@theMarket: A Wash-Rinse-Repeat Market
There was nothing to see in the markets this week, simply more of the same crisis news that may keep the media happy, but no one else. Tariffs and trade remain in the forefront and will continue to do so. What should investors do?
Just move on and enjoy your summer. The Fourth of July falls in the middle of the coming week with stock markets closing for half the day on Tuesday. As such, many professional traders will take the entire week off. Given that the Northeast faces their first summer heatwave as well, the corridors of Wall Street should be quite empty.
So whatever ups and downs the stock market may have next week will mean little to nothing. Those who must remain at their trading desks will be young, bored, and trying to make something "happen." Don't get sucked into it, because whatever will be done next week will probably be undone in the following week.
It should be abundantly clear by now that the continued antics coming out of Washington hold the key to short-term price movements in the markets. As a long-term investor, I have repeatedly advised you to ignore the small stuff and keep focused on the horizon, where things still appear bullish.
By now, you are probably aware that the administration floated a new trial balloon last weekend in their on-going trade war. They suggested that they might ban technology exports to China and other nations on the grounds of national security. That sent the U.S. markets crashing on Monday. By the end of the day, with the Dow down over 500 points, Trump sent out both Treasury Secretary Steve Mnuchin, and Director of Trade, Peter Navarro, to do some damage control. Both men immediately contradicted each other, but, in the confusion, they managed to pull the Dow off its lows.
Tuesday proved to be another wash-rinse-repeat day with Larry Kudlow, the president's economic adviser, chiming in with more negative and confusing comments on the trade and technology issue. The markets, which had rebounded off their lows, promptly gave up all their gains and sank further. In the end, the administration canned the whole idea. Instead, Trump asked Congress to strengthen the laws already governing foreign investments in areas that may pose a threat to the nation.
In the meantime, Harley-Davidson, the American motorcycle icon, became the president's latest whipping boy. Readers may recall that this company was a specific target of the EU's retaliatory tariffs in response to Trump's tariffs on foreign-made steel and aluminum products. The European tariff (31 percent) was so effective that Harley announced it will move its production of European-bound cycles to Europe. The stock was down 7 percent on that announcement, as Trump lashed out at the company for "waving the white flag." Mid-Continental Nail, the largest manufacturer of nails in the U.S., also announced layoffs because of the steel tariffs.
Although the announcements came as a surprise to the president and his men, it shouldn't. Companies are not by nature political animals; they are economic entities required to answer to shareholders, not politicians. In the face of retaliatory tariffs by foreign countries, corporate managers need to worry about how that will impact their business. U.S. tariffs against imports will mean they can raise their prices here at home and make more money, but the opposite happens overseas in a tariff war.
To avoid the wave of retaliatory tariffs against American products, it makes total sense for businesses to shift production and jobs out of the U.S. and into the countries that have established these tariffs. Harley-Davidson is simply the first company to do so. Many more should follow if the trade war heats-up.
But all of that is still in the "what-if" stage of development. As I said, it keeps the media employed, but does precious little for you or me. Turn off the television, shut down the internet and ignore the newspaper headlines. Instead, go sit by the lake, pool, or ocean next week and work on your tan. Now that would be a productive use of your time!
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The Independent Investor: Currencies & Trade Wars
What's up with the dollar? The greenback is strengthening and is having its best quarter since 2016 against an array of foreign currencies. Is this an accident, or is it something far more dangerous?
Economists will tell you that the Trump tariff crusade is responsible. New trade barriers, which the president is suggesting, would usually lead to higher prices at home, according to economic doctrine. Products we import would cost more, whether we are talking about steel, automobiles, or baseball caps.
As prices increase, so should the U.S. inflation rate. As inflation rises, bondholders will demand higher interest rates to keep up with inflation. In turn, higher interest rates would normally lead to a stronger dollar. In the real world, this explanation is not so cut and dried.
There could be any number of macro scenarios that I could spin, which could alter the dollar's rise. For example, the Fed (which controls U.S. interest rates) could decide not to raise interest rates for other reasons. The impact of tariffs might also end up being so minor that prices barely budge. In other cases, breakthroughs in technology (such as oil and gas fracking) or in a manufacturing process could lower the cost of certain products even while others are going up due to the tariffs.
