@theMarket: Markets Held Hostage by Trade & Machines
If it were not for computer-driven trading, it might actually be funny. Financial markets are careening up and down on a daily basis based on the next tweet or comment from the Trump administration or its counterparts in China. We could see more of the same next week.
Rhyme or reason has truly left the station. Day by day, the trade war of words is accelerating. This week, the U.S. banned China's largest technology company, Huawei, from doing business with American companies. The president accused the company of espionage. The Chinese responded by threatening to drop trade negotiations. Markets collapsed, led by semi-conductor and technology stocks.
A day later, the administration walked back their ban, at least temporarily, once they realized the entire U.S. semiconductor industry would be crippled by their move. Markets spiked higher. Then, Stephen Mnuchin, the U.S. Treasury secretary, admitted there was no planned dates to resume trade talks — pow, markets fell again.
Thursday, the president, in a free-wheeling news conference, announced a trade deal with China will happen "fast." Confused investors jumped back into the markets chasing stocks up on Friday morning and down in the afternoon.
Over in China, there also appears to be an escalation in the tariff/trade verbiage. The Chinese government-controlled media have stepped up its anti-U.S. rhetoric, quoting Chinese officials, who are increasingly painting America and its leaders as irrational and unreasonable. A protest song of sorts has hit their air and internet waves, gaining massive popularity among the billions of Chinese citizens.
Rather than caving-in to our demands, it appears that China is hardening its stance and intensifying its "Made in China 2025" import substitution program. Readers may recall that China's long-term economic strategy is to become self-sufficient in producing the goods and services they need to supply their increasingly affluent population. They envision a centrally planned mercantile society that, in the end, will cease to depend on the U.S. and its imports and rely solely on domestic production.
While China would prefer to wean its need for U.S. goods and services gradually, over a period of a few more years, if push comes to shove, they seem willing to take the hard road, and cut off much of their trade with the U.S. if negotiations fail. After all, while the population may suffer and economic growth would slow, it's not as if the Chinese populace can vote Xi Jinping out of office.
Xi, last week, actually gave a speech in Yudu, a small county where Mao Tse Tung's Long March began, 85 years ago. The two-year march, over some of China's most rugged and difficult terrain during the Chinese civil war, is the stuff of legends within China. Xi's message was clear: China may be in for another long march of "enduring hardship" and should be prepared if negotiations fail.
Despite this war of words, the majority of investors still believe that a deal will be done and done fairly quickly. As such, any hint that reflects positively on the trade talks is an excuse to buy. This tendency is exasperated by computers that are programmed to respond to certain key words (that signal it to buy or sell the markets).
Computers cannot reason. They do not know if the president's tweets or statements are backed up by facts and they don't care. Neither, evidently, do human investors. I can see this continue to play out until June 1. That's the date when China's second round of tariffs will be levied on U.S. goods. That's next weekend. If no breakthrough occurs by then, and I don't believe it will, then expect the next shoe to drop and the markets with it.
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The Independent Investor: Don't Take Loans From Your Tax-Deferred Accounts
It sounds too good to be true. Why borrow from a bank when you can take a loan out from your 401(k) or 403(b) and pay yourself back in both interest and principal? If that sounds like a great deal, it's not.
Money purchase plans, profit-sharing plans, 457(b) plans and both 401(k) and 403(b) plans may offer loans, but IRAs, SEP IRAs, and SIMPLE IRAs do not. The IRS does have some restrictions on the borrowing. It limits how much you can borrow at any one time. In general, you are limited to the smaller of 50 percent of your vested account balance, or $50,000. However, there is one exception (hardship) that allows you to borrow up to $10,000 even if it exceeds 50 percent of the balance. It also requires you to pay yourself a reasonable rate of interest on your loan. Generally, you have five years to repay the loan, although you are required to pay at least quarterly payments.
Recently a thirtysomething-year-old client told me he had taken out a $7,000 loan from his $50,000 403 (b) tax-deferred retirement plan years ago. He was surprised to find that it was not an interest-free loan and that he was required to pay off the loan in its entirety before he could draw from the account in retirement. What's worse, if he quit his job, his company required that he pay off the amount in 60 days. He thought it was the IRS that laid down the rule provisions, but that is not the case.
It is the company you work for that offers the plan. Some companies won't let you borrow. Others have limitations on how much much you can borrow and how much you pay in interest. What happens if you fail to repay the loan? The IRS will consider the loan a distribution from your plan. You will then need to pay income tax on the amount, plus a 10 percent penalty if you are not age 59 1/2 or older.
There are only a few cases where borrowing from your tax-deferred account makes economic sense: If you have an immediate emergency, say a medical issue, that cannot be financed any other way, an immediate cash obligation and your credit score prevents you from borrowing in any other way, or an extremely high interest debt that is threatening to send you into bankruptcy, or worse, may require you to take out a loan.
