Waiting for Data

For some weeks now, investors and policymakers alike have been waiting to get a clearer picture of where the American economy is heading. Are the inflation worriers correct that this year’s burst of price increases will become embedded, or will the Federal Reserve’s patience be rewarded? Is the labor market recovery lagging, with millions of Americans still out of work, or are labor shortages now hurting recovery? The last two weeks brought new releases on the labor market, on August 6, and prices on August 11 and 12. But they did little to clear up the uncertainty. The labor market data that we discussed a week ago showed a drop in unemployment, but to a rate still well above pre-pandemic levels. And the data were collected before the July surge in Covid-19. 

Inflation data released last Wednesday were interpreted by markets as giving the Fed more room to wait before tightening. Consumer prices jumped again in July, with the year-on-year increase of 5.4 percent matching that in June and far above the Federal Reserve’s target 2 percent. But core inflation rose at its slowest pace since March of this year measured by the MoM change in prices, and there were some signs that post-pandemic price surges may be easing. Producer price releases told a more worrying story on Thursday, rising 7.8 percent YoY in the month. That wasn’t enough to upset markets, as equities reached new highs last week. Uncertainty about the ramifications of Afghanistan is casting a shadow today. This may be temporary. On inflation, market breakevens still suggest a return over time to something closer to the Fed’s target after a period of faster inflation. Consumers are less sanguine, according to the University of Michigan consumer survey. That showed consumers expecting inflation of more than 4.5 percent a year ahead, and long-term inflation at 3 percent. The bottom line? We need to wait a while longer for the pandemic disruptions to the economy to work through the system. One indication that the White House is worried about inflation: a unified and unusual call to OPEC to raise production to reduce oil prices. That may cheer up families driving over Labor Day this year. But it won’t help the climate.
Source: RockCreek
Observations and takeaways for investors:

Twenty years on — defeat.

As the Taliban retook Afghanistan more swiftly and completely than almost anyone expected, the shocking news has led many commentators to compare it with the fall of Saigon. That may overstate the failure — although the sight of helicopters evacuating Americans from the Embassy as the Taliban marched into Kabul on Sunday, was horrifying. We are reminded of the history that engaged the US in Afghanistan after 9/11 and the years that followed, as well as the subsequent support by most Americans of the promises of President Trump and President Biden to get the US out. This was not the way to do it. Our deepest sympathies and thanks must go to the service members who came back from Afghanistan bearing hidden as well as visible scars, and to those who lost family and friends in what was likely an unwinnable war, waged at far too high a cost by politicians and military leaders across two decades. There may be geopolitical ramifications as well. It is no accident that China and Russia have reached out to the Taliban leaders who have made a mockery of US attempts to negotiate a ceasefire. 

Help Wanted.

Help wanted signs have become a familiar sight. Whether in the National Parks of the US Rocky Mountains or the English seaside, it seems that workers are in short supply. Restaurants want chefs and servers, hotels want receptionists and housekeepers. This partly reflects travel restrictions that have stopped a typical influx of seasonal workers. It also reflects the jerks and bumps — or frictions — of dramatic shifts in demand during the rollercoaster of the pandemic. According to reports from the President of ManpowerGroup North America, demand for blue-collar workers is up by 24 percent from a year ago, with a 50 percent increase in demand for operations and logistics workers. This compares to a rise of just 14 percent in demand for knowledge workers, more of whom kept their jobs last year. 

Political Pause?

Congress is now adjourned for the summer. But there won’t be much of a pause in politics, including around the next legislative battles on economic policy. Crucial debates on spending, taxes and the debt ceiling are shaping up for the fall.

First — the good news. The Senate last week achieved what had begun to seem impossible: bipartisan agreement on important legislation. On August 10, the Senate passed a huge and complicated infrastructure bill with 19 Republicans — including Minority Leader Mitch McConnell — joining all 50 Democrats to support passage. There has been agreement for a long time that America’s infrastructure is in urgent need of modernizing and repair. Infrastructure investment is good politics as well as economics. As the International Monetary Fund notes, “public spending on infrastructure can make a meaningful contribution to job creation. Overall, one percent of global GDP in public investment spending can create more than seven million jobs worldwide through direct employment effects alone.”
Winning support across party lines for such spending has nevertheless been elusive for one American President after another. This bill embodies compromise. Its overall price tag of $1 trillion is big, but much smaller than the White House initially wanted. It includes money for broadband access, replacing lead water pipes and reconnecting underprivileged communities, as well as for more traditional roads and bridges. It has been swelled by inclusion of special projects that helped to win support from individual Senators. But with the money to be spent out over a number of years, few economists are too worried about its overall size. And it will provide continued fiscal support going forward which is likely to be needed as the pandemic burst in spending ends.

