The Days Ahead: Geopolitics a wild card. Europe elections
One-Minute Summary Stocks marginally down and Treasuries up for the week. You’d think with that, the Fed must have cut rates or something. But no it’s another week of trade, slower economic numbers and the expectations of lower rates for a while. Every economic number that comes in low…and there were plenty this week with industrial production, capacity, retail sales, import prices…reinforces the lower rates for longer story. Confidence remains fragile. We see companies holding off on big decisions and playing it safe. It's not enough for a recession but definitely slower.
Markets are just taking this all on board. We track four “fear” trades: gold, yen, 10-Year Treasuries and the VIX. All trades which turn sharply up when things are bad. The only one with a sustained rally is the 10-Year Treasury, now at 2.4%. The other three have all calmed down.
1. Trade talks, war, progress, and retaliation. Yes, something for everyone. China responded with tariffs on $60bn of goods from June 1st and the U.S. went ahead with 25% tariffs on $200bn of imports (bad). Goods which are on board ships now (it’s a 4 week journey from China) aren't affected but they will be from then on (good). The U.S. agreed to remove steel tariffs on Canada and Mexico (good). The U.S. claimed military superiority depends on the automobile industry so is looking at imposing tariffs on auto imports from Japan and Europe (bad).
Auto tariffs are complicated. The U.S. imposes a 25% import tariffs on trucks. Trucks include SUVs….even small ones like RAVs and CRVs. So they're made in the U.S. They also outsell cars 2.5:1.
Here’s a rough guess on how much other countries charge.
So that’s as high as 60% if you want an American car in India and 25% in China. Even places like Australia at 0% , can have luxury car taxes, which hit U.S. manufacturers. The Administration’s goal, we think, is to have that entire map the same color as Canada.
With all that going on, why are stocks so calm? Well part of the reason is that the tariffs a) hurt the Chinese economy a lot more than the U.S. and b) tariffs are not necessarily paid for by U.S. consumers. There’s much debate on this ranging from “it's a straight up consumer tax” to “it won't cost them anything”.
Recent import prices were down year on year for the fifth straight month and we think consumers will barely notice the tariffs. We realize this is not the mainstream opinion. But we’re interested in stocks, investing and the economy not polemics. And so far, we’re okay with the U.S. outlook.
We discussed last week how tariffs may not hit consumers but skipped over the foreign exchange point. The Renminbi has weakened by about 3.5% in the last week and by 10% over the last year.
That's not enough to cancel out the tariffs entirely but shows major risk aversion by currency and Emerging Markets traders.
What's next? Sit this out. We already reduced Emerging Market exposure and we could do that again if the tariffs stick or there’s a bad deal.
2. Recession Watch Housing is a leading indicator of recession. One only has to think back to the carnage in 2008 to remind ourselves how overstretched borrowers, bad lending and a housing oversupply can crash the economy very quickly. There are numerous housing indicators: new sales completed sales, pending sales, mortgage applications, starts, permits etc. Existing home sales are important for homeowners. We all feel good when the house down the road goes for 20% more than we paid for ours. But existing home sales don't generate much economic activity other than some commissions and the occasional kitchen rebuild. New home sales are more important to the economy because they require some entrepreneurial activity, building materials and labor.
So new housing starts is the one to look at and it’s good news. Interest rates and consumer confidence drive starts. Last year, as rates increased, starts fell by 7%. This year, as rates eased back after the Fed’s “patient” stance, they've come back, especially with multi-family units, which are up 13% from 2018 lows.
This is quite a turn from last year when we (and others) called the top of the housing market. So all better on the housing front? Yes from an immediate recession concern. Nothing to see.
But on the broader side, there are some important changes to the housing market. We've discussed many times the increase in student debt, local housing markets that have squeezed out borrowers and the delay in household formation.
This has meant mortgage levels have flattened and mortgage debt as a percent of GDP has fallen... a lot. Foreclosures (the lower line) are at 25-year lows. But as the New York Fed points out, people using a mortgage have fallen steadily and now (h/t BMO):
“At the end of 2018, about 26 percent of Americans between 20 and 69 had a mortgage, the lowest point reached in the twenty years of available data.”
So, it seems more and more people are opting out of parts of the economy that made baby boomers so wealthy.
Bottom Line: Emerging Markets are our chief concern. They're going to be hurt most with trade problems.
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