Nearly 3 out of 10 Americans borrow from their retirement plans. The problem is that they erroneously view them as their own personal piggy bank, until something goes wrong. If you lose your job, for example, you not only have no income coming in, but the loan is due in 2-3 months. If you can't pay it back, you get slapped with additional taxes (as a distribution), which, unless you have a new job lined up, has to be paid out of whatever you have in your checking account.
Since these loans are paid back with your after-tax dollars, you end up paying taxes on the money twice. Once, out of your paycheck, to repay the loan and a second time, when you start withdrawing money in retirement.
Finally, these plans were established to provide you a winning combination of tax breaks, company matches, and the compounding of gains from your contributions, so that you can save for retirement. None of that occurs while you have a loan outstanding. Instead of a contribution each quarter, the loan repayment is taken out of your paycheck each quarter.
If you take the full five years to repay the loan, not only are you missing out on five years of savings and compounding, but also the opportunity costs that the markets provide you.
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@theMarket: Markets Sell in May
The old adage "sell in May and go away" seems to be working this year. In short order all three averages experienced a down draft over the past few days that amounted to about a 5 percent decline in total. Is there more to go on the downside?
If I were a betting man, I would say the odds are in favor of more declines in the weeks ahead. I base that bet on the assumption that it will take at least until the end of June before we get anymore clarity on whether or not President Trump is willing and able to salvage a trade deal with China.
By now, most readers are aware that there has been an abrupt change in expectations on whether or not the tariff trade wars will end anytime soon. Both countries have escalated their rhetoric and at the same time made clear that more tariffs are in the works unless a resolution can be successfully negotiated.
There is a G-20 meeting coming up at the end of June. Reports are that President Trump and his Chinese counterpart, Xi Jinping, will meet at that time. Until then, investors can expect this war of words to continue. Traders will be cocked and ready to pull the trigger on every tweet, comment, or action by either side. I expect markets to respond (up or down) with a vengeance.
At the same time, expect to read and hear how tariffs are bad for worldwide economic growth. The bears will begin warning that Trump's actions towards China will cause the U.S. economy to tip into recession next year. I expect the inverted yield curve will be resurrected and demands that the Fed cut interest rates immediately will likely occupy much of the headlines. And there is some truth to that. As long as a global trade war is a possibility, corporate investment is not likely to rise, nor should it.
We have heard this all before and may hear again in the months ahead. The facts are that while some progress can and most likely will be made in forging a trade agreement with China, the real difficult issues, such as intellectual property safeguards, will take much longer than anyone expects.
One troubling aspect in the president's recent remarks is his willingness to keep tariffs in place, not only in China, but in his negotiations with other countries. We knew when he was elected that there would be a protectionist flavor to his economic policy, but as time goes by his stance has hardened.
The last time the United States actively used tariffs as an economic policy weapon was back in the Thirties. As readers may remember, those policies by us as well as our trading partners ushered in the Great Depression. Could it happen again?
Some argue that the world has changed, and circumstances are different. Protectionism, after years of giving away the shop in trade deals such as NAFTA, is just leveling the playing fields. That may be accurate, but it flies in the face of every economic principal I have studied. If that is truly the endgame here, let's hope it turns out better than the vaunted tax cut that was supposed to supercharge the economy and lead to massive investment in this country.
As the drama continues to play out on a daily basis, look for the markets to remain unsettled. While the ups and downs are nerve-wracking and unpleasant, it's part of a necessary and overdue reset in equity prices. I believe it is temporary and in time will lead to higher prices overall.
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The Independent Investor: Epidemic Pulls Pork Prices Higher
The African swine fever could cause prices in China to spike 70 percent or more this year. The highly infectious disease is spreading throughout Asia and could lead to a large increase in the price of pork here at home as well.
Before you ask, this highly infectious virus, while deadly to pigs, is not harmful to humans. The problem is that when even one pig is tested positive, the entire herd needs to be slaughtered as quickly as possible. There is no cure.
The government is taking this epidemic seriously, and well it should. Tough new government rules have been implemented this month in Chinese slaughterhouses and processing plants to identify and test for the virus.
The Chinese are the world's largest consumers of pork, accounting for 49 percent of all pork consumed. Domestic hog production, prior to the epidemic, was roughly 700 million pigs. To date, only about a million pigs have been infected, but those figures may be understated. A Shanghai-based consultant company, JCI, is forecasting that pork production will fall by almost 16 percent this year to 8.5 million metric tons. That would leave roughly a 7 million metric ton shortfall in supply.
The government's inspection efforts have slowed down business and reigned in demand, at least temporarily. But given the popularity of pork in China, most producers are believed to have large stockpiles of pork supplies, most of which are in cold storage. As such, Chinese producers are dipping into their cold storage supply to satisfy demand and keep prices somewhat reasonable, at least until the second half of the year.
