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On China’s Bear Market & North Korea’s Heist
The global AI rout last week hit China’s stocks hard. If China’s AI trade was a bubble that now has burst, William says, President Xi’s push dream of a “Wall Street East” could pop as well. An AI bust would only reinforce households’ perception of Shanghai as a casino, with odds set by the Politburo, thwarting Xi’s push to steer household savings into stocks, particularly tech stocks. … Also: The North Korean government is under investigation for stealing $6 billion in cryptocurrency, the largest crytpo theft to date. The breach exposes crypto’s vulnerabilities and puts China, North Korea’s chief benefactor, in a sticky spot.
Could Midterms Give Wall Street A Cold Shower?
I. When Gridlock Isn't Good for Stocks The US midterm elections will be over tomorrow night. According to betting markets, Democrats have roughly a 95% probability of winning the House and a 76% probability of taking the Senate (charts). We suspect that stock investors have yet to fully discount the possibility of a Democratic sweep of Congress. Some may remain skeptical that polls confirming strong support for Democrats are accurate. They might reckon that Democrats are more likely than Republicans to talk to pollsters over the phone. In any event, Wall Street traditionally welcomes political gridlock because it reduces the likelihood that Congress will pass extremist legislation. But this time could be different for two reasons. First, deepening partisanship could turn gridlock into damaging political paralysis at a time when the Bond Vigilantes are already uneasy about Washington's unsustainable fiscal trajectory. A Democratic sweep could complicate negotiations over government spending and the debt ceiling. Prolonged shutdowns and fiscal standoffs could push Treasury yields higher, weighing on equity valuations. Second, gridlock's traditional ability to constrain policymaking may not hold this time. President Donald Trump has relied heavily on executive authority, with some of his most market-disruptive policies, including tariffs and military action against Iran, pursued largely without congressional approval. A Democratic-controlled Congress may therefore do little to restrain him. Moreover, with the midterms behind him, Trump may feel even less constrained politically and more willing to pursue controversial policies through executive action. Hence, a blue wave could deliver a cold shower for stocks, though we would view a significant selloff as a buying opportunity given the remarkable strength of the economy and corporate earnings. One encouraging development ahead of the elections was today's reports that the US and Iran are working on a peaceful diplomatic solution to their war. Iranian President Masoud Pezeshkian said he has granted his government greater authority to pursue peace talks, while President Trump and Vice President Vance also signaled progress. Hopes for a deal sent the price of Brent crude oil down 7.6% to $104.77 per barrel (chart). However, we have been here before with apparent diplomatic breakthroughs. We still see a high risk of military re-escalation. The bid-ask spread remains wide, with Tehran demanding sanctions relief, the release of frozen assets, and an end to the US naval blockade of Iranian ports, while Washington insists on nuclear concessions. Meanwhile, Iran's leverage over the Strait of Hormuz has been weakening. According to shipping data, for roughly half of September, Gulf oil exporters shipped more crude than they were shipping before the war. II. US Economy Continues To Roar The US economy remains strong despite the volatility of the domestic political and geopolitical scenes. Consider the following: (1) Construction spending. Construction spending fell 1.9% m/m in September to $2.19 trillion (saar), reversing most of August's upwardly revised 2.0% increase. Nevertheless, spending remains just below last year's record high (chart). September's decline was driven by a 5.5% m/m drop in private residential construction, attributable to a 13.0% plunge in home improvements (chart). Elevated materials costs and higher mortgage rates continue to weigh on the housing sector. Meanwhile, private nonresidential construction rose 1.1% m/m, supported by continued investment in data centers and power infrastructure. The AI investment boom remains a powerful tailwind. Data center construction spending surged 8.6% m/m and 90% y/y in September, reaching a record $96.5 billion annual rate (chart). (2) Manufacturing. The ISM M-PMI rose from 54.5 in September to 55.5 in October, marking its tenth consecutive month of expansion, the longest streak since 2022. Production jumped to the highest reading since November 2021, while new orders edged up to 55.5. Employment also remained in expansionary territory (chart). Inflationary pressures remain troublesome. The prices-paid index eased from 77.9 to 75.2 in October but remained above 70 for the ninth consecutive month. Regional Fed surveys also point to persistent price pressures. Higher energy costs, tariffs, and elevated metals prices continue to boost input costs (chart). (3) Bank lending. The Fed's latest Senior Loan Officer Opinion Survey (SLOOS) painted a mixed picture of credit demand. Banks reported weaker demand for commercial and industrial (C&I) loans, mortgages, and auto loans in Q4, while credit-card demand strengthened (chart). Lending standards remained broadly unchanged for C&I loans but tightened somewhat for commercial real estate loans (chart). Encouragingly, actual bank lending tells a happier story. C&I loans surged 11.3% y/y through October 21, while total loans and leases increased 7.9% y/y (chart). Credit growth is broad across bank sizes, with lending up 8.1% y/y at large banks and 5.4% at small banks (chart). Meanwhile, banks' allowances for loan and lease losses have remained relatively stable at around $202 billion, despite the acceleration in lending (chart).
Some AI Lessons In A Booming Economy
Today, Elias and Ed examine lessons that emerged from last week’s financial market turbulence. While stock investors soured on AI-related stocks, pulling the S&P 500 down despite good performance from most sectors, the week yielded several insights that are encouraging for the AI trade. … Less encouragingly, last week showed how little tolerance investors now have for under-delivering AI companies. Analysts with unattainably high estimates are to blame for that. But at least such investor skepticism inhibits bubble formation. … Also: The US economy is firing on all cylinders, as the release of Q3 real GDP growth shows, and underlying demand was even stronger than the headline number suggests.
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