Stock markets haven’t priced in a Never Ending Trade War

Investors consider tariffs and the trade war as only being temporary. A U.S. – China trade deal, will sound the all clear signal for markets and the economy. But there are indications that we may be in for a longer, more prolonged set of trade battles. A Trade War could last as long as Trump remains in office.

Consider:

  1. U.S. steel and aluminium tariffs remain in place even after the U.S. signed a new trade deal with Mexico and Canada on Sept. 30.
  2. The administration wants to retain the ability to slap punitive tariffs on China permanently as part of a new trade deal.
  3. The administration is moving to institute $11 billion in tariffs on European aviation imports, and there are concerns that the next step is tariffs on European auto imports.

 

Bank of America Merrill Lynch global economist Ethan Harris has said he expects trade wars to continue over different issues and with different trade partners, even if there is an agreement with China. “The trade war is not going to go away during President Trump’s tenure in office. I think it will go through periods of hot war and cold war,” he said.

 

There are political and economic reasons for a long trade war.

On the political front, Trump campaigned on reviving U.S. manufacturing, reducing trade deficits and making better trade deals.  A continued pitched battle with U.S. trading partners shows his political base that he is fighting for them in hopes of being re-elected. Also, the trade hawks in the Trump administration want some form of permanent tariffs in place and welcome trade battles.

On the economic front, the Trump administration believes that tariffs are a good negotiating tool to force countries to eliminate unfair trade practices. The goal is giving U.S. industries protection to redevelop and gain market share back from China and other low-cost competitors.

Unfortunately, temporary tariffs won’t work. It’s clear that a manufacturing revival requires substantial investment and it takes a lot of time to move plants back to the United States.  Capital will only flow to these industries if it believes its protections from cheap foreign goods is permanent, not temporary.

How tariffs are hurting the economy!

  • Trade uncertainty has damped corporate spending on capital projects.
  • Corporate profit margins are expected to contract because tariffs have increased costs but market conditions won’t allow corporations to increase prices.
  • Share buybacks are at all time highs, a sign of low business confidence.

Year to date, the North American stock markets have been steadily rising. However, first quarter earnings estimates have been reduced and disappointing results could spark a market correction. Fund managers have been getting defensive as one of best performing sectors during the past 12 months has been utilities.

Timing the market is next to impossible but investors are still buying on rumors of a U.S. – China trade deal and probably sell on news. You may want to avoid putting any new money into the markets or raise some cash and wait for a better buying opportunity.

 

 

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Some share buybacks programs are hurting investors & workers

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Between 2008 and 2017, 466 of the S&P 500 companies spent around $4 trillion on stock buybacks, equal to 53 percent of profits. The Trump tax cut of 2018, helped corporations to repurchased more than $1 trillion of their own stock, a staggering figure and the highest amount ever authorized in a single year.

Under a share buyback program, a company purchases a certain number of its own shares on the open market. Reducing the number of outstanding shares making the remaining shares worth more. One of the most obvious reasons for the growth of such programs is to help offset the effects of generous stock compensation packages for executives, including stock options and stock contributions to employees’ 401(k) programs.

In theory, management only repurchases stock if it expects to enhance shareholder value more that way than by using the cash for capital spending, acquisitions, product development or dividend distributions. In reality, it has helped poor management use financial engineering to artificially increase earnings and hopefully keep share prices from falling in value.

A very simple example below shows how financial engineering works. A corporation buybacks 50,000,000 shares at $20.00 each which increases earnings by $0.25 and reduces the price earnings ratio from 20 to 16 making the company more attractive to investors.

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General Electric is a perfect example of corporate mismanagement. From 2015 to 2017, they repurchased $40 billion dollars’ worth of shares at prices between $20 and $32 and their share price is now only $10.21, a total waste of shareholders’ money.

When corporations direct resources to buy back shares on this scale, they reduce their ability to reinvest profits more meaningfully in the company in terms of R&D, new equipment, higher wages, paid medical leave, retirement benefits and worker retraining.

It’s no coincidence that at the same time that corporate stock buybacks have reached record highs, the median wages of average workers have remained relatively stagnant. Far too many workers have watched corporate executives cash in on corporate stock buybacks while they get handed a pink slip.

Recently, Walmart announced plans to spend $20 billion on a share repurchase program while laying off thousands of workers and closing dozens of Sam’s Club stores. Using a fraction of that amount, the company could have raised hourly wages of every single Walmart employee to $15, according to an analysis by the Roosevelt Institute.

