Midterm Season… But For The Economy
Authors: Andres Larios
Story of the Week: Yarden Pri-Noy
Editors: Venus Dhanda, Sydney Sibrian, Daniel Hou, Faith Spalding
Intro:
Welcome to the Weekly BluRB, a newsletter catered to students and professionals to get the latest news and insights on global markets. Get prepared for the week by reading four weekly stories circulating around equity markets, macro trends, geopolitics, and new business developments. And the best part: we’ll give you an informed view about where we think prices, policy, and trends are going in the near future. The content in these writings is for informational purposes only and does not constitute financial or investing advice.
Last Week’s Calls:
Occidental Petroleum Overweight: -2.16% on news of less tension in the Middle East
Fed 25 bp cut: 95.6% probability (at time of publication)
Steady Upward Brent Crude Prices: $78 weekly average
Equity Markets: US Financial Sector Points to a Soft Landing
Third-quarter earnings are off with a bang, with major indexes in the U.S. stock market rallying to record highs on Friday. The Dow Jones Industrial Average (DJI) was up 400 points, while the S&P 500 settled just above 5,825. This past week saw investors tracking financial and energy stocks (for geopolitical reasons) after an uncertain start of the week for equity markets. Financial institutions were ultimately responsible for the market’s late week upturn due to solid third-quarter earnings from JPMorgan Chase (JPM), Blackrock, Wells Fargo, and BNY Mellon, as well as an out-of-consensus CPI print, fueling expectations for a November rate cut (elaborated on in the US Macro Section).
Chart 1: Rallying Performance of Major U.S. Equity Indexes
The performance of banks and other major financial institutions are good proxies for the health of consumers and corporations. These large entities are responsible for providing liquidity to markets, which in turn allow for businesses (who employ large sums of people), governments, and citizens to maintain their financial health. With this context in mind, it is no surprise that financial institutions’ earning season is getting so much attention. In the broader sense, the US economy is in a strong position, yet strong speculative undertones remain about a hard vs. soft landing.
As noted, JPM (the world’s largest bank), Blackrock (the world’s largest asset manager), Wells Fargo (the third largest bank in the US), and BNY Mellon (the world’s largest custodian bank) released their third-quarter earnings on Friday morning. The major underlying story for these institutions revolved around quarterly earnings growth being weaker than a year ago, yet, still beating analysts’ expectations in a high interest rate environment. Ultimately, by topping expectations, these stocks experienced a strong week.
The major focus was on Blackrock, which announced that its total assets under management had increased to $11.5 trillion. Part of this surge can be attributed to major asset management firms’ push towards blending investments in both private and public markets as demand for ‘alternative’ markets by investors continues to strengthen.
JP Morgan headlined earnings season, thanks to its size, global presence, and strong ties to American economic health. Following their earnings announcement, JP Morgan’s CFO, Jeremy Barnum stated, “Broadly, I would say these earnings are consistent with the soft landing narrative,” seeing as banks depend on consumer and corporate willingness to borrow. Following Friday’s announcements, Evan Brown of UBS Asset Management concurred, “When financials do well, this is what a soft landing looks like. It’s a positive overall sign for the economy and sets a positive tone for earnings releases in other industries in the next few weeks.”
Next week, Goldman Sachs, Bank of America, Citigroup, and Morgan Stanley will release their third-quarter earnings. Their stocks surged on Friday in congruence with the financial sector’s momentum. Major banks are deeply interconnected, and as such, their earnings should beat analysts’ expectations. We recommend keeping tabs on these stocks, with the exception of Bank of America, seeing as Warren Buffett continues to slash his stake in the company to below 10%.
US Macro: Inflation Confusion, National Debt Updates, and Ineffective Federal Leadership in Response to Hurricane Season
While in the previous section we discussed in detail the role of the closest corporate proxy to the state of the US economy, there is no shortage of news with regards to its true health. Notably, new CPI data shows that inflation is cooling, albeit at a lower rate than expected, and a Congressional Budget Office (CBO) report from Tuesday announced that the US Federal deficit increased by $139 billion to $1.8 trillion in the 2024 fiscal year. Most importantly, however, the Southeast has recently been battered by two devastating hurricanes, raising many questions about the role of federal disaster relief and prevention efforts, communication between Washington D.C. and state governments, and the fiscal costs needed to protect and rebuild American homes and infrastructure.
Thursday’s CPI print was overall positive, as the Bureau of Labor Statistics (BLS) reported a 0.2% increase in month over month inflation and a 2.4% increase in yearly inflation. These numbers are supportive of a soft landing and the Federal Reserve’s relative success in achieving one half of its dual mandate as inflation inches near its 2% target. However, the numbers came in hotter than expected as the consensus on Wall Street was a 0.1% increase in monthly inflation and a 2.3% increase in yearly inflation. However, this break from consensus is largely being cast aside as the overall print seems supportive of the Fed’s 50 basis point cut in September and in line with our call for a less aggressive 25 bp cut in November (currently at a 95.6% probability).