The dollar's strength or weakness will also depend on what is happening overseas. The economic conditions of other nations will impact their own currencies relative to ours. In many countries, the exchange rate is not determined by market forces, as is the greenback. In many cases, currencies are controlled by a central government. A currency could be "pegged" to the U.S. dollar, or to a basket of currencies. It could rise and fall in a pre-set range pre-determined by the government's central bank. Governments can also control how much of any currency their citizens may own.
In a trade war, like Donald Trump appears to be waging, a country can use its currency to countervail the price impact of tariffs on their exports. Let's say you are a Chinese manufacturer of Major League baseball caps. You compete with one of two American companies. They may make a better product, but also charge more for it, let's say 10 percent.
So, being a great patriot and baseball fan, the president decides to slap a 10 percent tariff on all baseball caps imported from China. Now, the Chinese manufacturer has neither a price or quality advantage. His sales suffer and America "wins." However, the Chinese government could alleviate the situation by allowing their currency to devalue by that 10 percent. In this case, the cost to the American importer of Chinese baseball hats remains the same, because it now costs him 10 percent less (in U.S. dollars) to buy the hats.
Fast forward to today. The latest salvo in Trump's trade war is to threaten to raise the amount of Chinese goods taxed by the U.S. to $450 billion. That would mean that tariffs would be applied to nearly all the $505 billion in goods that China exported to the U.S. last year. That would be a real blow to the Chinese economy. To soften that blow, China could decide to let their currency, the yuan, weaken to the point that the impact of tariffs would be erased.
In the past two weeks, the yuan has fallen three percent against the dollar. It is still up about 5 percent against the greenback over the last year, but that can easily change. Is the Chinese government deliberately causing the decline?
If they are, you can't prove it. Going back to the economic models, one could argue that the tariffs Trump is planning to impose would damage the Chinese economy, slow growth, and weaken their currency. The recent decline could only reflect that fear among currency traders.
Whatever the case, China is not the only player that may be tempted to play this game. All of Europe and Asia will be hurt by American tariffs. It makes economic and political sense for nations to protect their own fortunes and those of their people in the event of a trade war. Some would argue that it is their duty to do so.
Since all is fair in love and war, deliberately weakening a nation's currency in relation to the dollar in response to tariffs could be a smart move. Some might even argue it is the patriotic thing to do.
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@theMarket: Ignore the Noise and Profit
The world is in turmoil. The news is all bad. Trump is threatening to up the ante on tariffs. NAFTA is kaput. Our trade partners hate us. China won't back down and, if you have time to spare, you are reading about immigrant kids locked in Texas dog cages by order of the president. So why is the stock market holding up?
The fundamental reason remains the same. Under all the muck, there is and will continue to be a bid under the stock market. In past columns, I have explained why — corporate stock buybacks, M&A, higher dividends coupled with a strong economy and low-interest rates.
If you look at the technicals, which I do, every sell-off seems to stop at a technical support level. In addition, while the Dow Jones "Industrial" Average put together eight down days in a row (it hasn't done that for over 15 months), small-cap stocks were hitting record highs.
Why the divergence? Most of the Dow is made up of big industrial companies with a high exposure to overseas markets. Tariffs mean less business; less business means lower stock prices. Small-cap stocks, on the other hand, are U.S.-centric. They rarely export and most of their fortunes are tied to the U.S. market. Ever since the trade wars began in earnest, small caps have soared.
Over in the technology space, the same thing is occurring. While commodity stocks are getting crushed (tariffs are bad for trade), large-cap technology and biotech are soaring. That's largely because the world can't do without the products those sectors offer.
The point is that traders are having a field day, shorting the markets on every tweet, and buying them back when the indexes hit a certain support level. Selling material stocks and buying tech, then doing the opposite when the circumstances change. And this will continue. My advice is to just ignore the noise and take a long-term view.