Walmart is not alone. Harley Davidson authorized a 15 million share stock-repurchase around the same time it announced it would close a plant in Kansas City, Mo. And Wells Fargo has spent billions on corporate stock buybacks while openly plotting to lay off thousands of workers in the coming years.

Senators:  Sanders-Schumer propose a bill to limit buybacks

Their  bill would prohibit a corporation from buying back its own stock unless it invests in workers and communities first, including things like paying all workers at least $15 an hour, providing seven days of paid sick leave, and offering decent pensions and more reliable health benefits.

They point out:

The past two years have been extremely disappointing for millions of workers. President Trump promised the typical American household a $4,000 pay raise as he pushed for his tax giveaway to the rich. The reality, however, is that from December 2017 to December 2018, real wages for average workers have gone up by just $9.11 a week. Why should a company whose pension program is underfunded be able to buy back stock before shoring up the pension fund?

Stock buybacks don’t benefit the vast majority of Americans because large stockholders tend to be wealthier. Nearly 85 percent of all stocks owned by Americans belong to the wealthiest 10 percent of households. So when a company buys back its stock, boosting its value, the benefits go overwhelmingly to shareholders and executives, not workers.

What do you think? Should government limit share buybacks?

 

 

Yield hunting in the Dogs of the Dow

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Investing in the Dogs of the Dow as a strategy dates back to 1991 from a book “Beating the Dow” by Michael O’Higgins. The Dogs of the Dow are the 10 highest dividend yielding stocks within the Dow 30. They are called investment “Dogs” because rising dividend yields tend to be a function of falling prices.

It is a simple strategy of allocating an equal amount of funds into each of these 10 stocks and holding them for a year. Normally, an investor would need to only rid about two to three stocks every year and replace them with different ones. These stocks are typically replaced because their dividend yields have fallen out of the top 10 because the stock price has either increased in value or have reduced their dividend payment. (Sometimes a stock, like GE that has fallen on hard times is removed from the DJIA altogether.)

Why am I hunting for yield in the Dogs of the Dow

  • My retirement accounts contain a large percentage of  U.S. dollar holdings.
  • I am a retired Canadian senior who requires income from my investments to pay bills.
  • Dividend stocks provide income and some downward protection during volatile markets.
  • Historically, Dow stocks have been very stable companies that can weather any market decline with their solid balance sheets and strong fundamentals.
  • The current yield on the dogs of the Dow are higher than the yield on 2 & 10 year U.S. treasuries
  • The Canadian dollar is currently trading at a 32% discount to the U.S. dollar which increases the income from holding U.S. stocks.

Dogs of the Dow 2019

Stock Symbol Company Name 2018 Close Dividend Yield
IBM International Business Machines 113.67 5.52%
XOM Exxon Mobil 68.19 4.81%
VZ Verizon Communications 56.22 4.29%
CVX Chevron 108.79 4.12%
PFE Pfizer 43.65 3.30%
KO Coca-Cola 47.35 3.29%
JPM JP Morgan Chase 97.62 3.28%
PG Procter & Gamble 91.92 3.12%
CSCO Cisco Systems 43.33 3.05%
MRK Merck 76.41 2.88%

At first glance, IBM has a very tempting dividend yield. However, I warned my readers that IBM wasn’t a good investment back in 2015 when Warren Buffett lost 11.8% on his IBM shares. Buffett has sold all his IBM shares for an estimated 2 billion dollar lost. The trend has been downward ever since and I don’t see a turn around anytime soon.

Warren Buffett looses $500 million on IBM’s Bad Quarterly Results

Oil stocks have been very volatile due to slower world economic growth, over-supply concerns and fears of a 2020 recession. I am eliminating  both Chevron and Exxon Mobil as potential buys.

I am using fundamentals to eliminate Coca- Cola, Merck and P&G because of their high price earnings ratios compared to the rest of the stock market. Plus, Coco-Cola and Merck have high dividend payout ratios which will make it difficult for them to increase dividend payouts going forward.

J.P. Morgan has never been a Dog of the Dow until this year. U.S. banks have seen their net interest margins decrease due a flattening  yield curve. In simple terms, they are paying more interest on deposits but loan demand is weak so they are getting less loan interest. U.S. banks have under performed the over all market. This is a possible turnaround candidate if economic growth comes in stronger than expected.

Verizon and Pfizer have been Dogs of the Dow for the past five years and have fairly good fundamentals. They both have stable share prices, low payout ratios and reasonable price earnings ratios. These two stocks are possible buys for income.

Dec. 2018 Verizon $52.93 4.46% Pfizer $36.22 3.75%
Dec. 2017 Verizon $53.38 4.33% