For those of you who would prefer to listen:
There will be a major meeting in the Bay Area next week. The World will be watching. Presidents Biden and Xi will sit down, face-to-face, in a significant engagement for the top economic powers. It will be the first and only in-person meeting for these two leaders this year. They last met at the G20 Summit in Bali in November, a year ago. The perceived desired outcome is “Competition, not confrontation”. That’s the set-up in San Francisco.
The landscape has changed drastically in a year. Things got more complicated with Russia’s invasion of Ukraine in 2022. The War in Israel makes it increasingly so. Election year politics will make it difficult for another meeting in 2024. Taiwan has a key election in January, and of course, our Presidential election comes next November. The stakes for both outcomes are seriously high.
President Xi also plans to meet with Silicon Valley executives while out here. That is an event which seemed completely impossible just 9 months ago when the Pentagon shot down that Chinese surveillance balloon. Tensions between the US and China this year have been at their worst in decades. The fact that the Chinese President is coming to America is a really big thing. The Market seems to like it.
Covid exposed our vulnerability in depending on Asia for strategic and vital things. The United States has been heavily reliant on Taiwan for its sophisticated chip needs; Still is. American companies design the chips. Taiwan manufactures them. This is a national security and economic risk that Congress has tried to address. We also must not forget that China seized Hong Kong early in the pandemic. President Xi knew that nobody would stop him. The Chinese President has similar aspirations for Taiwan. He’s on record stating he wants the military capability to do so by 2027. Many believe the ease in which Xi took Hong Kong without consequence makes a Taiwan grab very likely. The potential for conflict in the South China Seas would disrupt American access to those essential high-end chips. These are the digital brains of Silicon Valley’s output. Chips are the prize in the 21st century, much like Oil was in the 20th.
Here’s the thing. It’s not just about American access. Washington has been blocking chip sales to China of late. China is a massive market for US chip companies too. If US firms are denied access, they argue they have less money available to invest in US production capabilities. Intel CEO Pat Gelsinger said, “Right now, China represents 25% to 30% of semiconductor exports. Right, if I have 25% to 30% less market, I need to build less factories.” That would mean less jobs on American soil. The issues need to be weighed effectively. The White House needs to walk that thin line.
There’s also this: Taiwan Semi has delayed production plans for its Arizona facility. The company has struggled to find qualified workers while also navigating the requirements for labor unions. Part of the problem is American students’ STEM (Science, Technology, Engineering, and Math) scores continue to decline relative to the rest of the World. That means there are fewer qualified workers here. The lack of a coherent immigration policy makes it difficult for chipmakers to hire and retain skilled foreign workers. Immigration is such a critical issue ahead of the 2024 election, which impacts so much of the American way of life.
From our Washington sources: “Unlike the US, Taiwan has a sustained and coordinated commitment to semiconductor production that includes an educational and vocational system to produce a pipeline of qualified workers. Taiwan’s devotion is based on an existential “silicon shield strategy” where it believes the US will be more inclined to defend it if the US remains dependent on it for its advanced semiconductor needs. As a result, some question whether TSMC will ever be willing, or allowed, to produce its most sophisticated semiconductors in the US since it could make the US less likely to come to Taiwan’s aid from a Beijing invasion.”
If the current Taiwanese ruling party stays in power, Beijing will likely increase its aggressive military activity in the region to intimidate Taiwan. That, according to our sources. “Some question whether China’s economic struggles make it more or less likely to pick a fight with Taiwan. Some believe Xi Jinping will be less inclined to invade, given domestic problems. Others think he may welcome the distraction from internal challenges. Some fear that Xi may try to seize Taiwan to gain control over TSMC. If so, there are reasons to wonder whether TSMC would still be able to continue to access the materials and expertise from foreign suppliers needed to preserve its technological edge.”
China believes the United States uses “national security” concerns to prevent its global rise. It impacts all things economic, military and geopolitics. In response, China has begun applying similar “national security” concerns to justify its actions. Beijing has targeted American chip companies. It’s also flexed its muscles with its dominant position as a critical minerals supplier for batteries to disrupt the White House green energy transition.
What’s the goal in this meeting, you might wonder. It is not expected to lead to many, if any, major announcements, and differences between the two powers certainly won’t be resolved. That said, the fact that the two leaders are meeting and talking is significant. Communication is key, particularly if you’re at odds with one another. But they both want something out of it.
According to our sources, these top the list:
For Xi, a top request will be an end to the trade tariffs. President Biden has largely kept the Trump trade tariffs in place from 2018. The former President has said he would double-down on those tariffs if he is elected next year. There is little to no political incentive for Biden to change the status quo. Don’t expect anything new here.