Chart 2: One Month Percentage Change in CPI
A metric to look out for is core inflation (excludes food and energy costs) which increased by 3.3% in the past year, showing sticky prices in durable goods. When excluding shelter, ‘supercore’ inflation rose by 0.4% month over month, driven by healthcare, transportation, and clothing costs. As energy and food prices look prone to spikes due to trade and climate uncertainty, it is important for policymakers to note the stubbornness of this key metric.
Chart 3: 12 Month Percentage Change in CPI, including Core CPI
In other news, the CBO has released its report on the federal deficit in the 2024 fiscal year. The numbers are concerning because our deficit is increasing with no sign of stopping. With fiscal plans totalling $8 billion and $15 billion for presidential candidates Kamala Harris and Donald Trump respectively, we can expect the US economy to be exceedingly debt-funded for the next four years. The $1.8 trillion deficit was in part attributed to the high Fed Funds Rate environment as interest payments from the US Treasury for existing bonds totalled $950 billion.
While the economy is growing, it is important to note how an important underlying mechanism behind GDP is government spending. When considering the backdrop of decreasing credit outlooks by major rating agencies, unprecedented congressional disagreement with regards to fiscal spending, and unsustainable spending plans by both presidential candidates, the increasingly levered US government must find a long-term solution to its debt problem.
Chart 4: Proportion of Government Costs and Revenues Attributed to 2024 National Deficit
Another fiscal problem the US government is facing is the ramping costs of natural disaster recovery. Two weeks ago, Hurricane Helene made landfall in Tallahassee, Florida before dissipating in the Midwest. This past week, Hurricane Milton devastated Central Florida, with over 3.2 million Floridian homes and businesses losing total access to power. Yet, the Federal Emergency Management Agency (FEMA), has already spent $9 billion of its $20 billion budget in the first two weeks of the fiscal year. Without extra support from Congress, it is estimated that they will run out of disaster relief funding by the end of the month, leaving citizens across the Southeast stranded.
In the aftermath of these two storms, disaster costs for Hurricane Helene could exceed $34 billion and $100 billion for Hurricane Milton. In the wake of Hurricane Helene, weekly unemployment claims increased by 33,000, to 258,000, which was the highest spike in claims for the year. We can expect similar trends next week due to the effects of Hurricane Milton.
In D.C., policymakers have voiced their support for providing additional resources for FEMA and disaster relief programs, but they have struggled to take concrete action to support the American public. For FEMA to be effective in its job to provide disaster relief and Small Business Administration disaster loans, Congress has to approve a fiscal plan to increase their budget and mandate. As lawmakers rush to provide more emergency relief to the states affected by this hurricane, House Speaker Mike Johnson (R-La), has refused to reconvene Congress prematurely, opting to wait until November.
This decision may prove extremely costly to the American public, as members of both the Democratic and Republican parties have called on him to take action now to speed up the Southeast’s recovery. Ultimately, as climate change continues to exacerbate the severity of natural disasters, governments worldwide must be ready to pick up emergency disaster costs in stride and provide efficient, immediate help to their citizens – a job the US government is currently struggling to handle.
Global Macro: China’s Bazooka – A Masterclass in Disappointing Investors
A couple of weeks ago, we reported on China’s ailing economy and predicted some of the monetary easing policies enacted with the aim of stimulating short-term growth in their economy. The PBOC’s monetary easing policies included a plan to cut existing mortgage rates by the end of October, signaling to investors that a fiscal package (or bazooka) may also ensue. Those provisions initially boded well for the Chinese stock market as the SSE Composite Index rallied 29% between September 13th and this past Monday on monetary and fiscal easing expectations.
On Tuesday, this rally ended when a highly anticipated press conference by China’s National Development and Reform Commission (NDRC) failed to impress investors by not focusing on fiscal stimulus aimed at revitalizing consumption, but instead on regional supply-side growth. Chinese government officials often stress their 5.0% GDP growth rate as the main economic target for the nation. Seeing as they missed that mark in the second quarter of 2024, investors were looking for more promising signals regarding stimulus, especially due to the speculative nature of the recent stock market rally. Ultimately, this led Chinese markets to see a massive downturn for the rest of the week.
Following Tuesday’s announcement and China’s subsequent stock market dip, the PBOC announced an $81 billion swap facility to help institutional investors purchase more Chinese stocks and increase liquidity. This policy aims to prevent the stock market from dipping, regardless of its true valuation, which invites further investor speculation (which should remind investors of China’s 2015 bubble).
