.  Together (which is a more sound methodology) fair value is $42.71, meaning that current prices are above fair value but the deviation has been steadily closing in recent weeks.  We note that OPEC looks like it will keep production cuts in place into next year.  That probably keeps oil in a range of $55 to $45, basis WTI.  If the problems in Washington either undermine confidence in the U.S. economy or prompt the FOMC to back away from its tightening stance, the dollar could weaken and that may be the most bullish factor for oil.

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[1] http://www.politico.com/magazine/story/2017/05/18/trumps-worst-nightmare-comes-true-215153

[2] https://www.nytimes.com/2017/05/17/us/politics/robert-mueller-special-counsel-russia-investigation.html?hp&action=click&pgtype=Homepage&clickSource=story-heading&module=a-lede-package-region&region=top-news&WT.nav=top-news&_r=0

[3] ibid

[4] https://www.washingtonpost.com/world/national-security/house-majority-leader-to-colleagues-in-2016-i-think-putin-pays-trump/2017/05/17/515f6f8a-3aff-11e7-8854-21f359183e8c_story.html?hpid=hp_hp-top-table-main_transcript-6pm%3Ahomepage%2Fstory&utm_term=.2121d3dac6c0

by Bill O’Grady, Kaisa Stucke, and Thomas Wash

[Posted: 9:30 AM EDT] The political problem du jour is that former FBI Director Comey apparently kept memos and notes of his meetings and phone contacts with President Trump.  This is standard practice in bureaucracies.  Writing “memos for the file” is a way to preserve one side of a conversation that can be retrieved in case of a dispute.  In a disagreement under normal circumstances this practice leads to a battle of the memos, where two people describe the same event in different ways, questioning whether either person perceived what actually happened.  However, in this circumstance, the president is at a serious disadvantage.  He tends to treat each day as a new one and never seems to feel bound by what has been said or done before.  We fully expect the White House to dispute Comey’s recollections of what transpired.  Unfortunately, it will be the word of a careful lawyer against a president who is anything but careful.  It will be difficult for the president to defend himself against what is likely to be a steady revelation of damaging allegations.

We still hold that we are a long way from impeachment.  It is important to note that impeachment will always be a political act.  Although it is reserved for “high crimes and misdemeanors,” the founders left such crimes undefined.  It is hard to fathom that the party that controls Congress would impeach a president from the same party unless there were obvious treason involved.  There is some talk that Trump could be removed via the 25^th amendment.  This covers a president who becomes incapacitated in office and becomes unable to discharge the duties of that office.  Only a majority of the president’s cabinet is required to trigger a 25^th amendment ouster; if the president rejects this finding, Congress would have to approve his removal from office by a two-thirds majority.

Again, we are still a long way from this happening.  However, the fact that this is even being discussed in the major media does show how far things have devolved.  Shortly after the Comey memo news hit the press, S&P futures fell hard and have not recovered.  We also note the dollar is under continued pressure this morning.  The financial markets are becoming aware that, at a minimum, much of the agenda that boosted confidence and lifted financial markets is in grave danger of not coming to pass.  We will see some level of deregulation but major changes to taxes, infrastructure spending and even trade policy may be stalled.

On Friday, voters in Iran go to the polls to select a president.  Hassan Rouhani, the incumbent, is in what appears to be a tight race against the hardliner Ebrahim Raisi.  Although there are others running, the race will mostly be between these two.  Rouhani is considered the reformer, although only in the framework of Iranian politics.  The more radical reformers, who want to curb the power of the Supreme Leader, have all been removed from politics with many in prison or under house arrest.  Raisi is the favored candidate of the Iranian Republican Guard Corp (IRGC) and is rumored to be supported by the Supreme Leader, the Grand Ayatollah Khamenei.  The big issue in the campaign is the continued poor performance of the economy and widespread corruption.  Rouhani is probably best suited to rid the economy of corruption; the fact that he hasn’t had much luck in this area is because the corruption comes from the most powerful in Iranian society.  Raisi is accusing Rouhani of either being ineffective against corruption or complicit.

It appears that the major problem in the Iranian economy is the heavy involvement of the IRGC which uses businesses to support its members.  Essentially, the IRGC skims funds from businesses and employs its members in these businesses.  The hardline clerics appear to be part of this system and thus corruption will likely remain a dampener on Iranian economic activity.

What makes this election critical is that the Supreme Leader is 77 years old, and there are rumors he suffers from cancer.  If he dies within the next few years, the president will play a role in selecting his successor; in fact, the president may become the next leader.  Thus, the election on Friday is important to the future of Iran and the path of stability in the region.

