The Days Ahead: US inflation. Watch for German and China trade.
One Minute Summary: Markets were slow. Many traders and investors were off for the week. Europe was all but closed. The trade and political stuff makes for big jumps in volatility. This is good for bank trading desks and option writers. For long-term investors it’s not a problem unless they react to it. As we’ve mentioned before, this volatility feels unsettling because it’s been quiet for much of 2017. In fact, volatility is bang in line with its long-term average. Welcome back my friend, to the show that never ends.
U.S. Treasuries were up. Bond spreads ticked up. That's the credit worries at work. The S&P 500 was down 1.2% for the week. It’s down 2.5% so far this year but up 11% on the year. Small caps have done comparatively well this year. Tech was down again. It’s mostly fear of regulation because we don't expect earnings to be hit soon. We would still buy the protection we put in place for clients recently.
Europe and Emerging Markets were positive and have outperformed the U.S. by around 2% this year. Japanese exporters had a tough week. They're in the trade crossfire. Last year, Prime Minister Shinzo Abe gave President Trump a hat with a logo reading “Donald & Shinzo, Make Alliance Even Greater.” He may ask for it back.
1. What a mess with China: You may have noticed there was some chat on trade with China last week. Some 99.99% of economists believe trade wars hurt the world economy. The others don't. We found it useful to try and unpack some of the talk, ‘cos , you know, you might think we have a $500bn trade deficit with China. (Skip to the end if numbers are not your thing).
1. The U.S. has a $375bn goods trade deficit with China. That is made up of $506bn of stuff we buy from China and $130bn of stuff we sell to them
2. The U.S. has a massive $38bn surplus in services with China. Bigger by far than any other country. It's mostly travel, IP licenses and business services (do a consulting gig for Alibaba without even leaving your San Francisco office and it shows up here)
3. The trade deficit is thus $337bn. Still large but not $500bn.
4. Most of what the U.S. sells to China is food, aircraft, cars and capital goods. They're 52% of all exports.
5. Most of what China sells the U.S. is cell phones (some $65bn a year), computers and telecomm equipment and toys.
6. The U.S. has 25 products that account for more than $1bn in sales to China. China has 68 coming the other way.
Now it would seem that China is in a very good position here. The U.S. has targeted 25% tariffs on some $50bn of goods coming in from China. So that's $12.5bn. Here’s the full list, starting with Thorium. They left off the cell phones because because that “Designed in California, assembled in China” on the back of your iPhone means exactly that. Apple and others would have a fit if those were part of the deal.
China, of course, retaliated last time on the steel tariffs with 25% tariffs on $3bn of stuff from the U.S. That's the wine, ginseng and pork products one. So, that’s $750m. This time, they've targeted the big ones like soybeans, aircraft and cars. They floated a tariff rate of 25%, which would cost U.S. exporters around $22bn.
Put this all together and we’re looking at around $45bn of cost for U.S. exporters and U.S. consumers. That’s around 0.2% on a $20 trillion economy. If the U.S. goes with the $100bn increase we heard about last night, then add another $25bn for a total of 0.3% of GDP.
But this is not the point. What worries businesses is how far this can go, whether supply chains will have to be redesigned or business strategies rethought. So Boeing, John Deere and Caterpillar were all down around 12% recently. The stock market reaction, down some $1.5 trillion since February, is way out of proportion. But then it nearly always is.
The foreign exchange market, however, is not rattled. If markets get really scared about this, expect the dollar to strengthen and the Yen and Renminbi to weaken. It’s been the opposite.
Anyway, here's the trade deficit with China. It’s 50% of the U.S.’ entire trade deficit. If I were a betting man, I’d say the U.S. will have a tough time winning this one.
2. How about those jobs numbers? Meh, not so good. It was just 103,000 compared to 326,000 in February. We have a kind of love-hate relationship with the jobs numbers. On the one hand, they're a big, market-moving event. The Fed follows them because it’s part of their mandate. And you’ll occasionally hear an administration mention them. But they're subject to huge variations from initial to final, have weird seasonals and tend to over or under report against consensus by 50,000. Yes, a 100,000 estimate produces a 50,000 to 150,000 result. And that's considered fine.
Anyway, here they are with the bottom line showing average wage increases.
That’s the number that got everyone worked up two months ago when it spiked. We thought then it was a seasonal thing and it certainly looks that way now. Average earnings were up 2.7% but these are nominal not real increases and skewed to supervisory workers. The non-supervisory workers saw a much smaller increase and lower weekly earnings. Which means they had a modest pay rise but got to work less.
The market had other things on its mind and gave the numbers a big yawn. It was mildly bullish for Treasuries with rates at 2.78%. It all supports our low growth low inflation outlook.
Bottom Line: Expect markets to react a lot to bellicose trade talk. Mr. Zuckerberg will visit Congress. Probably best to stay clear of big tech for a while.
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--Christian Thwaites, Brouwer & Janachowski, LLC
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