War in Israel/Gaza
On October 7 Hamas invaded southern Israel, massacred 1,400 Israelis and others from around the world, and took 240 hostages. And so, Israel is now at war again, and is clearly determined to eliminate Hamas, which hides amongst and under its civilian population, making for immense suffering in Gaza. We can hope for an end soon where the people of Israel and Gaza can be secure and be free of Hamas and the threat of more needless bloodshed.
Adding this to the continued war between Russia and Ukraine, the impact of geopolitics on the global economy and markets is serious and significant. In the days after October 7, oil and gold prices spiked on the fear that the war in Gaza could spread across the region and that the United States and Iran could end up in direct confrontation. So far, the deterrence of US forces in the region has effectively eased that immediate concern.
The price of West Texas oil at roughly $77 a barrel is well below its October 19 high of $89. How could it be that oil is down so much in spite of a war in the Middle East? Beyond the leading headlines, there are always multiple factors that affect market prices, whether it be for commodities, currencies, equities or bonds. Simply put, supply is ample across the globe, and demand is tepid, particularly out of China.
Structural Changes in Fuel Demand
The world is very different from 1973. Fifty years ago, The Yom Kippur War led to an Arab oil embargo against the United States, and the price of oil rose 300% over the next three months. Then the United States depended on 36% of its oil supply from imports.1 Today, the US is arguably energy independent.2 The US Energy Information Administration expects US gasoline consumption to decline by 1% over the next year, which would imply the lowest per capita gasoline consumption in twenty years thanks to remote work, more fuel-efficient gas-powered vehicles, the adoption of electric vehicles, and overall inflation curtailing demand.3
Inflation News Improving
Beyond the recent drop in oil prices, inflationary pressures are slowly easing. The consumer price index (CPI) for September was up 3.7% over the last year, well below the peak of 9.1% in June 2022. Grocery prices rose just 2.4%.4 Other gauges of inflation, including the wage growth in the October unemployment report, have come in at or below expectations.5 The fall in oil prices could bring headline inflation down further for October.
Bond Yields Drop
The bond market enjoyed a strong first week of November with the yield on the 10-year Treasury note falling from 5% to 4.6%. The Federal Reserve held off once again on raising rates, and Fed Chair Powell struck a balanced view on whether or not they had finished hiking rates.6 The US Treasury announced a funding schedule with smaller-than-expected increases in debt offerings and warmed to the idea of taking a more market-sensitive approach to the amount of debt it issues at various maturities.7 Lastly, the employment report for October showed job growth slowing, which investors took as a sign that the Fed can avoid raising rates again.5 This past week a disappointing 30-year Treasury auction and some tough talk by the Fed Chair drove the 10-year yield back over 4.6%.8
Bottom line: a lot of progress has been made in the fight against inflation, but the fight does continue with the Fed aiming for inflation to eventually get to its 2% long-term target. The great news here for investors is that the much higher coupons that bonds offer today provide for substantially more portfolio income than two years ago.
Productivity – An AI Boost?
Productivity – the output per hour of work – jumped 4.7% in the third quarter, the fastest pace in the last three years and up from 3.6% in the second quarter. The annual productivity growth since 2019 is just 1.2%.9 Is this the beginning of a longer-term trend thanks to advances in automation and artificial intelligence (AI)? It’s too soon to tell, but the economy is certainly seeing a level of investment going on that is driving renewed growth at computer chip companies, computer manufacturers, and software providers. PC makers are about to launch AI-enabled computers and mobile devices. Business spending on AI is expected to hit $143 billion by 2027, which implies a 73% annual growth rate according to research firm IDC.10 Leading AI supply companies like Nvidia, Dell and Microsoft are trading near all-time highs. Goldman Sachs estimates that AI could boost overall profit margins from 12% to 16% over the next decade.11
What’s in Store in 2024?