Finally, although the Macron election has led pundits to suggest that populism is in retreat, we see three items that suggest this sentiment may be overly optimistic.  First, last Friday, the Austrian coalition failed which will likely bring new elections soon.  New elections will give the populist Freedom Party another chance to gain control of Austria.  The party is leading in the polls but no party commands a majority.  Even in new elections, the Freedom Party may not win; the decision to break the coalition came from the center-right People’s Party, who is gambling it can pull enough supporters from the Freedom Party to gain a majority.  It is worth noting that the People’s Party seems to have concluded that in order to win the path to power requires becoming populist, meaning the policies of globalization and deregulation are in trouble.  Second, the Dutch, who turned away the populists in elections earlier this year, still haven’t been able to form a government, showing that the right-wing populists there may not be a majority but it is a large enough voting bloc to prevent the other parties from forming a government.  Third, in Greece, a general strike is being held today to protest against austerity.  Centrist policies that support austerity remain unpopular in the southern tier of Europe but are being forced upon them; at some point, a pushback appears inevitable.

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by Bill O’Grady, Kaisa Stucke, and Thomas Wash

[Posted: 9:30 AM EDT] Another controversy…the Washington Post[1] reported late yesterday that President Trump revealed highly classified information to the Russian foreign minister and ambassador.  Although not illegal (the president essentially can determine the distribution and classification of information), the decision to share the intelligence is potentially reckless.  The sources of the information appear to be from deeply imbedded moles within ISIS and from a Middle East source.  The decision to share the information will likely put these resources at risk; the WP story indicates that the president revealed the city controlled by ISIS that generated the information.  U.S. intelligence agencies did not reveal this information with close allies so the action is troublesome.  Although the official stance of the administration is that nothing was revealed, it is notable that Tom Bossert, the assistant to the president on homeland security and counterterrorism, soon placed calls to the CIA and NSA to warn them of the breech.  If nothing was revealed, it seems odd that Bossert would have notified the two primary U.S. intelligence agencies of what occurred.

There are two issues that concern us about this report.  First, if this turns out to be a serious mishandling of critical information, other nations will stop sharing intelligence with the U.S.[2]  In fact, it is highly possible that U.S. intelligence agencies will be less open to sharing intelligence with the White House, fearing the security of the information.  Second, it’s important to remember that while there is a lot of information the government “classifies,” there is some information that is much more important than others.  In general, the “sources and methods” is often more important than the information itself.  This may be one of those cases.  The information seems to relate to the laptop ban on some international flights; it appears quite likely that some terrorist group has figured out how to put a bomb on a laptop that is difficult to detect.  The fact that laptops haven’t been banned on U.S. flights suggests that either (a) TSA’s methods can screen these bombs, or (b) (the more likely scenario) the laptop bomb is so sophisticated that they can’t be mass produced and thus the terrorist group wants to create a greater sense of terror than attacking an international flight would probably bring.   If the president’s actions inadvertently reveal a path to sources and methods, it would seem reckless.

Here is where this action may start to affect financial markets.   Political events tend to be “tail” risks.  In other words, they are the sort of things that are difficult to predict, and if predicted, are difficult to determine their market effects.  At a minimum, a White House that seems unable to avoid constant controversy will eventually undermine market confidence.  Financial markets have put a good deal of faith into this president; the sharp rally in equities and the dollar strength we have seen since his election are a testament to the hopes that this administration would cut taxes, boost infrastructure spending and lift growth.  Instead, we are seeing precious political capital squandered in unnecessary errors that distract policymakers from moving on the agenda the markets expected.  Perhaps the “canary in the cage” is the dollar.

The line on the chart shows the dollar index over the past nine months.  We have placed a horizontal line from the election to now.  The dollar has essentially given up all of the post-election gains even though the FOMC appears on a path to at least two, if not three, more rate hikes this year.  If other markets begin to conclude that the administration isn’t going to get anything accomplished, we may see similar moves in other markets as well.

This doesn’t mean the White House can’t recover.  However, the current path is raising the chances that this administration will be unable to formulate policy which will be disappointing to investors.  At the same time, the economy is holding up, earnings are solid and rates remain manageable.  There is nothing that signals an immediate problem for equities.  Unfortunately, the political situation is becoming more of a headwind when investors were anticipating a tailwind.  That could become problematic as the year continues.

In other news, the recent ransomware attacks appear to be tied to North Korean hackers.  Although the clues are not conclusive, a number of cybersecurity officials suggest that there is evidence pointing to North Korea.  Apparently, the WannaCry virus used tools that North Korean hackers used against other targets in the recent past.  At the same time, it should be noted that although this code isn’t commonly used, it could have been copied by a criminal organization or another state with hopes of pinning it on the Hermit Kingdom as cover.  Still, if the North Koreans were involved, it will tend to make it easier to put sanctions on them with wider support.

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[1] https://www.washingtonpost.com/world/national-security/trump-revealed-highly-classified-information-to-russian-foreign-minister-and-ambassador/2017/05/15/530c172a-3960-11e7-9e48-c4f199710b69_story.html?utm_term=.f059dc318ad3

[2] Concerns over sharing intelligence have been rising since Trump was elected.  http://www.haaretz.com/israel-news/1.764711

by Bill O’Grady, Kaisa Stucke, and Thomas Wash

[Posted: 9:30 AM EDT] Financial markets are quiet, although we are seeing a strong rally in crude oil (see below).  Here are the themes we are following this morning.

