US and China agree on trade deal framework, Bessent says he has narrowed down Fed Chair choices to 5

Key Concepts

• US-China Trade Deal Framework: Agreement on a preliminary framework for a trade deal between the US and China, raising optimism for de-escalation of the trade war.
• Magnificent 7 Earnings: Upcoming earnings reports from major tech companies (Microsoft, Meta, Alphabet, Apple, Amazon) are a key focus, with AI being a significant driver.
• Federal Reserve (Fed) Rate Cut: High certainty of a 25 basis point rate cut by the Fed this week, influenced by cooler inflation data.
• Fed Independence: Concerns about potential political influence on the Federal Reserve, despite existing mechanisms to protect its independence.
• Artificial Intelligence (AI) Investment: Massive capital expenditure by tech giants on AI, driven by customer demand and long-term contracts, but with some "bubbleicious" aspects related to debt-funded off-balance sheet investments.
• Rare Earths: China's significant control over rare earth minerals and potential export restrictions remain a sticky point in US-China trade negotiations.
• Soybean Purchases: China's commitment to substantial US soybean purchases, with questions about near-term implementation.
• Fentanyl, TikTok, Shipping Tariffs: Consensus reached on these topics in trade talks, but details remain vague.
• Crypto Miners and AI: A trend of crypto miners pivoting to provide computing power for AI, leading to significant stock gains.
• SoftBank's OpenAI Investment: SoftBank's substantial investment in OpenAI, one of the largest private tech funding rounds.
• Automotive Industry Shift: Carmakers, including Porsche, are shifting strategy away from a full focus on electric vehicles, which is being welcomed by markets.
• US Administration Policies and Auto Industry: The impact of US administration policies on US automakers, particularly regarding tariffs and competitiveness.
• Bitcoin and Gold: Bitcoin's rise driven by trade deal optimism, while gold prices fall for the same reason.
• Asian Markets: Surge in Asian stock markets, with Nikkei and Kospi hitting record highs.
• European Markets: Flat performance in European markets, with anticipation of ECB interest rate decisions.
• Argentine ETF: Significant pre-market gains for an ETF linked to Argentina following President Javier Milei's election win.

US-China Trade Deal Framework

The US and China have agreed on a "very positive framework" for a potential trade deal, according to Treasury Secretary Scott Bessant. This agreement is seen as a significant step towards de-escalating the ongoing trade war. President Trump landed in Japan, his second stop on an Asian tour, following a visit to Malaysia.

Key Points:

• Framework Agreement: A preliminary agreement has been reached, with both US and Chinese state-run media reporting progress.
• Tariffs Off the Table: Treasury Secretary Bessant indicated that 100% tariffs are "effectively off the table."
• Market Reaction: This news has boosted investor optimism, leading to gains in assets like Japanese stocks, the Australian dollar, and Bitcoin.

Remaining Challenges and Sticky Points:

Despite the optimism, several major questions and challenges persist:

1. Rare Earths: China's dominant control over rare earth minerals, crucial for electronics, remains a significant issue. Reports suggest that Washington and Beijing may be postponing decisions on this matter, with China potentially delaying export restrictions by one year. This has led to gains for some international miners but losses for US-based firms like USA Rare Earths.
2. Soybeans: China has committed to "substantial purchases" of American soybeans. However, the near-term feasibility is questioned, given China's recent large purchases of non-US soybeans. Companies involved in farming equipment will be closely monitoring this.
3. Fentanyl, TikTok, and Shipping Tariffs: While negotiators indicated a consensus on these topics, the details are vague. Differences remain regarding a sale of TikTok, and while China is expected to make commitments on policing fentanyl exports, implementation is a concern.

Outlook:

The upcoming meeting between Presidents Trump and Xi Jinping in South Korea on Thursday is anticipated to be historic, but its significance hinges on the actualization of the agreements. Investors are advised to expect continued market volatility as negotiations progress.

