Weekly Investment Update (04/26/2024)

We believe it is critical to separate a shifting market narrative from an actual change in underlying fundamentals. In recent months, both interest rates and equity markets have reacted to a perceived change in the trajectory of inflation and path of monetary policy, with rates moving higher and expectations for interest rate cuts being pushed further into the future. On the surface, this week’s GDP report did little to dispute this view, with growth missing expectations (1.6% vs estimates of 2.2%) and inflation looking hotter than anticipated. However, the details of the GDP report were far more encouraging, with key indicators of underlying demand such as private investment and real final sales both growing over 3%. Later in the week, the Fed’s preferred measure of inflation, core PCE, was in line with expectations at 0.3% month-over-month and 2.8% year-over-year. Consistent with solid economic growth, several mega cap technology companies reported earnings this week, with Alphabet, Meta, and Microsoft reporting strong results. Taken together, we maintain our view that inflation will continue to track toward the Fed’s 2% target while economic growth will remain strong enough to support earnings growth. The Fed’s bias will remain toward easing, which we believe is likely in the second half of the year.

Amid Rising Geopolitical Tensions, Supplemental Security Bill Signed Into Law

What is happening: Congress passed legislation this week to provide military and humanitarian aid to Israel and Gaza, Ukraine, and U.S. partners in the Indo-Pacific region, including Taiwan. In addition, the legislation also mandates that the popular Chinese-owned social media app Tik-Tok must undergo a forced sale within 12 months or face a ban from operating within the U.S. A confluence of recent events played a role in pushing the long-awaited security deal over the finish line, including a recent escalation in tensions between Israel and Iran, Russian battlefield gains in Eastern Ukraine, and former President Trump's tacit approval for a portion of the additional Ukraine aid to be structured as a loan. While aid to both Ukraine and Israel has become contentious, the legislation still passed both chambers with bipartisan support and was signed into law by President Biden.

Why it matters: Both Ukraine and Israel have faced increased military threats in recent weeks. U.S. intelligence has warned that Ukraine is at risk of losing the war to Russia by the end of the year if further aid is not provided. In the Middle East, Israel’s war against Hamas continues alongside Iran's first-ever direct attack on Israeli territory. While most of the incoming Iranian missiles and drones launched at Israel were successfully neutralized, the attack highlighted the threats U.S. allies in the region face from Iran as well as the reliance U.S. partners such as Israel and Ukraine have on U.S. weapons and other military support. We believe additional military spending will benefit defense companies such as Northrop Grumman, a Bessemer holding. A rise in geopolitical instability in Eastern Europe or the Middle East also has the potential to result in volatile commodity markets or supply chains disruptions, two factors that could affect the trajectory of inflation. Partly due to an increased risk of geopolitical instability, Bessemer equity portfolios remain equal weight the energy sector relative to respective benchmarks. For example, we believe Bessemer holding Chevron is well positioned to benefit from oil price volatility that could result from a further escalation of tensions in the Middle East.

In the Indo-Pacific, aid to Taiwan serves as an important signal at a time when the U.S. is once again focused on Europe and the Middle East. China hawkishness remains an area of rare bipartisan agreement in Congress, further evidenced by the Tik Tok portion of the security deal, regardless of any legal challenges the ban is likely to face.  We remain vigilant in assessing the developing geopolitical situations abroad as well as how U.S. lawmakers respond that could have ramifications on Bessemer portfolios.

U.S. Dollar Strength Reigns Over the Rest

What is happening: The U.S. dollar has appreciated 4% year-to-date, remaining strong as central bank policy in the U.S. appears set to diverge relative to developed international peers. The European Central Bank, Bank of England, and Bank of Canada signaled that they are prepared to cut their policy rates in June, while the probability of a June cut by the Fed has decreased.  

The U.S. dollar has strengthened in recent years due to strong domestic growth and elevated interest rates. Specifically, from 2009 up to February 2020, the U.S. experienced its longest economic expansion. The expansion continued once businesses were permitted to resume post shutdowns caused by the pandemic. Second, U.S. corporate profit margins widened, enticing foreign investors to purchase U.S. equities. Likewise, yields earned on U.S. bonds were more compelling than alternative developed market bonds. Lastly, the U.S. dollar benefits from its status as a safe-haven currency. Accordingly, when global economies weaken, as was the case during the Global Financial Crisis, the Covid pandemic and the Russia-Ukraine War, investors flee to U.S. dollars.

Why it matters: The U.S. dollar index has been on an upward trajectory since before the Global Financial Crisis, up 46% as of March 2024. A focus on the dollar will likely garner more attention as the U.S. presidential race progresses and our trade policy with China evolves. A stronger U.S. dollar has pros and cons. On one hand, it can contain inflation and encourage foreign flows into U.S. capital markets — a dynamic that bolsters wealth and lowers the cost of capital. On the other hand, the U.S. has run a current account trade deficit at the detriment of U.S. manufacturing. Bessemer has maintained an overweight to U.S. equities and, therefore, has benefitted from the dollar’s recent strength.