Wentz Weekly Insights
U.S. to Restrict Exports of AI and Cloud Services to China

The past several weeks have seen a series of restrictions on trade between the U.S. and China, specifically over newer technology, for many reasons relating to national security concerns. Although Congress was out on recess until this week, Treasury Secretary Janet Yellen last week was the second cabinet member to visit China over the past month in attempt to keep progress on maintaining the relationship. While there has been no resumption of communication militarily, after then House Speaker Pelosi’s visit to Taiwan, Yellen’s visit focused more on commerce and to prevent escalation between the two. Her meetings comes several weeks after Secretary of State Andrew Blinken visited China which was reported as “constructive.”
Yellen’s two-day trip involved meetings between some of China’s top economic officials in which she attempted to convince China that it is not the goal of the US to seek economic advantage against the country, but rather the actions the US has taken are targeted to safeguard national security.
The U.S. has prepared to take steps to prevent China from accessing chips needed to advance its technology in AI and quantum computing. Two weeks ago, reports surfaced from the WSJ that the Biden Administration was considering new restrictions on exports of AI (artificial intelligence) chips to China. There was no timeline for the rollout of the restrictions, but the report said it would affect many of the new chips developed by Nvidia and AMD and said the administration is likely to wait until after Yellen’s trip to China.
It was a week later the WSJ reported the Biden administration was preparing to restrict Chinese companies from accessing U.S. cloud computing services. These restrictions were seen as a way to close a loophole some national security analysts said would allow Chinese companies to bypass current export controls by using cloud services, allowing companies to gain certain capabilities without purchasing advanced chips such as the AI chips. The U.S. has become increasingly concerned AI could be used to help create advanced weapons or produce malicious computer code.
China responded by announcing new export restrictions on two rare earth metals – gallium and germanium and related products. China said the new restrictions are meant to safeguard national security and interests. The metals are a key input to producing semiconductors and other goods such as chargers, EVs, and telecommunications equipment. China produces approximately 60% of the worlds supply of the two metals.
While the two sides remain in talks, this is something worth following as AI and technology continues to advance. This is unlikely to have a major impact on any U.S. company, but the broader risk is increasing tensions between the top two economies of the world.
Meanwhile, markets were focused on employment data from last week. The monthly ADP employment report, something that typically does not receive as much attention, came in red hot signaling almost half a million jobs were added in June which was double the expectation. The number of job openings fell slightly but there are still 1.6 openings for every unemployed person, a ratio Powell said the Fed would like to see get closer to 1.1. After the DOL’s employment report on Friday came in near expectations, with 209,000 new jobs, economists and analysts were blaming the hot ADP report on seasonal adjustments.
Markets moved lower and treasury yields spiked after the employment reports, with the thinking that if the economy is still so strong where it is adding this many jobs, it would be able to handle higher interest rates.
