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Weekly Market Analysis - Answering Your Questions on October’s Three Market Surprises
Posted on3 Things to Know
The Widening Middle East War: What Will its Impact Be?
As we have noted routinely over the years, regional conflicts can have severe local impact. It is historically very rare, however, for these conflicts to drive a new direction in the world economy (see chart).
Could US Labor Action Derail the Economy?
No labor action has driven the US into recession in post-WWII history. The number of lost hours worked from labor actions in the US is still running at a fraction of the 1970s average. So, while we have resolution for now, markets can add a potential renewed strike in January to their list of worries over the path of growth and inflation. But as this week’s experience illustrates, it is easy to exaggerate the long-term consequences of the strike.
Do China Policies Change the Return Outlook for Equities?
After a three-and-a-half-year bear market that lowered Chinese share prices to levels first reached in 2006, several announcements from China’s Politburo, Ministry of Finance and Central Bank in late September sent share prices up at a record-breaking pace. There’s a chance we’re less than halfway through this bull market for three key reasons (more overleaf).
Summary
Presidential election years in the US have become known for “October” surprises – events that upend expectations for the race at nearly the last minute (for a history of these, please see Road to the Whitehouse: Part 8).
We have long argued that one data point does not make a trend, but amidst significant upward revisions, it is the soft July and August numbers that look like outliers. While many more pessimistic observers thought September employment could register as an October surprise, payrolls beating to the upside in September (adding 254K jobs) should put to bed the fear that the US economy is imminently or currently falling into recession. With the unemployment rate falling back to 4.1% on a robust gain in both jobs and the labor force, it looks like the Sahm rule will not have correctly timed a contraction this cycle. The strong September report should crystalize the view that the Fed will only cut rates by 25 bps in November and December.
The very start of October has brought new surprises to the fore in 2024. We look to provide some perspective on three of the most pressing new surprises in this week’s CIO Bulletin.
Portfolio considerations
While we believe this strong rally still has legs, China’s equity market has often performed like a “stampede of bulls” moving in and out. As noted, certain US policies could stand in the way of further gains. Our visibility and confidence level in China’s economic performance is admittedly fairly low. In such a case, we don’t think a cyclical bull or bear market should be the deciding factor in one’s strategic exposure.
Our direct weighting in mainland China equities for globally diversified, all-asset, medium risk portfolios is less than 3%. For all of Asia equities, just under 13%. There are portfolios designed for more or less exposure, but we believe no single country equity market makes a portfolio.
Source: Bloomberg, October 2, 2024. An investor cannot invest directly in an index. They are shown for illustrative purposes only and do not represent the performance of any specific investment. Index returns do not include any expenses, fees, or sales charges, which would lower performance. Past performance is no guarantee of future results. Real results may vary.
The Widening Middle East War: What Will its Impact Be?
The conflict sparked on October 7, 2023 has now widened on multiple fronts in the Middle East. A first direct exchange of fire between Iran and Israel took place in April, but the latest escalations appear significantly more dangerous for the region. We can’t possibly describe the human toll here. As usual, global markets have reacted in a predictable way. With Iran being the 7th largest petroleum producer state in the world amid fraught politics in the region and beyond, the global benchmark for crude oil jumped as much as 8% on October 1st before settling just 2.5% higher.
Despite the message that global diversification can help to shield investors somewhat from regional conflicts, we do take security quite seriously in managing portfolio risks. As multiple conflicts stretch the capacity of governments, we see greater incentives for bad actors to see this as opportunity. For investors, we believe allocating to less volatile assets like government bonds or more direct risk hedges alongside equities helps to balance the rewards with risk management.
Could US Labor Action Derail the Economy?
During the last major port strike – lasting from October to mid-November 1977 – real GDP growth slowed to zero but then bounced back to a 16.4% annualized rate by the second quarter 1978. There was much else going on in the economy at the time. Domestic production and retail spending didn’t slow, but international trade contracted around the event. Inventories were drawn down during the labor action but spiked up after the strike ended. Inflation was already quite high and only accelerated well after the strike for unrelated reasons. Despite 1977 being remembered as a notoriously bad year for the economy, US employment grew by no less than 200,000 per month during the year, including the months of the strike.
Today’s economic context differs significantly. Goods imports have risen somewhat in importance (11.2% of US GDP today vs 7.2% of GDP in 4Q 1977). Inflation is much lower, but markets are in a sensitive period assessing any deviation from the progress the Fed sees in driving inflation down further. US employment growth is also slowing significantly. If the strike had persisted through mid-October, it could have threatened total non-farm employment gains falling below 100,000 on the strike impact. And this threat could return in January if no further resolution is reached but given the rapid negotiation we have seen to date, that risk looks modest.
Do China Policies Change the Return Outlook for Equities?
The Chinese equity rally continued 27% in two weeks since September 23rd, with record breaking trading volumes. As discussed in our last two Asia Strategy bulletins (Re-Levering China and China Finally Begins to Fight Deflation) and the September 14th CIO Bulletin, the monetary and fiscal policies announced over this period were unprecedented, representing a pivotal reversal in the direction of economic policy from the highest levels of China’s leadership. Enabling this pivot was the start of the Fed’s rate cut cycle, which gave more flexibility to policymakers in China and worldwide.
While there remains a lot of skepticism on the longevity of this rally, there’s a chance we’re less than halfway through this bull market for three key reasons:
- So far, the rally has been funded by savings accumulated by firms and households over the past few years. Leverage has yet to be applied and it is likely a powerful source of funding for this rally, as it is funded cheaply by the central bank. The bull market likely won’t end until financial policy turns to tightening again.
- Earnings growth and cyclical economic recovery is under way and may have more forthcoming. The amount of fiscal stimulus is substantial, and the equity rally itself is likely to lift the propensity to consume after two years of belt tightening. Upward earnings revisions have just begun and may extend further, with higher certainty for the financial and consumer related sectors.
- IPOs and other public offerings are likely to return, after low valuations have paused this original function of the equity market. These include the hundreds of firms lined up for IPO, as well as banks and other state-owned enterprises looking to raise capital. Until substantial capital raising takes place, financial policy is unlikely to tighten again.
