Market Recep & Tensions in the Red Sea (Weekly Insights 01/22/2024)
WEEKLY MARKET RECAP –
MEGA-CAP TECH TRADE REGAINS MOMENTUM; S&P 500 AT ALL-TIME HIGH
Equities: The MSCI AC World Index declined for the second time in the past three weeks led by weakness in international markets. The MSCI Emerging Market Index fell for the third consecutive week led by weakness in Asia. Within the U.S., large cap growth stocks led the S&P 500 to a fresh new record high. The strength in large cap tech was due to optimism about inflation expectations declining.
Fixed Income: The Bloomberg Barclays Aggregate Index was lower for the second time in three weeks. Treasury yields moved higher after hawkish Fed comments that suggested the path to rate cuts will be slower than markets anticipate. Floating rate instruments and leverage loans were the only area of fixed income to post a gain for the week.
Commodities/FX: The Bloomberg Commodity Index was lower for the second straight week. Despite frigid temperatures across the U.S., natural gas prices plummeted as storage remains full and delays are mounting given the crisis in the Red Sea. Gold prices fell for the second time in three weeks as expectations for an early Fed rate cut were slashed.
TENSIONS IN THE RED SEA
KEY TAKEAWAYS:
- Increasing geopolitical tensions.
- Houthi terrorists joining the Middle East conflict.
- Shipping costs are surging.
- Supply chain pressures could increase.
- Red Sea tensions put the Federal Reserve on the defensive.
It has been just over 100 days since Hamas launched an unprecedented attack on Israel which has sent geopolitical shockwaves through much of the Middle East and abroad. One of the risks to global markets is a larger, regional conflict breaking out in the Middle East which has the potential to disrupt trade and strain geopolitical relations. While we are not geopolitical analysts, we are watching the situation in the Middle East closely as it relates to potential investment implications.
- Red Sea hostilities: The prolonged war between Ukraine and Russia and fighting continuing between Hamas and Israel has escalated geopolitical tensions and hostility is now spreading to other extremist groups. Recently, the Houthi’s, an Iran-backed militant group in Yemen, have been attacking merchant ships in the Red Sea. The group has expressed that the attacks will continue until Gaza receives the aid they need. The group has stated their intention to continue attacks, regardless of the ship’s nationality or where it is going. As a result, the U.S. has led a multinational military operation in response to the attacks to protect merchant ships in the Red Sea.
- Houthi militant attacks: There have been ~25 instances of conflict in the Red Sea since late November. Originally the attacks were targeting shipping vessels that support Israel but have since turned into indiscriminate attacks. This is impacting the global supply chains and shipping costs. According to statistics from Xeneta, ocean freight shipping rates between the Far East and North Europe have increased by 124%, while rates between the Far East and U.S. East Coast have increased by 45%1.
- Importance of the Red Sea: The Red Sea is a vital shipping and trade route between Asia, the Middle East, Europe, and North America. The Suez Canal connects the Red Sea to the Mediterranean Sea, making it the shortest trade route between Europe and Asia. Roughly 12% of global commerce uses this waterway1. Shipping companies have said they are avoiding the Red Sea given the increased attacks, detouring ships traveling from the Far East to Europe around Africa via South Africa’s Cape of Good Hope. Companies are now facing increased shipping times, adding about 10 days on average to their travel1.
- Consumer impact: Raw materials and consumer goods are being affected along the supply chain. According to Bloomberg, ~6 million barrels of crude oil and ~1.6 million tons of grain have been diverted from the trade route.2
THE BOTTOM LINE:
The biggest risk at this point from the escalating geopolitical tensions in the Red Sea is the upside risk to inflation. While some Economists have downplayed the impact on inflation we are concerned of the impact this can have on the supply chain and then what it can do to inflation data. We have seen what the damage that disruptions to the supply chain have done to inflation in the past and we have finally repaired the flow of global trade from the pandemic. We can also look at history as a guide to what the impact can be on the supply chain. In 2021, the grounding of a major container ship (which blocked the Suez Canal) held up $9.6 billion worth of goods each day.3 We will continue to monitor these events and what it means for the economy. It puts the Fed in a difficult situation and investors should not be optimistic about aggressive rate cuts this year.
3. https://www.bbc.com/news/business-56533250