The next key event investors will be focused on is this week’s inflation data with the consumer price index on Wednesday. The headline level of inflation is expected to continue to move lower in the coming months due to the base effect – high prices in categories such as energy and vehicles this time a year ago will now begin to “roll off” the year ago comparison, so the annual change will be compared to a much higher number and make it appear inflation is lower. We will continue to focus on the monthly readings as well as the change in core prices, which exclude volatile components like food and energy prices, particularly prices in services. The consensus expectation is for core prices to rise 0.3% in June and 5.0% from a year ago, down from the 5.3% pace in May.
Week in Review:
Stocks were little changed to open the week on Monday which was a shortened trading day with markets closing at 1 pm. Auto stocks, specifically EV names, were the outperformers after Tesla reported higher deliveries than expected in the second quarter. Manufacturing data in the morning showed another sharp decline in activity in the sector which has seen negative reading for seven consecutive months. Also, over the weekend, Saudis said they would extend their production cuts by an additional month with Russia saying they would cut production as well. Oil didn’t move much despite the cuts, with stocks closing the day 0.12% higher.
Markets were closed for Independence Day on Tuesday but opened Wednesday mixed in somewhat of a quiet session. Cloud computing stocks were under pressure after reports the US was preparing to restrict Chinese companies from accessing cloud computing services. The FOMC’s meeting minutes from June were released that showed the support for additional rate increases, which markets already knew. All four major indices were lower, but the S&P 500 fared better as some of the mega cap names held up. The index fell 0.20% while the Russell 2000 was down 1.26%.
Thursday morning data included the ADP employment report that showed private payrolls grew double what was expected while jobless claims held steady. This, combined with hawkish commentary from Dallas’ Lorie Logan, the release of the FOMC minutes, and weakness in global markets, had yields moving higher and stocks pulling back. Corporate news included Meta launching its “Threads” in direct competition with Twitter, which later threaten to sue over. Stocks were lower all day although finished just off the highest levels of the day. The S&P 500 fell 0.79% with small caps underperforming, down 1.64%, and Treasuries were weaker with the 2-year up 7 basis points to 5.01% and 10-year at 4.04%.
All eyes were on the employment report Friday morning where it showed payroll gains of 209,000 for June, in line with expectations although wages ticked higher in the month and on an annual basis. Outside of the employment report it was a relatively quiet day. Treasury yields were initially higher but ended mixed with stocks lower for most of the day as the S&P 500 fell 0.29%.
The holiday shortened week saw stocks move lower amid a pickup in Treasury yields over a more hawkish Fed and increased expectations for more rate increases and strong data on the labor market. Bonds were weaker as the yield on the 2-year and 10-year Treasury notes rose to the highest level since the banking crisis, rising 6 basis points to 4.96% and 22 basis points to 4.07%, respectively. Oil ended the week up 4.6% on additional production cuts from the Saudis and Russia, while the dollar index was down 0.6% and gold up slightly. The major U.S. stock indices all finished lower as follows: NASDAQ -0.92%, S&P 500 -1.16%, Russell 2000 -1.27%, and Dow -1.96%.

