China visit goes smoothly

Chinese President Xi Jinping visited the United States for the first time in six years this week while attending the APEC summit in San Francisco. This much-anticipated visit included his first face-to-face meeting with President Biden in a year. The goal for both sides was to normalize relations, which have been strained over the last year. Both sides acted cordially (mostly) while attempting to address important areas of focus, including the wars in Ukraine and Israel and bilateral trade and military cooperation.

• US/China relations began to strain under the Trump administration and continued during Biden’s first term
• One of the main areas of tension has been the United States taking a hard line on what they have viewed to be unfair trade between the two countries
• US tariffs and sanctions have caused many US companies to begin to divest from manufacturing capacity in China in favor of friendly countries like India, Vietnam, and Mexico
• This has put pressure on China’s economy, which was already struggling given their harsh COVID-19 policies
• The reinstatement of direct military contact was a big accomplishment, given this has been cut off since Nancy Pelosi visited Taiwan in 2022
• However, it does not seem much progress was made in understanding which side China is on as it pertains to the several current wars
• Biden did refer to Xi as a dictator in an off-the-cuff remark, which could end up de-railing some of the progress made
• It will be interesting to see China’s actions over the coming months and years to determine whether or not our relationship has been salvaged truly

Inflation report for “deflationistas"

The latest Consumer Price Index (CPI) and Producer Price Index (PPI) were released this week, showing an even greater moderation in inflation, causing some discussion of deflation. Both CPI and PPI came in below expectations, with the former showing a 4% year-over-year gain, the lowest reading since September of 2021. PPI showed an outright decline in October, the largest decline since the throes of COVID-19 in April 2020. Year over year PPI still showed a modest 1.3% gain, but down significantly from the 2.2% reading in the prior month.

• These reports further solidified market views that the Federal Reserve is done raising interest rates
• Markets are trading as if the Federal Reserve has executed a perfect soft landing, which is being able to slow inflation without causing recession
• However, futures markets now show a 40% chance of rate cuts in the second quarter of 2024
• The Fed would only lower interest rates if the economy was showing significant signs of weakness
• Futures markets are by no means an accurate indicator; however, this has strengthened the argument of those who have been pointing to the lagging effects of interest rate hikes on the economy
• Many in this camp have been saying that we will eventually experience outright deflation, causing the Fed to cut interest rates aggressively
• As always, we don’t put too much weight in prognosticators, choosing instead to be positioned in a balanced manner as we have been all year

Small cap stock opportunity for active management

As discussed ad nauseam this year, the rally in stocks in 2023 has been led by just a handful of stocks, dubbed the “Magnificent 7.” What has been less discussed is the difference in performance between large-cap stocks more broadly and small-cap stocks, which has been the largest in 25 years. After a significant rally beginning earlier this month, the S&P 500 (which represents large-cap stocks) is now up over 17% for the year, while small-cap stocks, represented by the Russell 2000 are up just short of 2% for the year.

• Small-cap stocks are usually smaller companies that have different characteristics than their large-cap counterparts
• One factor is interest rates, which small-cap companies are more sensitive to given their reliance on floating-rate debt
• As interest rates have risen and remained high, smaller companies have been disproportionately affected, having to incur higher debt service
• Another factor is the profitability, which smaller companies are disproportionately less so than larger companies
• On the other hand, small-cap stocks have a more moderate multiple, providing an opportunity for cheap high-quality companies to outperform the broader indices
• This is yet another part of the market where we believe active management can produce better results than a passive-only strategy

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