Given the severity of the epidemic and the wrath of the government, if the present guidelines and restrictions are ignored, producers and distributors don't dare to buy fresh pigs, kill them, or sell the meat until the government gives them an all-clear. In the meantime, the epidemic has spread to Vietnam and Cambodia, which are also big pork consumers, as well as other nations in Asia.
In order to fill China's shortfalls in supply, pork producers in Europe and the U.S. are starting to increase shipments to China. That is despite the fact that U.S. pork exports are subject to a 62 percent tariff, thanks to the tariff war between the U.S. and China.
There are also other side effects to the pork crisis. Soybeans are the major source of pig feed. Less pigs means less demand for soybeans. That also hurts U.S. producers. China had already cut imports from American soybean farmers and the virus simply reduces demand for our exports even further.
Chinese consumers may also be forced to substitute beef and other proteins for pork. That could send prices of beef higher since China already represents 28 percent of the world's meat consumption.
While there have been no known cases of the African virus here, the U.S. is already taking precautions. The National Pork Producers Council recently canceled its 2019 World Pork Expo in Des Moines. Our government also announced increased safety measures to prevent the virus from entering our livestock supply. Most of their effort is focusing on what is called additional attention to "farm biosecurity."
About the only silver lining for America in this stormy situation is the present tariff war. As we plan to levy even higher tariffs on just about all Chinese imports, the risk of importing infected pigs has been dramatically reduced.
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@theMarket: Tariffs Trash Stocks
Volatility in the form of U.S. trade tariffs levied on China cut through investors' complacency with a vengeance this week. It took less than three days to drop the markets by 3 percent. Is it over or do we have another 5 percent or so to endure?
My bet is that it is over — for now. Sometime during the on-going trade negotiations occurring in Washington today and tomorrow, the thorny trade issues, (such as intellectual property (IP) protection for U.S. companies) will be kicked down the road. A compromise on other, easier issues will be announced as "on-going" (although not inked) and the Chinese delegation will fly home in an atmosphere of reconciliation.
From the president's perspective, China, after agreeing to a list of breakthroughs in the trade negotiations in Beijing two weeks ago, "broke the deal." Over a half-dozen important "firsts" involving IP rights, as well as other structural rules and regulations that have hampered U.S. companies doing business in China, were first agreed to as of two weeks ago. A week later, half of them had been deleted from the formal draft agreement sent to Treasury Secretary Steven Mnuchin and Chief Trade Negotiator Robert Lighthizer.
The move surprised the negotiators and infuriated the president. Sunday night, the president took to Twitter and threatened to raise U.S. tariffs on $200 billion of Chinese goods from 10 percent to 25 percent. The tariffs took effect Friday morning. The Chinese have responded by preparing their own additional tariffs on U.S. goods.
As you might imagine, the Dow dropped 500 points or more on Monday, spiking higher on Tuesday, down again Thursday, and by Friday no one (including the Algos and their computers) was sure what to do next so the averages spent the day moving up and down just because. The volatility index, which is a measure of fear and loathing in the stock market, exploded higher, putting even more pressure on world markets.
The Chinese market, as well as other emerging market indices, cratered. One of China's main indices, the Shenzhen Index, dropped over 7 percent in one day. As the markets fell, the financial media trotted out all the "what if" scenarios they could cram into their studios between commercials. Hopefully, you turned it all off.
Why, therefore, am I not more concerned? Well, for one thing, all this brouhaha has only pushed markets down by 2-3 percent. In the grand scheme of things, that's simply one of three or four normal pullbacks you should expect each year in the stock market. And, on average, you can expect at least one 10 percent correction per year. You should remember that.
Granted, if things escalate from here on the trade front, we could see another 5 percent downdraft or so. But it still wouldn't be the end of the world, given the gains we have enjoyed so far this year. You might argue that I am too complacent, given the impact that higher tariffs could have on U.S. economic growth, let alone global growth.
If economic activity did decline, I would fully expect the Fed to come to the rescue, cutting interest rates in order to support the economy, while goosing the stock market once again. In fact, one could theorize that the president is thinking along these same lines when he said on Friday that "there was no hurry" in lifting these new tariffs.
I have been warning readers for weeks that all signs pointed to a market pullback. All that has happened is that we are now in one. In the short-term anything could happen. We could bounce from here, get back to the old highs and fail. Things might also quiet down on the trade front for a week or two, while investors' focus may switch to what's happening in Iran or North Korea. Those areas could also cause markets to fluctuate. Take it in stride.
My advice is to look beyond these events and keep focused on the fact that there is still a whole lot of good news supporting the markets just under the surface.
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