Recent Economic Data

  • The U.S. PMI index was 46.3 for June, right in line with consensus estimates and falling another 2 points from May’s survey, indicating activity in the manufacturing sector that continues to contract. Survey respondents noted a sharp decline in new orders, near the weakest since the financial crisis in 2009, with demand weakening and export orders falling. Future output expectations declined as well. Despite the drop in orders, employment remained strong with manufacturers continuing to replace voluntary leavers and fill vacancies. Good news again, the prices index fell at its fastest pace in three years.
  • The U.S. ISM manufacturing survey index was 46.0 in June, falling deeper into contraction from 46.9 in May for the seventh consecutive month of contracting. New orders improved but are still declining with the index at 46.6 in June from 42.6, production slowed due to the lack of work and the prices index fell further.
  • The U.S. monthly trade deficit narrowed slightly in May with a deficit of $69.0 billion, shrinking from a deficit of $74.4 billion in April. Exports fell 0.8% to $247.1 billion, while imports fell 2.3% to $316.1 billion. All in, the volume of international trade saw a sizeable pullback in May. The volume of trade fell 1.7% or $9.6 billion to $563.2 billion. Through the first five months of the year, trade activity has fallen $5.7 billion and over the past year is down 5.2%. Although a smaller deficit is a positive for GDP, a lower amount of trade activity is a negative sign for economic growth.
  • Construction spending in the U.S. rose 0.9% in May this year, driven by a rebound in residential spending which rose 2.1% in the month and a small pullback of 0.2% in nonresidential spending. Compared to a year ago, construction spending is up 2.4%, down about 2.5% after adjusting for inflation. Strength has been seen in nonresidential spending which is up 17.3% over the past year, offset by a sharp 11.4% decline in nonresidential spend.
  • Vehicle sales in the U.S. rose to a 15.7 million annual rate in June, above the expectations of 15.3 million and jumping from the pace of 15.1 million sales in May, and up 20.9% from a year ago.
  • The ISM non-manufacturing index (on the services sector) was 53.9 for June, above the estimates of 50.8 and May’s read of 50.3. Business activity improve in June according to the survey with 15 of the 18 industries reporting growth in the month. Nearly every component increased compared to May which indicated activity that was barely growing.
  • The number of job openings as of the last day of May were at 9.824 million, down slightly from 10.103 million in April and relatively in line with the estimates. There are now a little more than 1.6 job openings for every unemployment person, a ratio Powell said he would like to see at 1.1. The number of separations in the month was little changed at 5.9 million, with the number of quits rising by a quarter million to 4.0 million and the number of layoffs unchanged at 1.6 million.
  • The number of jobless claims filed the week ended July 1 was 248,000, up 12k from the prior week with the four-week average at 253,250. The number of continuing claims was 1.720 million, down slightly from the prior week and at the lowest level since February. The four-week average was 1.746 million, also down slightly.
  • There were 497,000 new private payrolls added in June, according to new data from ADP, surging in June and well past the 235,000 estimate. The most jobs were added in consumer facing industries like leisure and hospitality, health services, trade/transportation, but declining in manufacturing, information, and finance. Jobs were added in all sized markets expect large employers. Pay growth remains high but has continued to slow, now seeing an annual increase of 6.4% in June, down from 6.6% in May.
  • The number of payroll gains for the month of June was 209,000, according to the Department of Labor’s establishment survey, which was in line with expectations of 213,000 but perhaps surprising to the downside after we saw a strong ADP employment number the day prior. This was the smallest monthly payroll gain since mid-2020 when payrolls were declining. Strong job gains were seen in health care and government, and to a lesser extent leisure and hospitality, business services, and construction, with small declines in retail trade. Moving to the household survey, another measure of employment that includes small-business startups, the labor force grew 133,000, the number of people employed rose 273,000 to 160.994 million, while the number unemployed declined 140,000. This caused the unemployment rate to drop 0.1% to 3.6%. Wages grew 0.4%, a little more than the 0.3% expected and are up 4.4% from a year ago, higher than the 4.2% annual increase that was expected and ticking up from a 4.3% annual increase in May. It was a pretty ‘in line with expectations’ report.
  • Mortgage rates rose to their highest level of this year, with the prime 30-year rate climbing 10 basis points this week to 6.81%, according to Freddie Mac’s weekly mortgage survey. The high water mark this cycle was 7.08% in November last year.

Company News

  • Tesla said it delivered 466,140 vehicles in the second quarter, beating the consensus estimate of 445,000 vehicles, rising 10% from the first quarter and 83% from the second quarter 2022, and the highest quarterly deliveries for the company.
  • Bloomberg reported Alibaba was exploring options and doing a strategic review of Youku and Tudou businesses as part of its overall restructuring, including injecting the businesses into Alibaba Pictures or even a separate listing. The two segments represent its video streaming platform. Alibaba later denied the report.
  • The Financial Times reported Apple is cutting production forecasts for its Vision Pro, Apple’s new mixed reality headset product it announced last month. The report states manufacturers of the product, which include China’s Luxshare Precision Industry, are struggling to get a handle on the complex design and difficulties of manufacturing the product. Plans for a more affordable version have already been pushed back, the report added. Plans are now to make less than 400,000 of the headsets in 2024, much lower than Apple’s internal sales target of 1 million units.
  • Facebook parent company Meta launched its “Threads” last week, which is viewed as a direct competition and will function similar to Twitter. Threads will be linked on Instagram and use that account for access. Zuckerberg tweeted that it had seen 5 million new users in the first four hours.
  • Exxon Mobil said it is forecasting lower earnings in the second quarter due to lower natural gas prices and weaker oil refining margins. It said lower natural gas prices would impact profits by $1.8 billion to $2.2 billion and lower margins would impact profits by another $2 billion to $2.2 billion.

