The Days Ahead: Brace for another week of trade stuff.
One-Minute Summary Trade and new IPOs. That was pretty much all we needed to know about the week. We discuss both below but would just point out that stocks were up 17% year-to-date a week ago and they're now up 15%. We'd had a straight four months of gains. When you get your expected return for the year in one third of the time, some people are going to take profits.
One of the things we’re reminded of, is that getting tough on China is a bi-partisan deal. Even corporate America is quietly cheering this on. We think one of three things can happen:
It all gets worse and confidence evaporates
There is a deal and tariffs are reset
There are more negotiations and something gets done
We think #3 is the most likely but it will be a heck of a bumpy road.
Meanwhile Treasuries continue to rally. The soft CPI numbers on Friday capped a week of so-so economic reports. The whole yield curve out to 11 years is now below the Fed Funds rate, which suggests the Fed will stay put.
1. Trade Tariff Tweets: was pretty much all you need to know about markets early last week. We saw some, frankly irresponsible, headlines from people like Bloomberg, who should know better. “Swoon…precipice…soaring volatility”. Gimme a break. The market was down 2% from Friday’s close to its low point on Tuesday. The worst performing stocks (those down 7% or more) had nothing to do with trade but were companies with their own set of problems. Mylan, a generic pharma company, for example, was down 22% but that was due to a big revenue miss. Companies with big China exposure (e.g. Apple, Yum) were down no more than average.
The tweets were quite straightforward.
We might also add that the tweets were two of 71 tweets sent out in 48 hours. That’s three per waking hour. So it’s unlikely they're the product of thoughtful deliberation. And we certainly have no insight into the strategy.
But it's worth breaking down.
The tweet says simply that there will be 25% tariffs on $575bn worth of imports. The current tariff schedules would raise around $32bn. The new tweeted schedule would raise $143bn. That’s around 0.6% of GDP and a little less than the amount the U.S. economy grew in Q1 (see Table 3).
The U.S. imported around $539bn (not $575bn) worth of goods from China last year and ran a total trade and services deficit of $378bn. That’s made up of a services surplus of $40bn and a goods deficit of $419bn.
The actual imports of goods from China is around 15% lower this year (yes, tariffs tend to do that) so the more likely number for China imports in 2019 is probably $490bn, again, not $575bn. Plug 25% into that and we’re looking at $120bn. Still a big number but the same as about 6 weeks of U.S. GDP growth.
Now, there are a number of ways to pay that $120bn (ignoring FX changes):
Chinese companies can lower their prices
U.S. importers can face a margin squeeze
U.S. consumers end up with higher prices
Of course, it’ll probably be all three. Governments may also make it easier on all three parties. Both China and the U.S. have provided aid to the most affected parties, as when U.S. farmers received $12bn in compensation for the collapse in soybean exports.
So far, import tariffs have not hit the consumer much. Some 35% of U.S. imports from China are cell phones, computers, telecom and computer accessories. Just looking at my desk, the phone, screens, laptop, desktop, keyboard, router and something else with many wires….all made in China. It's possible that they will all be 25% more expensive a year from now. But very unlikely.
The bottom line is that the tariffs are really no big deal for the U.S. The worst case we can come up with is a 0.6% reduction in GDP. If the threat to growth was real, we would have seen the Australian Dollar weaken (a reasonable proxy for the Chinese Renminbi) or Mexican stocks rally. Mexico is a net beneficiary of U.S.-China trade tensions. But no. Neither moved.
China stocks were down a lot more than the U.S., some 6%. But that makes sense. Chinese export to the U.S. account for 3.5% of GDP. For the U.S., it's 0.6%. So there’s some truth that all this hurts China more than the U.S.
The biggest effect of the trade wars is on confidence and financial markets. Markets were due for a sell-off and some overdue profit taking. We think the overall effect is fleeting.
2. Recession Watch: Consumer Debt One interesting feature of the post-crash landscape is that households have become reluctant borrowers. Here's the growth of personal income and revolving (i.e. credit card) debt and fixed debt (i.e. vehicles).
Prior to 2009, consumers borrowed freely. Since then, income (top line) has grown 45% but both types of debt have grown 30%. Yes, there’s a lot more student debt around but that kind of debt is deflationary…it holds back household formation. The above tells us that there’s very little inflationary pressure coming from consumers and so any recession is likely to be mild.
Last week, new numbers came out on credit showing total outstanding credit rose only $10bn. For most of 2018, it was growing at $20bn a month. Consumers just don't seem ready to increase debt.
3. When risk goes up…Treasuries do well. That's not always so but it has certainly been the case this time round. There are other risk-off trades such as gold, the Swiss Franc, Yen and German Bunds but U.S. Treasuries have the liquidity and depth those lack. Last week, there was plenty to worry the market and there was even a hint that Chinese buyers stayed away from Treasury auctions in retaliation for the trade threats.
The 30-Year Treasury is now around the same level as it was in January 2018 and the 10-Year Treasury is at 2.46%. Three-month bills, from which FRN price, are at 2.44%. We think the Treasury market strength signals an easy Fed, slowing growth, a trade stand off and a place to hedge against rising volatility, as measured by the VIX index. With that, we’re happy to keep our position.
4. Top of the market? No. We've learned that if you play that game, it ends up badly. But here are a few indicators that make us go…really?
Lyft reported its first quarterly earnings and lost $1.1bn on revenues of $776m and gave out $859m in stock-based compensation.
Uber…enough has been said but companies selling a dollar for 95cents tend not to do well.
Softbank, a Japanese investment trust that owns a bunch of tech stocks, including Uber and Sprint, tried to convince investors that it should not trade at a 50% discount to NAV and ended up with this slide.
So that's rainbow unicorns flying into AI traffic with the share price tagging along. We think. (h/t FT Alphaville).
Bottom Line: Earnings season winds down. Probably some short-term upticks as trade news comes and goes. As one of our long term lessons goes, “Never trade on headlines.” We feel we've set portfolios up to withstand the next few months of headlines.
Please check out our 119 Years of the Dow chart
Subscribe here for our investment updates
People who swear are honest.
--Christian Thwaites, Brouwer & Janachowski, LLC
Please note that this discussion of our investments and investment strategy (including our research and investment process) represents our investments and investment strategy at the date of this commentary, and is subject to change without notice. We cannot assure that the type of investments discussed in this commentary will outperform any other investment strategy in the future, nor can we guarantee that such investments will present the best or an attractive risk-adjusted investment in the future. This is for general informational purposes only; references to an individual security should not be construed as a recommendation to buy or sell that security. The securities mentioned in this commentary are only several of the successful as well as unsuccessful investments by us, and do not represent all of the securities we have purchased, sold or recommended. Although we deem reliable the sources of the statistical and other information referred to in this commentary, we cannot guarantee the accuracy or completeness of any statements or numerical data. Past performance is no indication of future results.
All charts from Factset unless otherwise noted.