Big Tech Earnings Week and AI Focus

This week is a major one for earnings reports, with five of the "Magnificent 7" tech companies scheduled to announce their results: Microsoft and Meta on Wednesday, followed by Alphabet, Apple, and Amazon on Thursday. A total of 170 companies are expected to report.

Key Points:

• Magnificent 7 Performance: While the profit edge of these tech giants over the rest of the index is narrowing, they are still projected to deliver stronger results. Earnings for the group are expected to rise by 16.6%, compared to 8.1% for the broader index, according to data from Else.
• AI as a Driver: Many of these mega-cap companies are key players in the artificial intelligence (AI) industry, which has been a primary driver of stock market performance.

Company-Specific AI Exposure and Outlook:

• Microsoft: Expected to see the biggest rise in AI-related demand. Its partnership with OpenAI is a significant advantage, with deals signed by OpenAI with Oracle, Broadcom, and Nvidia directly benefiting Microsoft's Azure business. Azure Europe grew 39% last quarter, indicating continued strength.
• Alphabet (Google): Google Cloud is expected to be a fast-growing segment. Alphabet is also beginning to sell some of its own chips externally, potentially impacting Nvidia.
• Amazon: AWS, its cloud services provider, remains the largest player but is growing more slowly due to the law of large numbers.
• Meta: Does not have a cloud business; its AI exposure comes primarily from advertising and infrastructure spending.
• Apple: The strength of the current iPhone cycle is uncertain and may not be fully clear until after the holiday season. Apple is currently the most expensive stock in the Magnificent 7 group on earnings, despite potentially having the lowest growth even in a strong upgrade cycle.

AI Investment Dynamics and Concerns:

Gil Lura, Head of Technology Research at DA Davidson, discussed the massive spending on AI.

• Demand-Driven Investment: Companies like Microsoft, Amazon, Google, and Meta are investing heavily in AI to meet customer demand, with customers committing to long-term contracts for compute capacity.
• Leveraging External Capacity: These companies are also leveraging third-party capacity from providers like Oracle and Coreweave, sometimes through special purpose vehicles that are off-balance sheet. This is where some "bubbleicious" aspects arise, with tens of billions of debt funding capital expenditures away from these companies.
• Prudent Investment by Giants: The core investment by Microsoft, Amazon, Google, and Meta is considered prudent, driven by huge demand for AI deployment.
• Unhealthy Behavior and Related Party Transactions: A concern is the "unhealthy part of the behavior" where companies like Nvidia are creating related-party transactions with entities like OpenAI, Oracle, and Coreweave to expand the market and stimulate demand beyond their core customers. This is often funded by debt with high leverage.
• Speculative Nature of AI Assets: Despite the excitement, AI investments are still speculative, and the assets (like Nvidia's chips) may not yield the same returns in three to four years.

Advertising and Search Market Health:

• Meta and Google: Both companies are performing well in the ad market. Meta grew 22% last quarter, while Google grew 12%. The gap may narrow as election cycles pass.
• OpenAI's Potential Impact: The absence of advertising from OpenAI, which has a large user base, is noted. When OpenAI eventually introduces advertising, it is expected to take market share from Meta and Google, particularly Google. This is not anticipated this quarter but is a future consideration.

Federal Reserve and Monetary Policy

The Federal Reserve is expected to lower interest rates by 25 basis points at its upcoming meeting this week. This expectation is largely driven by cooler-than-expected inflation data released on Friday, which was delayed due to the ongoing government shutdown.

Key Points:

• Market Certainty: The market has fully priced in a 25 basis point rate cut, with 99% of economists also expecting it.
• Inflation Data: September's delayed Consumer Price Index (CPI) data showed that core goods prices are rising more slowly, and core services and rents are also falling. For example, shelter prices rose 0.2% in September, down from 0.4% in August.
• Fed's Approach: The Fed aims to avoid surprising markets. Attention is already shifting to the December meeting, where another 25 basis point cut is anticipated by the market.
• Government Shutdown Impact: The ongoing government shutdown poses challenges for data collection in October and November, making inflation numbers harder to interpret.

