Weekly Investment Update (10/04/2024)

Several macroeconomic events this week grabbed headlines. First, a U.S. port strike involving over 45,000 dockworkers was suspended on Thursday after just three days. The strike affected 36 major ports along the East and Gulf Coasts, including critical hubs such as New York, Savannah, and Houston. Although some retailers had taken preemptive steps to mitigate the impact of any extended disruptions (e.g., building up inventory), the tentative deal will be welcome news for businesses ahead of the election, now just five weeks away.

Across the world, China continues to introduce significant stimulus to combat its slowing economy. Given extremely depressed sentiment among Chinese equity investors, this incrementally positive news has propelled stocks in the region higher by well over 30%. Although we are skeptical that China will be able to sustainably stimulate growth, at the margin, Chinese policy actions are another positive macroeconomic development. When combined with disinflation, global central bank easing, and solid corporate earnings, we believe emerging risks around geopolitics (more below) and the port strikes will have minimal near-term impact on financial markets. As of this writing, the S&P 500 remains less than 1% below all-time highs.

Israel-Iran Escalation in the Middle East Causes Oil Prices to Increase

What is happening: Conflict intensified in the Middle East this week as Iran fired a barrage of missiles into Israel after Israel struck Tehran-backed Hezbollah. Oil prices increased on concerns that Israel would target Iranian oil facilities in response, causing supply disruptions. Brent crude oil rose from $72 on Monday to $78 by Friday, though we note that prices are still below the 2024 high of $91 and meaningfully below the 2022 high of $128.

Why it matters: Oil prices are driven primarily by supply and demand dynamics. The Middle East produces roughly a third of global supply, with Iran producing around 3 million barrels of crude per day. Iranian production has increased in recent years despite U.S. sanctions, with China being the dominant buyer. Estimates show that an attack on Iran’s oil infrastructure has the potential to impact roughly 300,000 to 1.5 million barrels, depending on the type of attack. Still, it appears that an attack on Iran’s energy infrastructure is not Israel’s next preferred course of action, though it remains a risk over the coming months.

The duration and intensity of the conflict as well as energy market dynamics are key for assessing the potential impact on the economy and markets. A rise in oil prices would need to be sustained to contribute to a resurgence in inflation. Currently, oil markets remain well supplied relative to demand — the U.S. is producing near record highs, and many top oil producing countries have sufficient spare capacity. Additionally, the OPEC+ alliance of oil producing countries has a plan to restore additional capacity in the coming months. While a geopolitical premium has returned to oil markets, the fundamental backdrop does not show a large market imbalance. We believe the recent increase in interest rate yields indicates that markets are primarily being driven by economic factors, including the labor market report, rather than geopolitical developments.

U.S. Jobs Report Defies Expectations, Positive for Risk Assets

What is happening: The September jobs report exceeded consensus expectations on all fronts. The U.S. economy added 245K jobs, outpacing the expected 150K, the largest job addition in six months. Employment gains were broad based, and there was notable strength in the service sectors of employment. The unemployment rate ticked down from 4.2% in August to 4.1%. Additionally, job gains for the prior two months were revised upward by 72K, indicating the employment picture is not as soft as may have been perceived in prior months. Average hourly earnings also accelerated a bit on an annual basis from August and are now at 4.0%.

Why it matters: Overall, the labor market report was much stronger than anticipated and supports our view that a recession should be avoided in the near term. Solid wage growth continues to support consumption and underpin a continued expansion, though at a slower rate. That said, one data point does not make a trend, and we expect to see continued softening in the labor market in the coming months given several forward-looking labor market indicators, but we also note that the Fed has ample tools to respond.

While the September jobs report paired with the most recent inflation report could slow the pace of Fed easing, we believe the destination matters more than the pace. It is likely that the Fed will shift to 25 basis point increment rate cuts for the remainder of the year. The Fed is in recalibration mode, adjusting rates to become less restrictive on the economy, but if the pace of easing slows due to stronger economic data, we would view this as a positive for corporate earnings and risk assets.