October 21st, 2022
Stronger than expected corporate earnings and a string of positive developments out of the UK pushed the Dow Jones Industrial Average to its third straight winning week. Bank of America and Goldman Sachs kicked the week off on a high note as both topped estimates, boosted by larger net interest spreads and heightened market volatility which lifted fixed income trading. U.S. defense contractor Lockheed Martin also added to the bullish sentiment by posting its largest earnings jump in ten years. The company’s High Mobility Artillery Rocket System (HIMARS) have been in high demand, helping Ukraine to defend against Russia’s invasion. In the UK, new Finance Minister Jeremy Hunt gave markets a much needed dose of confidence. Hunt essentially scrapped his predecessor’s controversial tax measures that had sparked turmoil in UK bonds markets, requiring the Bank of England to step in to restore stability. Hunt’s installment to the post and the measures he has now vowed to undertake essentially undercut Prime Minister Liz Truss’s platform, prompting her resignation on Thursday. Her 45-day tenure as prime minister is the shortest in British history and the clock is now ticking on finding her replacement, who will become the fifth British prime minister in six years. Top contenders include former finance minister Rishi Sunak and a possible return of former Prime Minister Boris Johnson. Given how the political drama has roiled the UK, and global financial markets more generally, traders will be carefully watching how the race unfolds.
U.S. economic news was generally light this week but data did show that the Fed’s rate hikes are taking a toll on home sales. China was also set to release Q3 GDP figures this week but cancelled the release at the last minute. The report was expected to show a significant slowing of the Chinese economy, but with the 20th National Congress of the Chinese Communist Party currently underway, Chinese Leader Xi Jinping seemingly wanted no distractions leading to his unprecedented third term. It’s nice to be the king. Overall, markets benefitted from a strong shift in positive sentiment that helped the Dow add 4.90% on the week.
Home Sales Fall on Rising Rates
Rising rates continued to chip away at the housing market as existing home sales fell to a 10-year low in September. Sales of previously owned homes fell -1.50% month-to-month to an annual rate of 4.71 million units. That marks the eighth straight monthly decline. The slump in the housing market has been driven by the Fed’s rate hikes which have lowered affordability with the average 30-year fixed rate mortgage now over 7.00%. That’s in stark contrast to the 3.00% average rate earlier this year. The surge in the lending rate has, on average, added $1,000 to homebuyer’s monthly payments. There are few signs of relief for potential homebuyers as would-be sellers have forgone adding their homes to the market’s inventory. At the end of September, there were 1.25 million homes for sale, down -0.80% yoy. At the current sales pace, that represents a 3.2-month supply. In comparison, six months is considered a healthy balance between supply and demand. Despite lower sales, limited inventory is still leading to multiple offers on available homes. By comparison, during the 2008 to 2010 market downturn, inventory levels were four times higher than they are today. Tight supply also means higher prices with the median price of a home up 8.40% yoy to $384,800. It’s not just the higher end of the market which is pushing up prices. The rise in prices is occurring across all price points. It remains slim pickings for potential homebuyers for the time being as high prices and elevated borrowing costs keep sellers holding on to their 3.00% mortgages.
China Data No-Shows
On Monday, China’s National Bureau of Statistics cancelled the release of quarterly GDP data without providing a reason or setting a new date. Days earlier, the country’s custom agency failed to release monthly official trade data also citing no reasons for the delay. The missed deadlines come as China held its party Congress this week, extending Chinese leader Xi Jinping’s term for another five years. This would be his third consecutive term leading the country, but one where he now faces considerable economic headwinds. China has become increasingly authoritarian and nationalistic as Xi has consolidated his power over the past two terms, and nowhere has that been more evident than in his Zero Covid policy, which has wreaked havoc on domestic consumption. The country’s strict adherence to the policy has now resulted in many global manufacturers exiting China as they struggle with manufacturing disruptions and higher shipping costs relative to other regions. The country’s property market also remains under intense pressure, weighed down by heavy debt pushing many into default, stalling projects, and leaving homebuyers out of luck as projects remain unfinished. China became an investing darling during the Financial Crisis, but the combination of Xi’s nationalistic ambitions, the increased risk from authoritarianism (exemplified in China’s zero Covid policy), and now the blackout of economic data appears to have finally soured corporations’ and markets’ love affair with the nation.