China would also like to see a removal of technology curbs. The Biden administration has implemented controls preventing Chinese companies from acquiring advanced semiconductors. This has bipartisan support. Lifting the bans has zero chance ahead of the election. Beijing seems to understand this. China is spending aggressively to build its own domestic chip plants. This is also another reason why Taiwan is so important.
President Biden is expected to push for a Chinese crackdown on fentanyl. Both nations have blamed each other for the opioid crisis. However, private Chinese firms export many of the chemicals used in creating the highly potent fentanyl before it’s trafficked into the US. Washington has made it clear they want more cooperation from China to address the crisis.
The American President may push Xi for more transparency over everything, from China’s nuclear arsenal and its Belt and Road spending to how it manages its economy. For example, Beijing stopped providing data on the nation’s youth unemployment rate after it hit record highs. There’s a black hole for data in China, which makes it very hard to invest in. President Xi would like to see a return to foreign investment in China. This is an area in which they might find some common ground.
Back to the Market:
Stocks sold-off sharply on Thursday, breaking the 8-day rally. The trigger was a very weak Treasury auction. It was quite telling. Demand for longer-term US debt is shrinking. The 30-Year auction priced at a 4.77% yield. That was 5 basis points above where the Market was trading. This might seem small, but it was the largest tail to current going back to 2016. The bid-to-cover ratio was the worst in 2 years and primary dealers were forced to take nearly 25% of the auction. That’s twice normal. The 30-Year auction was a complete contrast to the 3-Year offering. The takeaway is there is substantial demand for short-term US debt. But looking further out, investors are showing their caution with their wallets as America’s debt keeps building with no signs of spending cuts actually happening. This is new.
The benchmark 10-Year Treasury yield closed out the week at 4.6%. It was 4.50% a week ago. It was 5% 2 weeks hence. Yields have an inverse relation to price. Higher yields mean lower prices in Bondland. Of course, the reverse is true too. The Stock Market has been running in November on the back of lower yields. When yields rise, stock prices have been falling too.
The price of Oil has sunk. WTI fell 15% since the spike off the Israel attack. It has fallen to $75 per barrel. The United States is producing 18 Million barrels per day. That’s the highest ever. That might surprise many, considering it’s happening during the Biden administration. The Saudis have been cutting production in attempts to pump up the price. It hasn’t worked. Demand has slowed, which is playing a role. But both Russia and Iran have been pumping up production to generate much-needed revenues to keep their systems running. What they do with those revenues is a source of controversy and great debate. It’s not to the benefit of America. The answer is clearly playing a role in Israel and Ukraine. Presidents Biden and Xi best be talking about that in the Bay Area next week.
The one-day sell-off didn’t last. Stocks rallied into the weekend. November has been green on Wall Street. A welcome response to the previous 3-month declines. The S&P is in the midst of a pretty tight trading range as the year nears an end. 4200 has held 2 attempts in the sell-off. 4600 is the year’s high. The S&P closed Friday smack dab in the middle. We shall learn a lot more next week, and suspect the seasonal strength will remain. There are never guarantees. Friday, after the close, Moody’s put the USA on credit watch for a downgrade. This is the last remaining AAA rating. We covered this topic at length earlier in the year. Click here if you’d like to re-read.
Panda Bears left the National Zoo this week. Their leases expired. Pandas have lived there for over 50 years. This cannot be a coincidence. Beijing gifted a pair of them to the US to commemorate President Richard Nixon’s visit to China in 1972. There are only 4 pandas left in an American zoo from China. They’re living at Zoo Atlanta. That lease expires next year. If returned, it would mark the end of an era of “Panda Diplomacy.”
For decades, China has given the gift of panda bears to various countries in pursuit of better relations. Its origin began in 1941. China was under siege by Japan in World War II. The United States had been sending aid to the Chinese nationalist government. Madame Chiang Kai-shek, the First Lady, wanted a dramatic way of saying thank you. She sent 2 pandas to America by ship. The destination was San Francisco. Notably, the pandas were crossing the Pacific when Japan bombed Pearl Harbor. They made it through the Golden Gates safely. China changed its Panda policy in 1984. Bears were leased instead of given as a gift. This week, the lease expired in Washington. Perhaps if talks go well next week, we could see a return for the black and white critters. It could launch a new era of Panda Diplomacy, which the World could really use.
Saturday is Veterans Day. Its roots go back to World War I. The holiday grew out of the commemoration of Armistice Day, when fighting between the Allied countries and Germany ended on the 11th hour of the 11th day of the 11th month of the year. We at Bedell Frazier pay honor to those who served our great nation.
Have a nice weekend. We’ll be back, dark and early on Monday.
Mike
