Earnings, Data, & QA
What happened last week?
- The S&P 500 rose by 0.45%
- The Dow Jones climbed by 0.79%
- The Nasdaq slipped by -0.18%
Investors have questions about the Middle East, interest rates, if it is a good time to add to positions, the prospects of a government shutdown, and if policy makers in China are doing enough to improve the economy?
3 Things to Know
Israel-Hamas Conflict: The Impact Is Likely Regional
Hamas’s October 7th attack on Israel was the deadliest in the nation’s history. While the scope of the war that follows remains unclear, little risk of a wider regional conflict has been discounted in financial markets at this moment.
What moves markets are events that catalyze a turning point in regional economies or the global economy. 90% of history’s shocking geopolitical events since World War II did not cause a collapse in the world economy.
The economic impact of most conflicts is regional. According to top military and political advisors, neither Israel nor Iran will be in any rush to engage in a direct military conflict.
Experts have noted that Israel’s capacity to engage in a multi-front war was limited and that Iran had political and practical reasons not to provoke an even wider conflict. The defense support that the US has provided to Israel has been accompanied by extensive political activity designed to limit the geographic scope of the armed conflict.
For now, this matches the conclusions drawn by global investors.
After a 4.2% jump in the global crude oil price on October 9, petroleum markets have calmed. Brent Crude oil — the global benchmark — is at $89 per barrel at this date. This is a full 10% below its recent high set in September.
That said, Iran and Russia collectively supply 15% of the world’s oil. A disruption in supply could have a major negative impact on global markets, if sustained.
With OPEC cutting production more than US producers have increased supplies, US/European energy producers are worthy portfolio additions. Their stocks are a source of income and may provide a potential hedge against shocks and inflation.
Bonds over Equities?
Today’s bond yields have normalized to levels close to what we should expect going forward. The 2020’s “zero yield” world was an anomaly.
Today’s yields are also highly unlikely to rise to 1980 highs either, a decade of 10%-per-year wage growth. For bond investors, the sharp repricing of 2022 has greatly reduced fixed income investment risk.
With coupons averaging above 4.5%, the average US Treasury total return over 12 months would not be negative even if rates were to rise 100 basis points.
Investors looking at Investment Grade corporate debt could be looking at 6% yields or more for the next five years, far higher than the Fed’s estimate of its policy rate over that period (between 2.5%-3.0%).
Turning to equities, we believe the correction in US markets is likely to end when investors can clearly point to the peak in interest rates.
Our outlook for corporate profits — up 4% next year and +8% in 2025 — should be constructive even if industry analysts are excessively bullish.
China Stimulus: May Provide a Boost but Jury Still Out
We are seeing signs that Chinese authorities will take more material steps to bolster its economy.
Economic sentiment has remained negative due to the ongoing real estate crisis and a lack of commitment to address the issue wholistically.
The focus of the Chinese actions is likely to be on infrastructure. The method of funding appears to be a bond issuance. A central government bond could provide a clear sign of the government’s intent to inject material economic support.
In addition, Central Huijin, the sovereign wealth fund has taken larger stakes in China’s major four banks, a practice reserved for moments when strong policies are required to reset markets.
Many uncertainties remain as to the timing, size, and operation of this stabilization fund, but the Huijin purchases are likely just an initial step in efforts to shore up the equity market, with what is basically quantitative easing.
This type of stimulus would take time to have impact and would likely raise growth in the second half of 2024. We already expect some modest improvement in Q3 growth due to prior, smaller stimulus measures.
We have seen a pickup in industrial and consumer activity since August. Meanwhile seasonality favors equity performance in 4Q but we do not believe these measures are sufficient to return China to a sustained higher growth rate.
The focus on infrastructure rather than providing a more favorable environment for consumer, education, and technology companies to grow more rapidly also has limited long- term benefits.
See our weekly CIO Strategy Bulletin for more details