Dangerous Liaisons

There is a global shortage of ammunition. Increased demand due to the war in Ukraine and the conflict in Gaza has been compounded by a shortage of gunpowder.

Russia’s invasion of Ukraine has been a seismic event for NATO and defence spending. Years of under-investment, exacerbated by support for the global pandemic and energy crisis, has been laid wide open by the risk of Donald Trump becoming US president and withdrawing financial support for both Ukraine and NATO. However, globally, military thinking has shifted materially with the US moving from counter-insurgency investment in theatres like Iraq and Afghanistan, to the long-term challenge of China in the Pacific and protecting Taiwan.

UK and European defence companies which have been seen as pariahs, are now entering a golden age of investment. Companies are seeing order books stretching out as much as 10 years out and customers paying cash upfront to support a significant ramp up in production capacity.

A report from Germany’s largest economic think-tank, the Ifo institute, has estimated that European countries have enjoyed a €1.8trillion ‘peace dividend’ – the amount spent on defence compared with the 2% NATO target -since 1991. Meanwhile, Ukraine has consumed most of NATO’s weapon stocks which are only now just starting to be replenished. Europe needs to address up to 30 years of under investment in defence. In addition, there is the ‘Trump factor’ with Charles Michel, President of the European Council saying ‘We can no longer count on others or be at the mercy of election cycles in the US or elsewhere.’ In the UK, Grant Shapps has called for defence spending to rise from a target of 2.5% of GDP to 3%, but some suggest this would cost an additional £157bn by 2030.

With the war in Ukraine, the Russian economy on a full war footing, escalating tensions in the Middle East and China’s long-term ambition regarding Taiwan as well as Europe’s rearmament cycle, the outlook for defence spending looks robust. The problem for western governments is going to be how to fund the increased defence spending requirements, given all the other demands.

What have we been watching?

Gold climbed to a record high as the situation in the Middle East continues to escalate and central banks, particularly China, continue to buy the precious metal. It may also reflect expectations for the first US interest rate continuing to drift outwards as Federal Reserve (Fed) Chair Jerome Powell warned that ‘lowering too soon could be quite disruptive.’ US futures look to be shifting from the possibility of three rate cuts this year to two. The latest US jobs data was much stronger than expected, further dampening interest rate cut expectations. The yield on 10-year US Treasury stock climbed above 4.4%. The latest US inflation data is due this Wednesday. Elsewhere, there was some encouraging news for the European Central Bank (ECB) as inflation came in slightly lower than expected which looks supportive of a June rate cut.  The next ECB meeting is later this week.

Russia is reported to be planning a major new offensive in the Donetsk region to overwhelm the Ukrainian forces while they continue to suffer from ammunition shortages.

President Joe Biden and Xi Jinping had a ‘candid’ call in the first talks since November covering Taiwan, Tik-Tok and sanctions among other issues in nearly a two-hour long discussion.

Taiwan suffered a 7.4magnitude earthquake. Taiwan manufactures around 65% of the world’s semiconductors and production is likely to have been temporarily disrupted.

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In the UK, the Cold Chain Confederation warned that the new ‘common user charge’ that companies will have to pay to import food from the EU due to Brexit could feed through into higher food prices. Meanwhile, the latest YouGov poll suggests the Conservatives are on course for their worst result in a general election since John Major’s defeat in 1997, with Labour sweeping into power with more than 400 seats.

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Eurozone inflation dropped from 2.6% in February to 2.4% in March which was slightly lower than expected. Core inflation was also lower than expected at 2.9%. Interest rate futures are still suggesting the first rate cut from the ECB in June.  The latest ECB meeting minutes show the committee ‘agreed that the case for considering such a move was building.’

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The US manufacturing sector continued to grow in March, albeit at a slightly slower pace, with a PMI reading of 51.9. Meanwhile, activity in the service sector dropped to 51.6 in March but more importantly for the inflation outlook, the prices paid monitor dropped from 58.4 to 53.4.

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Confidence among Japan’s largest manufacturers slipped slightly in March according to the latest Tankan survey.  However, activity in Japan’s manufacturing sector picked up slightly in March with the PMI indicator up to 48.2. Japanese manufacturers have raised factory prices at the fastest pace since December to protect profit margins.

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China’s factory activity grew for the first time in six-months with the PMI indicator moving into expansion in March with a reading of 50.8.

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Brent oil moved above $89 on the latest developments in the Middle East and news that OPEC+ is extending its voluntary 2.2million barrels-a-day production cut into the second quarter of 2024.

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Finally, Thames Water has recently made the headlines for all the wrong reasons as it continues to suffer cash flow problems and sewerage spills. Whatever your view of water sector privatisation, the management team of Thames Water, regulator Ofwat or private equity ownership, what a sad day for the Cambridge and Oxford Boat Race when the winning cox cannot be thrown in the Thames due to the risk of E. Coli. How ironic that Thames Water, which needs more cash, appears to be facing an equity drought!

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Alpha Portfolio Management is a trading name of R C Brown Investment Management PLC which is authorised and regulated by the Financial Conduct Authority.