Wall Street Breakfast: Dire Straits

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Dire straits

U.S. House Speaker Nancy Pelosi is expected to land in Taiwan at 10:20 a.m. ET, defying Chinese authorities who have warned of consequences if the trip takes place. The White House has sought to distance itself from the visit, saying it cannot control another branch of government, but it is yet another headache for the administration, which already faces a midnight court deadline to defend $350B of Trump-era tariffs on China. While the U.S. has emphasized the trip does not signal a change in its ‘One China’ policy, Beijing has warned that its militarily will “never sit idly by” and “whoever plays with fire will get burnt.”

Backdrop: The last high-ranking U.S. official to visit Taiwan was then-speaker Newt Gingrich in 1997, which occurred in the aftermath of the Third Taiwan Strait Crisis and the island’s first democratic presidential election in 1996. At the time, the Clinton administration responded to the Chinese military buildup in the Fujian province by sailing all of its most powerful weapons through the Strait of Taiwan and staging the biggest display of American military might in Asia since the Vietnam War. China backed down in response, but a lot has changed in recent decades with a more powerful Chinese military and a new zeal to “reunite” Taiwan with the mainland under President Xi Jinping.

Rising risk aversion prompted markets to slide overnight in the Asia-Pacific, with some of the sharpest falls seen in Hong Kong (-2.4%), China (-2.3%) and Taiwan (-1.6%). U.S. stock index futures are also in the red, while the unease was most apparent in U.S. Treasuries as the 10-year yield slipped as much as 9 basis points to 2.51%. Taiwan Semiconductor Manufacturing (NYSE:TSM) – which is the island’s flagship company and the world’s largest manufacturer of semiconductor chips – will also be on the radar during the session as analysts debate the repercussions from Pelosi’s visit.

Best case scenario: The saber-rattling continues and the armed responses are restricted to military flexing. Chinese warplanes could fly close to Taiwan’s air defense identification zone, or naval activities could be conducted near the median line that divides the strait. Reactive measures could also be limited to the test-firing of missiles into the sea, while economic retaliation is on the table.

Worst case scenario: President Xi cannot afford to look weak amid slowing growth and a deflating property bubble, and it is indeed dangerous when autocrats feel that they are beginning to lose power. The People’s Liberation Army could send warplanes over Taiwan, prompting the island to decide whether to shoot them down. America and its allies in the region would likely be drawn into the conflict militarily, sparking further global turmoil following the U.S. withdrawal from Afghanistan and Russia’s invasion of Ukraine. (29 comments)

Energized profits

Earnings from the oil majors continue to roll in after Chevron (CVX), Eni (E), ExxonMobil (XOM), Shell (SHEL) and TotalEnergies (TTE) posted a combined $60B in profit for the second quarter. BP (BP) today also announced an underlying Q2 profit of $8.5B, more than three times the number seen a year ago and its highest quarterly profit in 14 years. Similar bumper results are expected on Thursday from ConocoPhillips (COP), which will be the last supermajor to report quarterly numbers.

What’s happening? High commodity prices from the war in Ukraine and strong refining margins due to growing demand are helping propel soaring returns for the world’s largest energy companies. In fact, BP raised its dividend by 10% following the latest results, and said it was committed to buying back $3.5B of shares in Q3 after completing $2.5B of repurchases last quarter. Capital discipline was also displayed, with net debt falling to $23B, down from $33B in the year-ago period.

“Today’s results show that BP continues to perform while transforming,” CEO Bernard Looney said in a statement. “We do this by providing the oil and gas the world needs today, while at the same time investing to accelerate the energy transition.” While investors should be happy with the outsized profits, consumers are not as ecstatic about the rising energy prices, and the topic has become a political flashpoint. In May, BP announced over $20B of planned U.K. investments, but the attempt failed to head off calls for a windfall tax (similar discussions are taking place among progressive lawmakers in the U.S).

Going into August: The S&P 500 Energy Sector is the only one to record significant performance for 2022. The component has risen 39% since January, with the next closest competitor being Utilities, which is up only 3% YTD. The other nine sectors – which span Technology and Consumer Staples to Financials and Real Estate – are all negative for the year. (8 comments)

Flying chaos

Besides long queues and lost luggage, the travel situation doesn’t appear to be getting better anytime soon. Carriers have been trying to recoup the severe losses suffered over the past few years by making as much money as the can from soaring demand as they come out of the pandemic. The problem is that airline and airport staff have not returned to pre-COVID levels, a pilot shortage is exacerbating the issue, while any wrinkles in one division can cause knock-on effects or meltdowns in other areas of the entire flying operation.

Time to act: British Airways has suspended ticket sales for short-haul flights from London Heathrow over the next week, in a move that is likely to push up ticket prices and add to record U.K. inflation. The British flag carrier already announced it would cancel 10,300 flights through September, in response to the airport imposing a cap of no more than 100K departing passengers per day. The news also comes a week after International Airlines Group (OTCPK:ICAGY), BA’s parent, revealed that it had returned to profit for the first time since the pandemic, but warned of “acute” challenges in scaling up performance.

“We’ve decided to take responsible action and limit the available fares on some Heathrow services to help maximize rebooking options for existing customers, given the restrictions imposed on us and the ongoing challenges facing the entire aviation industry,” said a BA spokeswoman.

Will the same happen in the U.S.? This past Sunday, 17 major U.S. airports saw at least 20% of their flights depart late. The worst of the troubles were seen at Charlotte Douglas in North Carolina and at Harry Reid International Airport in Las Vegas, where 38% and 32% of all flights were delayed, respectively.

Publishing battle

The latest high-profile antitrust lawsuit has hit the courtroom as the U.S. Justice Department attempts to stop Penguin Random House from buying rival publisher Simon & Schuster. The $2.2B merger would reduce the “Big Five” industry publishers from 5 to 4, along with Hachette Book Group, Harper Collins and MacMillan. The suit is also part of a broader competition crackdown by the Biden administration, which has beefed up its campaigns following the signing of an executive order on “Promoting Competition in the American Economy” in July 2021.

The arguments: The DOJ maintains that the transaction will hurt industry competition and cut authors advances by “diminishing overall output, creativity, and diversity among books published.” Simply put, Penguin believes the complete opposite. It thinks the deal will “enhance competition” by pooling its resources, as well as offering better deals to authors that’ll force other publishers to “compete harder” for titles.

The trial is taking place in federal district court in Washington, D.C., and is anticipated to last two to three weeks, with a final ruling expected in November. Among those slated to testify on behalf of the DOJ are famed author Stephen King, whose books have been published by Simon & Schuster, as well as other literary agents like Pulitzer Prize-winning journalist Charles Duhigg.

Outlook: If the combination is approved, it could trigger further consolidation in the publishing sector, but if the deal is blocked, Simon & Schuster parent Paramount Global (NASDAQ:PARA) would likely offload the publisher to a private equity firm. Paramount has already committed to divesting the company, which is what triggered the merger with Penguin Random House in the first place.