Fed Independence and Political Influence:

Treasury Secretary Scott Bessant's comments about the list of candidates to replace Fed Chair Jerome Powell have raised questions about the Fed's independence.

• Political Bent: The fact that a political appointee is discussing potential replacements for the Fed Chair suggests a more political dimension than in the past.
• Protection of Independence: Despite potential political pressure, it is not straightforward to influence the Fed. The courts have previously blocked attempts to remove Fed Governors, citing insufficient cause.
• Complexity of Changing Fed Makeup: Changing the composition of the Federal Reserve committee is a complex process. It requires replacing multiple governors, each with 14-year terms.
• Market Reaction to Loss of Independence: The market would react negatively to any perception that the Fed is not maintaining its independence or its mandate of stable inflation and a stable job market.

Trending Tickers and Market Movements

Mining and Rare Earths:

• Companies like Critical Minerals, MP Materials, and Linus Rare Earths are experiencing significant swings, directly tracking the progress of US-China trade negotiations. China's control over rare earths remains a key factor.

Crypto Miners and AI:

• A notable trend is the pivot of some crypto miners to provide computing power for AI. IN (likely referring to Iris Energy or a similar company) is highlighted as being up nearly 900% in six months, with further gains this morning.

SoftBank and OpenAI:

• Japanese investment fund SoftBank has made a significant bet on American technology by approving the remaining $22.5 billion of a $30 billion investment in OpenAI. This is one of the largest private tech funding rounds ever, leading to speculation about a potential OpenAI IPO.

Pharmaceuticals:

• Swiss giant Novartis is acquiring Aidity Biosciences for approximately $12 billion in cash, a 46% premium. Aidity specializes in neuroscience.

Automotive Industry:

• A trend of carmakers shifting strategy away from a sole focus on electric vehicles is emerging. Following GM and Ford, Porsche has announced its own strategy shift. This move, while potentially concerning from an environmental standpoint, has been welcomed by markets, with Porsche shares initially jumping.
• US Administration Policies and Auto Tariffs: Tom Narayan from RBC Capital Markets discussed the impact of US administration policies on American automakers. A recent policy shift broadened the scope of what parts qualify for a 3.75% offset on MSRP, significantly reducing tariffs for companies like GM and Ford. This is expected to lead to higher consensus numbers for next year and potentially make US-made vehicles more competitive on price against foreign-made cars. The benefit is seen as a net positive, though the extent of direct competition with luxury brands is debated.

Earnings Updates:

• Keurig Dr Pepper: Released its Q3 report, raising its full-year constant currency net sales growth outlook and reaffirming its full-year adjusted earnings per share guidance. Net sales reached $4.31 billion, a 10.7% increase year-over-year. Shares rose nearly 6% in pre-market trading.

Market Overview:

• Bitcoin: Up significantly due to optimism surrounding a potential US-China trade deal.
• Gold: Down for the same reason as Bitcoin's rise.
• Asian Markets: Surged, with the Nikkei breaking the 50,000 level to hit a record high. The Kospi in Korea also reached a new record. Earnings from companies like Samsung, Hitachi, and BYD are expected.
• European Markets: Generally flat, with optimism from other regions not translating. The European Central Bank is expected to keep rates on hold this week.
• Argentina ETF: Up almost 16.5% in pre-market trading following President Javier Milei's election win.
• Wall Street: Trading in the green, continuing its strong performance from Friday.

Conclusion

The week ahead is dominated by significant developments in global trade, corporate earnings, and monetary policy. The framework agreement between the US and China offers a glimmer of hope for de-escalation, though key challenges remain. The upcoming earnings reports from the Magnificent 7 tech companies will be closely watched, with AI investment and its implications being a central theme. The Federal Reserve is widely expected to cut rates, influenced by moderating inflation. Meanwhile, shifts in the automotive industry and the evolving landscape of AI investment present both opportunities and potential risks for investors.