BREAKING: Edouard Philippe has been named PM of France.  He is a member of the Republican Party, suggesting the newly inaugurated President Macron is leaning right.  Philippe could be replaced after legislative elections next month.

Hack attack: On Friday, reports of a ransomware attack in the U.K. emerged.  They rapidly mushroomed, with some 200k computers compromised worldwide.  The U.K. health service was severely affected, car plants in France were forced to close and numerous areas of the Russian economy were struck.  Reports suggest that whoever is behind the attacks isn’t making a mint—the NYT reports that, so far, they have made about $33k.[1]  Fortunately, the attack does appear to be a bit amateurish.  For example, a researcher in Britain noted that a “kill switch” was imbedded in the code.  He activated it and slowed the spread of the virus.  Nevertheless, there are some bigger issues that have been revealed by this attack.  First, we have allowed the software industry to be held faultless for its bugs.  This was a legal decision made to allow the firms, when in their infancy, to grow rapidly.  If they were liable for the damages wrought from software that had security flaws, the growth of the internet and microcomputers would not have occurred as quickly as it did.  We saw similar legal decisions in other industries.  In the early days of railroads, the burden of safety was on the parties crossing tracks, not on the railroads.  This fostered faster growth of railroads at the cost of public safety.  Over time, as the railroads became established, the laws changed and rail crossings became clearly marked with gates to reduce the odds of crashes at rail crossings.  We may be reaching that point now.  If a software firm could be sued for putting out bad software, it would be more careful.  Second, a system that has multiple entry points is vulnerable.  Phishing attacks work because the hacker is betting on one mistake.  In a large entity, the odds that one inadvertent opening of an attached file is worth taking.  Third, software companies have to take steps to encourage users to update systems.  The concern about updating systems is that often the company decides to make “improvements” in the underlying software that the user may not want.  New isn’t always improved.  And so, there is always a fear that if one updates their software, they may get an unwelcome change in the “look and feel” of the software.  Hence, there is a reluctance to update which means critical security patches are not downloaded.  Fourth, the idea that software companies can orphan software, at least for security purposes, has to be abandoned.  The money the company made by selling the software didn’t expire—neither should the obligation to maintain its security.  The bottom line in all of this is that the tech industry is sitting on mountains of cash—being allowed to sell a defective product without ramifications, perhaps appropriate in the early days of technology, is becoming difficult to defend and thus a change in the legal landscape is probably coming.

North Korea launches missile: Over the weekend, North Korea launched a new “medium long-range” ballistic missile which it claims can carry a heavy nuclear warhead.  Analysts monitoring the launch say this test represents a major improvement in North Korean missile technology.  The Hwasong-12 is an improvement; on the other hand, it doesn’t appear to be capable of intercontinental flight.  This missile is probably a threat to Japan and Southeast Asia but not to the U.S. mainland.  Sadly, the technology does show progress toward an ICBM.

The Silk Road meeting: China held a large meeting for its “one belt, one road” investment program designed to recreate the Silk Road, which was a transit for goods to move from China to Europe.  The original road was on land; this one is designed for both land and sea.  As part of this program, China is building port facilities across Southeast Asia.  Not all nations are welcoming; India is not participating in the meetings and Russia is concerned about China’s growing influence in the overland part of the program which runs through the ‘stans, a region Russia views as part of its near abroad.  We view China’s program as a form of imperialism.  Unlike the U.S., which exercises its hegemony through the dollar as reserve currency and by acting as importer of last resort, it appears that China is trying to utilize its growing excess capacity by funding infrastructure in foreign lands.  This is a form of what the European powers did in the 18^th and 19^th centuries when they too found themselves with excess capacity.  They acquired colonies which became targets of exports; in other words, the colonies were forced to accept imports from the mother country which maintained employment in the colonizer.  It also offered a venue for mother country saving which would be protected from expropriation.  We note that China is furiously building a “blue water” navy to protect these investments.  Although the U.S. press is framing the Silk Road initiative as filling the void caused by the U.S. abandonment of free trade and the TPP, an outgrowth of “America First,” it is only partly that.  China would have needed to do this regardless of the existence of TPP.  However, the absence of TPP greatly enhances the likelihood of success.

OPEC + Russia extend deal: Although the rest of the cartel needs to agree, that is mostly a formality.  The fact that the Saudis and Russians have agreed to extend cuts into Q1 2018 is bullish for oil.  Oil prices are stronger this morning.  We continue to maintain that oil prices are in a range between $45 and $55.  We expect oil prices to move toward the top end of that range in the coming weeks.  This is good news for U.S. oil producers; effectively, OPEC + Russia is creating a price umbrella that offers price protection to expanded output.

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[1] https://www.nytimes.com/2017/05/13/world/asia/cyberattacks-online-security-.html (paywall)