This week it was another missive from our Tweeter-in-Chief that sent investors into a tizzy. Trump threatened to levy 10 percent tariffs on another $200 billion of Chinese goods, if China retaliated on the president's first round of trade tariffs. China seemed unfazed by the tactic. So far, this week has been a war of words not actions.
Investors should not underestimate the Chinese response, nor assume that it will be confined to tariffs. Kim Jong Un made yet another trip to Beijing this week without fanfare or announcements. Trump assumed that after his historic meeting with the North Korean dictator, he removed that bargaining chip off the trade table. China could be putting it right back in its hands.
U.S. Treasury bonds could be another chip on the table. China holds a lot of them, as do other countries. Over the last two months, foreigners have sold about $5 billion/month of our debt. Analysts believe that selling our bonds would hurt the Chinese as much as it would hurt us. That's true, but in this trade war, both sides seem willing to suffer to achieve their ends.
Clearly, for the U.S., reducing both exports and imports would wipe out most of the impact of the tax cut. Since the economy is enjoying a faster growth rate this year, (almost 3 percent in the next quarter or two), we could probably absorb some of those negative impacts. The same thing could be said for the losses we would suffer in jobs.
Given that the economy is hovering at a historic level of unemployment and may drop even further to under 3.8 percent, it would be an ideal time to be hit with some job losses. Throwing a million or two Americans out of work, as a result of trade wars wouldn't be the end of the world from an economic point of view. Of course, you or I might feel quite differently if it was our job that was on the line. Nonetheless, in this world where even the most obvious of truths can be blamed on others (and believed by many Americans), why not bet the farm since it's not yours anyway?
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The Independent Investor: The Next Recession
Over half the economists on Wall Street believe that by the end of 2020, we will experience our first economic downturn in years. If so, when might you begin to prepare for a rocky two-year period for all of us?
The good news is that we still have another year or so of stock market gains, job growth and more importantly, wage growth. As it stands, the U.S. is currently enjoying its second-longest economic expansion in history with an unemployment rate that hasn't been this low in decades. Wage growth, after languishing for years, is expected to top 3 percent by the end of 2018, while GDP could achieve greater than 3 percent this year and a further 2.5 percent next year.
So how does an economy go from blue skies to dark clouds in so short a time? This economic expansion is now entering its final stage, according to economists. As the good times grow, investors and consumers tend to overborrow and overspend. That's human nature, but it almost always leads to inflation rising, which touches off a rise in interest rates that ultimately slows the economy.
By that time, consumers are back in debt and paying more interest on that debt, while corporations are stuck with an overabundance of goods produced that no one wants. So, everyone pulls back, causing the economy to slow, and the rest is history.
Normally, a recession will span a year or two before the economy recalibrates. In the meantime, the stock market falls anywhere from 15-30 percent and the mood is somber. I have seen it repeatedly in my career. And yet, for some reasons, investors always act as if this is some new startling new development.
The timing of a recession can always be called into question. Any number of things could prove to be a tipping point in ushering in a recession sooner than expected. In 1991, skyrocketing oil prices proved the culprit. In 2001, the dot-com bubble caused a year or two of declines, in 2007, it was a housing bubble. This time around there are several "what ifs" that could hasten our demise.
Right now, a global trade war, instigated by Donald Trump, could tip the economy (both here and abroad) into recession. Trump's latest threat: levying tariffs on almost $200 billion in Chinese imports, would certainly elicit a like response from the Chinese. Tariffs on goods of that proportion would drive both economies into recession.
A crisis in Europe could also hit us hard. Italy is none too stable right now. Populists forces might set in motion their exit from the European Community. That would cause a great deal of instability among European nations, the Euro, and their economies. That, too, could tip our country, as well as their own, into recession.
Oil prices might prove to be our downfall once again if geopolitical events among countries in the Middle East (Iran, Syria and Saudi Arabia) come to blows. An escalating conflict there would surely send oil prices back over $100/barrel with negative consequences for the U.S., as well as other global economies.
Finally, U.S. interest rates could move higher in direct response to our president's actions towards our global allies and enemies. In the last two months, foreigners have reduced their U.S. Treasury holdings by about $10 billion. Russia has reduced their holdings by half. That is a relatively small amount, but as more and more governments realize that "Making America Great Again" will be at their expense, why should they hold our bonds?