Markets continued to move higher this week, driven in part by a better than expected crop of earnings reports and greater sensibility out of the UK. Although we’re still relatively early in the earnings season, the Q322 growth rates estimate stands at 3.10%. Of the 99 companies that have reported earnings to date, 74.70% have topped expectations which is above the long-term average off 66%. This week’s rally is particularly encouraging as it also coincides with a jump in treasury yields to above 4.30%, which suggests equity investors are becoming more confident the Fed’s planned rate hikes will be able to tackle inflation while managing a softish landing. That remains to be seen, but what you can say with three weeks of positive returns is that the negative feedback loop has paused. Next week we will have our first read on the impact the Fed’s hikes have had on economic growth as U.S. Q3 GDP numbers are set to be released. Earnings season will also shift to tech where we’ll see what those CEOs have to say about the state of the economy.
The Week Ahead
High inflation and rising rates slowed economic growth in 1H 2022, but strong demand could lead growth to bounce back in Q3. The Atlanta Fed’s GDPNow is currently forecasting growth of 2.90% in the third quarter, driven by strong consumer and business spending which is expected to more than offset falling residential investment. Traders will also pour over the latest personal income and spending figures for continued spending power into Q4.
David and Goliath
This Monday, October 24th marks the nine-month anniversary of the Russian invasion of Ukraine. When the war began, many analysts believed it would be over quickly, with Moscow signaling that Russia planned to overtake Ukraine in a blitz lasting only days or a few weeks which seemed palpable. Ukraine is Europe’s second largest country after Russia, which it shares a border with, and it is twice the size of Italy and slightly smaller than the state of Texas. Its military spending in 2021 was just a little more than one-tenth the size of Russia’s 2021 spending. Russia had more soldiers, more weapons, more vehicles, and more aircraft than Ukraine, yet it has yet to achieve its objective of a takeover of its southwestern neighbor. Military strategists around the world have observed a number of key factors that have contributed to Ukraine’s successes against Russia, including the use of a U.S. based satellite system.
Elon Musk’s SpaceX Starlight division has been a critical tool for the Ukrainian military. It is the only business operating satellites in low-Earth orbit (LEO) that are capable of providing internet connections in remote and rural locations around the world, including Europe. SpaceX was founded in 2002, and the company designs and manufactures its Starlink satellites that it began launching into orbit in 2019. As of September 2022, the system includes 3,000 satellites that enable anyone with a Starlink terminal to tap into high-speed internet, including Ukrainian troops. Musk’s company – with U.S. support – provided more than 20,000 Starlink terminals to Ukraine. The terminals connect small satellite dishes with a constellation of LEO satellites. Ukraine has relied on Starlink to target Russian ammunition depots and locate enemy positions. The satellite system has not only enabled members of the Ukrainian military to carry out sophisticated intelligence collection and fire support operations against Russia, but it has also helped blunt Russia’s attempts to jam signals, block the internet, and undermine Ukrainian command and control capabilities.
Paying for the use of Starlink in Ukraine has been a point of contention between SpaceX and Ukrainian and U.S. defense officials. At one point, Musk indicated SpaceX would fund the effort, but Musk has waffled on that issue as of late. Musk has said that the use of his Starlink service in Ukraine is costing his company around $20 million per month and that support cannot continue indefinitely. Ukrainian officials, the Pentagon, and Musk have reportedly been in contact regarding ongoing funding for the crucial telecommunications support.
Conversely, Russia has been severely hampered by a lack of communications infrastructure, with their military often having no internet or cell phone signal, and with radios only reaching a couple of miles. This has forced the Kremlin to deploy senior officers close to the front lines and has significantly hindered coordinated movements. Furthermore, Russia subscribes to a “top-down” chain of command that is only further slowed by lack of internet and cell service among its troops. By comparison, Ukraine’s command structure enables junior officers in the field to make “in the moment” battlefield decisions, making Ukrainian forces more nimble, effective, and efficient. Throughout the war, Ukraine has also out-maneuvered Russia. It has focused many of its tactical operations on cutting off supply lines to Russian forces rather than engaging in direct tank battles and artillery exchanges that Russia prefers.
The world has been watching this David and Goliath battle between Russia, which boasts one of the world’s strongest militaries, and Ukraine, which has launched successful counteroffensives with just a fraction of the weapons, personnel, and equipment that Russia possessed. History has yet to be written, but with its heroic military response, the Ukrainians have proven to be a very formidable modern day David.