By Avi Deutsch
November 11, 2023 – I recently returned from spending several weeks with my family in Israel. The mood there, which after the murderous Oct 7th attacks could only be described as existential despair, has morphed into one of righteous anger. Israelis know how to come together in difficult times, and civil organizations have stepped up in incredible ways to fill the void left by a bumbling government. The people’s confidence in the Israel Defense Forces has also rebounded from the blow it suffered on that darkest of Saturdays. Israel took a punch to the face, but it’s back in the fight.
For many Israelis, President Biden deserves a lot of credit for this turnaround. Biden is hardly a supporter of Israel’s Prime Minister, Benjamin Netanyahu, and I suspect there are many aspects of Israel’s current action in Gaza that he struggles with. But through it all, Biden quickly recognized that October 7th marked a critical juncture in the global power struggle. Biden has long sought to solidify and expand American alliances in the Middle East, and the battle against terror organizations is a common cause with many Arab countries, even if their leaders cannot acknowledge this publicly.
Opposing the US in the Middle East is, first and foremost, Iran. What was a quiet war is now an overt one, with Iran operating forces in Lebanon (Hezbollah), Yemen (Houthis), Gaza (Hamas), and Syria (Iran’s own Islamic Revolutionary Guards Corps) both against the US directly and against its ally Israel. Iran has spent years building proxy armies as a tool for power expansion, and it’s beginning to commit these forces in earnest.
Watching from the sidelines are China and Russia, who have not intervened directly but have used their state media organizations to support Hamas. This move is a part of a growing alliance between China, Russia, and Iran, the latter of which was invited to join the BRICs Block back in August. Though these actors have their own interests, they are bound by a desire to restore their power and prestige to their historical peaks, in opposition to the US hegemony.
Beyond the local context, the war in Gaza should be viewed as part of this global struggle for power, with implications for investors that go beyond the volatility in oil prices. In the immediate time frame, the US will have to replace the munitions it’s sending to Israel and Ukraine, as well as find a way to fund the aid package for Israel in what is becoming another congressional battle.
Over the longer term, the events of the past month will join the Ukraine war in pushing the US to strengthen its military forces. After two long wars in Iraq and Afghanistan, the US military has a long way to go to prepare for a more conventional war against one or more opponents. This has real implications for the US economy. The funding will have to come from increasing the already large deficit, or from budget cuts. Both these options seem almost impossible to conjure in our fractured Congress.
Finally, increased defense spending may hamper the Fed’s attempt to bring inflation down to its 2% target. This could mean higher rates for longer, unless the Fed decides that interest rates cannot fix the structural issues of the US economy, namely the shortage of employees, and agrees to live with higher inflation.
There is much more to be said about the events taking place in Israel and Gaza, and my perspective on these difficult issues is anything but unbiased. I invite anyone who is interested in discussing these matters further or has questions that I can try to answer to reach out to me directly.
I wish us all more peaceful times ahead. May the families of the bereaved know no more sorrow.
With that, I turn to the US economy and markets.
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Never have investors been so excited about rising unemployment. Such are the capital markets of 2023, in which the most dominant player is the Federal Reserve. A slight increase in October’s unemployment rate to 3.9%, coupled with the lowest number of new jobs since June, sent the 10-year US treasury falling from a high of 4.9% earlier that week to a 4.5% at Friday’s close (remember that for bonds, yield down means price up). Equity markets also rallied, with the Dow rising 5% in just one week.
In what has now become a tired routine, investors continue to look for clues that the Fed’s interest rate hikes are coming to an end. The good news about the economy is bad news for investors who fear more rate increases. The bad news is good news if it means that rates might have to come down. The pendulum swings are nauseating.
In all, labor market and manufacturing data do suggest that the economy is slowing, though to what extent is open to debate. As a result of this slowdown and cooling inflation, investors now see a 90% probability that the Fed will keep rates steady at its December meeting, and a 51% chance that rates will decrease by May of 2024.1 It would be wise to take these predictions with a teaspoon of salt. As we’ve seen earlier this year, the US economy, led by the US consumer, is surprisingly resilient. While no one expects a repeat of Q3’s 4.9% GDP growth in Q4, don’t be surprised if rumors of the demise of the US economy are greatly exaggerated.
If Fed officials sometimes sound perplexed about what’s happening with the US economy, they are far from alone. Stock market investors have also struggled to reconcile Q3’s strong earnings reports with news of a slowing economy. Add to that the global turmoil coming from the Middle East and Ukraine, coupled with an increasing uncertainty about the Chinese economy, and the confusion in the markets is palpable. Stocks started October with a climb, dipped to their lowest level since March, before rebounding in November to their October peaks. As of early November, the MSCI All Country World Index (ACWI) is hovering around a 10% YTD gain, well below its August peak of 17%.
The uncertainty and volatility of the last month are a good reminder of some tried and true investment principles. First, bond yields can move quickly, and investors who want to lock in the higher yields we’re currently seeing should be careful about trying to time interest rate peaks. Similarly, the adage ‘stay invested’ continues to hold true in the stock markets of the last few weeks. Especially in periods of turmoil, it’s important to trust the process.
— AMD