by Peter Jones, CFA
Senior Vice President
Research and Portfolio Management
As the calendar turned to the final quarter of 2024, there was plenty of economic and geopolitical news for investors to digest. On the geopolitical front, escalation in the Middle East leaves us on the brink of a major regional war that could include a higher level of involvement from the United States military. Our job is to be objective and contextualize geopolitical developments in the context of the markets and economy. On this front, this escalation manifested in two key areas. First, defense stocks such as Lockheed Martin saw strong outperformance. It is no surprise that defense contractors attract investor capital when tensions and uncertainty are on the rise. Second, we saw a material increase in the price of oil as investors considered the possibility of supply disruption in the Middle East. Should the rise in oil prices continue, it would flow through not only to prices at the pump, but also into general inflation levels…right as the Fed has all but declared victory in their battle against inflation. Our take is that the risk of a continued rise in oil manifesting in resurgent inflation is relatively low.
Sticking with international developments, we’ve seen an enormous rally in Chinese markets. In the past couple of weeks “The Party” has announced various measures to stimulate the sluggish Chinese economy. Two weeks ago, Chinese markets were flat and had produced the worst return of any major stock market. After an unprecedented ~30% rally over two weeks, Chinese markets are now the highest returning stock market in the world. While investors are displaying exuberance in response to the stimulus measures, we’re not so sure that it is justified. After all, lower rates and fiscal spending will do little to address the structural challenges in China. Namely, a vastly oversupplied property market against a population in outright decline. Our position has been that China is a market where we want to limit our exposure in client portfolios. Not only are there structural challenges and increasingly hostile trade policies between China and the USA, but investing in Chinese markets has been entirely unpredictable for decades. As seen in the chart below, Chinese markets have been a spectacle of high risk and low returns.
Transitioning back home, we received highly anticipated labor market data this morning. One of the key developments in 2024 is that the focus has shifted from inflation worries to job market worries. Recently, the monthly trend in job creation has been softening and the unemployment rate has been on the rise, albeit modestly. Conventional wisdom is that to keep the rate of unemployment steady, the U.S. economy needs to add about 150,000 net new jobs each month to offset population growth and immigration. Until this morning, the trend had moved below 150,000. With the Bureau of Labor Statistics reporting a blistering 254,000 new jobs in the month of September, the trend has flipped. The three-month average now sits at 161,000 which translates into a very healthy job environment. In response, investors are pricing a more modest pace of Federal Reserve rate cuts in the coming months, and the 10-year treasury yield shot back up to nearly 4%.
Takeaways for the Week
Geopolitical escalation in the Middle East is driving higher oil prices and higher stock prices for defense contractors
Chinese markets have rallied in staggering fashion, but our focus is on the long term
Labor market data has reversed the softening trend we’ve seen in recent months