Other News

  • The WSJ reported the U.S. was preparing to restrict Chinese companies from accessing cloud computing services in the U.S. In addition, after the US imposed restrictions on exports of certain AI chips to China, they responded with placing export restrictions on certain rare earth minerals including gallium and germanium which are two products used to make semiconductor chips. China cited the move was to “safeguard national security and interests.” China is the largest gallium and germanium producer, making up approximately 60% of the world’s supply.
  • Treasury Secretary Yellen said in her visit to China that she is “concerned about new export controls recently announced by China on two critical minerals used in technologies like semiconductors.” China announced last week that Chinese companies need to apply for licenses to export rare earth metals that are used to make semiconductors. Yellen added she has been “troubled” by punitive actions taken by China against US companies in recent months.
  • Oil moved higher last week after the Saudi energy minister said OPEC will do whatever necessary to support the oil market, suggesting a possibility for further production cuts in the near future. It was last weekend some of the OPEC members met with Saudi Arabia saying it would extend its 1 million barrels/day production cuts to August and Russia would cut exports by an additional 500k bbl/day. Additionally, OPEC secretary general indicated the cartel may be open to giving more counties membership, naming Malaysia, Brunei, Azerbaijan, and Mexico as possibilities.
  • Fed updates:
  • The FOMC meeting minutes from June revealed most of what we knew from Powell’s press conference and recent Fed speak – most members saw additional rate increases as necessary. Some even wanted to hike 25 bps at June meeting because there are few clear signs that it would see inflation move back down to target and the fact the labor market remains so tight. All agree inflation risks remains to the upside and inflation is unacceptably high. Members also noted increasing tight budget constraints in households
  • NY Fed President Williams said he supported June’s decision to hold rates steady but reiterated the fight against inflation is not over and incoming data will support that there is “still a ways to go,” and “we still have more work to do with rates.”
  • Dallas Fed President Lorie Logan said she thought a June hike was “entirely appropriate” and warned against easing policy tightening too soon. She added “the continuing outlook for above target inflation and a stronger than expected labor market calls for more restrictive monetary policy.” Logan said it is important for the Fed to follow through with the signals it sent in its projections on two more rate increases while saying inflation has remained stronger than expected and the pace of rebalancing in the labor market has remained slower than previously expected.

Did You Know…?

Travel Records

According to the aviation tracking website FlightRadar24, July 6 was the busiest day ever for global commercial aviation. According to the site, there were 134,386 flights tracked on that day alone. At one point, there were over 20,000 flights in the air at one time. This doesn’t include some of the flights that were scheduled, as London and more of the world’s top hubs saw high cancellations over air traffic control disruptions. In addition, on June 30 the Transportation Security Administration (TSA) said it recorded its busiest day ever with TSA throughput of 2,883,595, surpassing the old record of 2.883 million the Sunday after Thanksgiving in 2019. The seven day period (Friday to Friday) around the July 4 holiday week saw throughput of 19.864 million, up 14% from 2022’s level of 17.385 million, and 11% above 2019’s levels.

The Week Ahead

The calendar will be busier over the next several weeks from an individual company standpoint, as second quarter earnings season kicks off. We don’t see activity until later in the week with the large banks reporting on Friday which is typically seen as the official start to earnings season. Analysts are currently expecting a 7.2% decline in S&P 500 earnings compared to a year ago. Notable quarterly results this week will come from PepsiCo, Delta Airlines, and Conagra Brand on Thursday, then JPMorgan Chase, Wells Fargo, and Citigroup on Friday. Most attention will be on loan growth and how much banks are setting aside for bad loans which may give us a better idea on the health of the consumer. But investors will most likely be most focused on the inflation read coming out Wednesday morning. The consumer price index is expected to have grown 0.3% in June at the headline level and 5.0% from a year ago for core prices. Other economic data releases on the calendar include the producer price index and jobless claims on Thursday and import and export prices and consumer sentiment on Friday. In addition, the Fed will release the latest monthly data on consumer credit on Monday where we will be looking at the increase in revolving credit like credit cards. The Fed will continue to make headlines with several policymakers making public appearances this week. On the political side President Biden plans to attend the NATO commit in Lithuania on Tuesday and Wednesday.