In 2024 the economy will feel the full impact of the big rise in both short- and long-term interest rates. We’ll know if the Fed went too far or if they got it right. Will they be able to declare victory over inflation? Will the job market and, therefore, consumer spending just soften or fall apart? Will earnings growth take a significant hit, or will a broad-based productivity rise help profitability at all firms large and small across all sectors? Will another geopolitical crisis occur, or can the turmoil in Eastern Europe and the Middle East find a pathway towards peace and stability? Then there is the 2024 election now less than a year away.
The modern world powers on in spite of dark threats. Breakthroughs in technology, engineering, and medicine accelerate even as political divisions widen. Late 1973, fifty years ago, looked like a horrible time to invest thanks to high inflation, war in the Middle East, the oil embargo, the height of the Cold War tensions with the Soviets, the US struggling in Vietnam, the Watergate scandal, and domestic strife. It was not easy to be a long-term optimist then, but, in time, the rewards were reaped many times over. It has been almost two years since the stock market peak. It is a frustrating time. Patience is being tested, but reasons abound for that patience to be rewarded in time.
Stay on course despite the bumpy ride. The potential for better returns from both stocks and bonds is compelling.
1. Herman, Arthur. “Echoes of the 1973 Oil Crisis.” WSJ, 15 Oct. 2023, www.wsj.com/articles/echoes-of-the-1973-oil-crisis-gaza-israel-pipeline-fossil-fuel-4c5fd928.
2. USAFacts Team. “Is the US Energy Independent?” USAFacts, 14 May 2023, usafacts.org/articles/is-the-us-energy-independent.
3. Short-Term energy outlook – U.S. Energy Information Administration (EIA), 7 Nov. 2023, https://www.eia.gov/outlooks/steo/.
4. Bureau of Labor Statistics. “Consumer Price Index – September 2023.” USDL-23-2185. 12 October 2023. Web. 13 November 2023. https://www.bls.gov/news.release/pdf/cpi.pdf.
5. Smith, Walmon Joseph. “October Jobs Report: U.S. Job Growth Shows Signs of Slowdown.” The New York Times, 3 November 2023. Web. 13 November 2023. https://www.nytimes.com/live/2023/11/03/business/jobs-report-october-economy.
6. Cox, Jeff. “Fed Holds Rates Steady, Upgrades Assessment of Economic Growth.” CNBC, 1 Nov. 2023, www.cnbc.com/2023/11/01/fed-meeting-november-2023-.html.
7. Goldfarb Follow, Sam. “Markets Got an Unexpected Boost From Washington. Will It Mark a Turning Point?” WSJ, 5 Nov. 2023, www.wsj.com/finance/investing/markets-got-an-unexpected-boost-from-washington-will-it-mark-a-turning-point-ad12f950.
8. Wallerstein, Eric. “Stock Market News, Nov. 9, 2023: S&P 500 Closes Lower, Snapping Eight-Day Winning Streak.” WSJ, 9 Nov. 2023, www.wsj.com/livecoverage/stock-market-today-dow-jones-11-09-2023/card/demand-for-30-year-treasurys-proves-weak-sending-yields-surging-oIJ5kBDb2sytqyspLC6x.
9. Mutikani, Lucia. “US Productivity Rises at Fastest Pace in Three Years in the Third Quarter.” Reuters, 2 Nov. 2023, www.reuters.com/markets/us/us-productivity-rises-fastest-pace-three-years-third-quarter-2023-11-02.
10. Savitz, Eric J. “PC Sales Are Ready to Take off Again. It’s All About AI.” Barrons, 2 Nov. 2023, www.barrons.com/articles/ai-pc-dell-hp-stocks-6f117d1e.
11. Daniel, Will. “The A.I. Boom Will Boost Corporate Profits 30% or More Over the Next Decade, According to a Goldman Sachs Senior Strategist.” Yahoo! Finance, 18 May 2023, finance.yahoo.com/news/boom-boost-corporate-profits-30-161954268.html.