Now the caveats. The bill has to pass the House before going to President Biden’s desk. House Speaker Nancy Pelosi and a large contingent of House Democrats have indicated that they will only consider the $1 trillion infrastructure bill once the Senate has also agreed on a budget that contains much more social spending, focused on transforming federal support for families and for the poor, with tax increases on corporations and the wealthy to help pay the $3.5 trillion cost over coming years. The Senate last week also took the first step to consider that bill, passing a broad and non-binding budget resolution, this time along party lines. But already Democrats Joe Manchin of West Virginia, and Kyrsten Sinema from Arizona have said that the price is too high. And on Friday, nine House Democrats warned that they will not support a vote on this budget plan until the House passes the infrastructure bill. At RockCreek, as we have said before, we see a very narrow path for President Biden and Democratic leaders in Congress to win passage of both bills. And passing one without the other is just as hard. Getting to victory will require luck as well as skill, and a willingness to compromise that restive House progressives may not have. Messages from constituents as members of Congress go back to their districts will help to shape what gets done this fall.

From carrots to sticks: renewed Covid-19 infections causing patience to run out.

Vaccine mandates are spreading. The summer rise in Covid-19 infections, hospitalizations and deaths has dashed the June hopes that Covid-19 was in the rear-view mirror. The Delta variant is still most feared, for its swift spread. But other variants can be expected to develop as long as the pool of unvaccinated people remains large. Some variants may be less susceptible to vaccines — as a small study has suggested is true of the Lambda variant, detected in the US but not dominant. In addition to raising pressure on the unvaccinated, the US government is moving to recognize that booster shots may be needed, at least for some vulnerable populations. 

For months, the focus in many countries was on securing supplies and then persuading the unvaccinated to get a shot — or a jab as it is called in the UK. On this side of the Atlantic, where even mask mandates are controversial, it seemed unlikely that there would be a switch from carrots such as lottery tickets and outright payments to sticks. For one thing, those who refused a vaccine seemed to be the ones mostly at risk, in what the head of the Centers for Disease Control (CDC) had called a pandemic of the unvaccinated. But as the Delta variant has taken hold, experience has shown that even the vaccinated can be vulnerable to catching and transmitting Covid-19. The calculus has shifted further in the past week. The current 7-day moving average of new daily infections is almost ten times the low point in June. The White House has been quietly pressing businesses and health facilities to take firmer action, following President Biden’s decision to require vaccination or frequent testing for federal workers. Workers’ representatives are divided on whether to welcome or resist mandates, with the AFL-CIO and large teachers’ unions supporting while Chicago-based teamsters and New York health care workers oppose. Sadly, since this is an issue of public health and scientific facts, politics appears to be playing a big role in determining views for and against. 

In Europe, vaccine passes are also gaining ground — controversially in France but with broad support in Italy. Indeed, Prime Minister Mario Draghi is chalking up some wins. The negotiating skills that he showed as President of the European Central Bank are working in the political arena, with an effective Covid-19 vaccination program this year and a successful reform effort that is securing European funds for a fiscal response to the pandemic recession.

Markets in Europe continue to see renewed investor interest with the region’s equity market maintaining pace with the US this year. Investors in developed markets have largely shrugged off the lingering health concerns as corporate earnings have been stronger than expected for many companies. European equity funds saw an estimated $1.5 billion of inflows last week — the most seen over the past two months. STOXX Europe 600 has now reached 10 consecutive sessions where it has achieved a record high — its longest such streak since at least 1990. Meanwhile, analysts are raising earnings projections, keeping P/E multiples in check. Even though market performance has been strong, it has still been slightly outpaced by PMIs. This should give investors some assurance that European equities still offer reasonably good value even if growth moderates.