Chart 5: Call Options (Option to Buy) More Expensive than Put Options (Option to Sell), Highlighting Speculative Nature of Chinese Stock Market
Following the NDRC’s disappointing announcement, investors focused on a Ministry of Finance press conference held yesterday for more clarity. In it, Finance Minister Lan Fo’an pledged to increase China’s debt to revive the economy. In the press conference, he discussed helping local governments reduce their debt burden, providing subsidies to low-income households, and supporting the housing market. In theory, this was everything investors wanted to hear; however, he forgot to mention the size of the purported fiscal ‘bazooka’. Morgan Stanley analysts believe allocating Rmb10 trillion to a stimulus package is necessary. However, they raised concerns surrounding how aggressive China will be with fiscal spending as Beijing still believes it is more important to stimulate investment over consumption.
With the current lack of clarity, it is increasingly difficult to project China’s near-term economic outlook. We know there are significant deflationary pressures, a roughed-up housing market, and deep structural issues at the micro level that will be difficult to solve with centralized macroeconomic policy. Thus, investors may have been too bullish on a large-scale stimulus package. As Mohamed El-Erian recently stated, investors will be disappointed in China, “either because the bazooka never materializes or, if it does, worsens the structural and financial imbalances that had led them to deem China uninvestable only a few months ago.”
China is a complicated market to analyze because while it is the second largest economy in the world, its public investment information is not as trustworthy as that of Western nations, which is one of the reasons why property giant Evergrande was ordered to liquidate at the beginning of 2024. It is of our belief that China’s stock market is riding on an emergency insurance plan from the PBOC and cannot sustain its current high prices for much longer without addressing household consumption. In the case of a hefty fiscal package, we would need to be certain this wasn’t a rushed emergency measure, but instead a well-thought-out plan aimed at long-term economic growth.
Story of the Week: Everyone Hates Breakups, Even Google
In October of 2020, the Department of Justice sued Google for using “exclusionary agreements” and “anticompetitive practices” to maintain an illegal monopoly over the internet search market. In a filing earlier this week, the DOJ indicated that it would consider a breakup as a possible remedy. This comes after Federal District Judge Amit Mehta ruled that Google’s dominance in two markets (namely, “general search” and “general search text advertising”) did, in fact, constitute a monopoly, violating Section 2 of the Sherman Antitrust Act which prohibits the monopolization of any industry. Although the DOJ’s finalized remedy proposal will not be published until November 20th, the threat of a potential breakup led to a 2% dip in Alphabet’s stock on Wednesday, highlighting investors’ uncertainty about the future of Google’s dominant presence in the online search space.
So what happens if the DOJ breaks up Google? The DOJ argues that its proposed “structural remedies” would end Google’s “anticompetitive and exclusionary practices” in multiple markets; stripping Google of the power to raise prices at will and reduce product quality “more than it could in a competitive market.” In theory, this sounds great for consumers and other business owners: Google gets “broken up,” eventually allowing more firms to compete with Google in the general search market. In practice, however, consumers will experience much more than an increased number of options.
If previous antitrust cases, like AT&T (1982) and Microsoft (2001), are any indication—breaking up Big Tech monopolies is generally a difficult and ineffective remedy. Since the scale of a tech company is an essential component of its ability to compete—breaking up Google (for reaching the largest scale) might just open the door to other potential monopolists, all vying for that same advantage. In these kinds of markets, where scale is of utmost importance, smaller competing firms are heavily incentivized to form larger conglomerates in order to gain an edge. Although United States v. AT&T (1982) divided the telecommunications giant into smaller regional companies, the nature of that industry incentivized their eventual consolidation into AT&T and Verizon—the two corporations that presently dominate the space. If the market for online search is similar, breaking up Google might just be a temporary solution that merely addresses the problem until the next dominant player comes along.
There are also issues in the actual implementation of a breakup. Such “structural remedies” generally involve barring the target company from competing in specific industries, allowing other companies with less scale to gain a foothold. Google, however, draws massive appeal with the fact that its many different products form a popular online ecosystem that is hard to replace —integrating different services like YouTube, Chrome, Cloud, Drive, and Search. Although it remains unclear exactly how the DOJ plans to carve up Google, the cohesive network which Google provides is undoubtedly at risk. Importantly, since most of Google’s income comes from its online search advertising, other companies providing these diverse services might not be able to provide them for free. Considering this, a breakup of Google could have a profound impact on the billions of users who rely on free access to the company’s services in their education, work, and everyday life. Ironically, this lawsuit—which aims to lower consumer costs—has the potential to ultimately increase the costs of these services by constraining the only producer able to provide them for free.
Nevertheless, you (probably) shouldn’t be worried! Antitrust breakups, especially with Big Tech companies, are relatively difficult and are less effective than more targeted “behavioral remedies.” Most likely, Google will just be banned from its “exclusionary agreements” with various other companies—like Apple, Samsung, and Verizon—no longer being the default search engine when most devices are purchased.
Make sure to tune in next week for more market updates and global insights!