China, for example, in response to Trump's tariff threats, could respond by dumping our treasury bonds. That would cause interest rates here at home to spike higher. That would cause even more panic among foreign holders, who would be happy to sell more of our bonds. I could see a nasty chain reaction, a sort of dot. com-like bond sell-off, which could spread throughout the economy and the stock market.
Barring any of these worries, however, we still have some clear sailing ahead for our economy. The stock market usually begins to discount a recession 6-9 month ahead of time, so it won't be for a year or more before we need to prepare for the inevitable, which would be just in time for the next election.
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@theMarket: Trump's $50 Billion in Chinese Tariffs Trashes Markets
Investors waited all week for President Trump's verdict. On Friday, he did not disappoint his followers. He decided to move ahead with plans to slap $34 billion in tariffs on Chinese imports. Stock markets worldwide fell on the news as investors await a Chinese response.
And China will respond. Chinese trade officials have already outlined their planned retaliation. China will match Trump's 25 percent tariff on 818 products by doing the same on 106 American goods worth about $50 billion.
We can expect an accelerating war of tit-for-tat tariffs in the weeks ahead. For example, the United States Trade Representative plans to add an additional 284 Chinese imports to their list (amounting to another $16 billion) by July 6. You can bet China will respond in kind.
Some on Wall Street still hold out hope that these tariff threats could still be averted. Although these tariffs could be implemented as early as next week, they could also be delayed if negotiations between the two nations continue. The White House could conceivably wait a minimum of 30 days or as much as 180 days if they chose to do so.
There are several other issues that can come into play on the trade front. European nations this week released a list of counter tariffs they plan to implement in response to Trump's 25 percent tariffs on their steel and aluminum exports. In addition, both Mexico and Canada have already released tariffs on U.S. imports of their own. We could see a virtual avalanche of global tariffs that could bury investors up to their necks.
While many businessmen and corporations are horrified at the administration's actions, others think it is the best thing that could have possibly happened. Clearly, the weight of historical evidence indicates that everyone loses in a trade war. If opposing forces respond in kind to another nation's tariff increases (as they are now), the result would logically be a reduction in global trade, which, if it continued, could result in a second Great Depression.
Yet, after decades of getting the short end of the stick in trade deals, as the president claims, how else do we, as a nation, change the status quo? Are there other, less dramatic, methods of accomplishing our national objectives? Of course there are, but those methods would require months, if not years, of negotiations by trade experts. However, that is not the hand we have been dealt.
None of the administration's top men have that kind of expertise. Nor would it matter if they did, because Donald Trump does not have the patience, disposition, or knowledge to pull that off. No, in Trump's case, it will always be "his way or the highway." Get used to it.
As for the markets, it is interesting to note that the stock markets are no longer declining as they did in February and March at every tweet on trade. It appears market participants, while still responding to short-term headlines, are keeping their eyes on the longer-term prospects of a stronger economy and better earnings. While we remain in a trading range, this one seems to have an upward tilt. Higher highs and higher lows continue to support stocks.
In the coming weeks, we could see even more volatility as nations rattle their sabers on trade, but depending on where you live or where you work, not all is gloom and doom on this front. If you are a soybean farmer, a worker that depends on low-cost steel and aluminum to keep his job, or possibly an auto worker (if tariffs on autos is next on Trump's tariff list), then tough times could be just ahead for you and your family.
But a banker in North Carolina, a small business owner in energy-rich Texas, or a tax-conscious, elderly millionaire that wants to make as much as he can before passing on his wealth to his beneficiaries are more likely to approve of Trump's tariff strategy.
In a polarized country where "getting and keeping your own" supersedes the common good, a trade war that hurts others can be easily rationalized away. As long as it remains "the other guy's problem," and not yours, what's not to like? Commerce Secretary and billionaire Wilbur Ross warned that Americans would feel some pain in the months ahead because of trade issues. We will, but you can bet that Wilbur sure won't be feeling it.
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