With many investors away on summer vacation, trading in the US equity market is rather listless. For example, just 3.4 billion shares were traded on the NYSE last Thursday, compared to average daily volume this year of 4.7 billion. The S&P 500 ended less than 1 percent higher for the week and is up 1.7 percent month-to-date. That being said, the latest news on the corporate earnings front continues to be positive overall. Walt Disney’s report of a strong rebound in park visitors contributed to a $918 million quarterly profit for the company and provided further evidence of consumer demand for travel and leisure. Disney’s shares ended the week 2.2 percent higher. While corporate data from Q2 has been overwhelmingly positive and able to support record highs for markets, investors are still weighing the potential implications of rising Covid-19 infections from the Delta variant. Airbnb nearly quadrupled its revenues and exceeded earnings expectations, yet its shares fell immediately following its report on management’s warnings about volatility from the Covid-19 Delta variant. Meanwhile, the increased pace of vaccinations and clear need for booster shots has been a boon for vaccine makers. Shares of Moderna and BioNTech have risen 10.2 percent and 14.9 percent this month, respectively, and have both surged more than 200 percent this year.

Emerging Markets.

In a reversal of recent trends in emerging markets, Chinese markets experienced a modest bounce-back last week, led by large cap growth names. For the first time in months, MSCI’s EM ex-China benchmark underperformed the main EM index. However, it would be naïve to think that this is the beginning of a turnaround for Chinese tech companies. The Chinese authorities are in the opening stages of a sustained restructuring away from the consumer-based business models of the current tech behemoths. As we’ve written in prior commentary, the stated reason is to address the very real inequality that exists in the nominally socialist republic. But there may also be a more practical aspect to this turn of events — one rooted in Beijing’s desire to suppress any illusions of power China’s tech CEOs might harbor. 

A historical parallel might prove useful. In the early 15th century, China vaunted the largest naval fleet in the world, with upwards of 3,500 ships. Led by the eunuch admiral Zheng He, the Chinese ‘treasure fleet’ was routinely sailing to the Middle East and Africa and back decades before Columbus. China’s foreign trade prowess soon gave rise to a fabulously wealthy merchant class — too wealthy it turns out for the political elite inside the Emperor’s civil service. As Nobel Prize-winning Princeton economist Angus Deaton posits in his book The Great Escape: Health, Wealth, and the Origins of Inequality, “the emperors of China, worried about threats to their power from merchants, banned oceangoing voyages in 1430.” By the 1470s all records of admiral Zheng He’s voyages had been destroyed so that future generations could not repeat his feat. While it is unlikely China’s tech giants will be left to rot in port, we believe they will pay a more subservient role going forward. 

What about the other half of China’s tech ecosystem? China’s focus on high-tech sectors such as semiconductor manufacturing and artificial intelligence is also rooted in the same desire to control what it views as the pivotal area to dominate — if it hopes to replace the US as the world’s pre-eminent superpower. But alas, this is where China faces a structural weakness no seafaring ban can address. As shown below, China still very much relies on the US, the EU and the rest of Asia for a significant portion of their technology inputs. Onshoring even a modest part will take time and significant cost at a time when China’s growth rate is rapidly converging. In the meantime, the US and the EU will no doubt make full use of this bargaining chip in the hopes of slowing down China’s ambitions. 

RockCreek Update
Last week, the Intergovernmental Panel on Climate Change released their latest report, calling climate change “widespread, rapid, and intensifying.” UN Secretary General António Guterres called the findings “a code red for humanity.” As RockCreek Founder and CEO Afsaneh Beschloss stated during the RockCreek Climate Summit, “We know that no single government company, multilateral pension fund, sovereign fund, endowment, foundation, university or investor can solve the climate crisis on their own. The scale is too immense, and the cost of failure is too high for any single entity to tackle it alone.” The release of the report underscores the immediate need to mobilize funds for climate-related investments and institutional investors are starting to see many new opportunities. “Rock Creek has prioritized sustainable climate smart investments as a high source of returns and we are continuing to partner with investors looking for new opportunities that accelerate climate action,” said Beschloss. “We don’t think there has ever been a better time to invest in the climate smart future. There have never been better opportunities to integrate the mission of an organization with the returns they need.”

The RockCreek Team

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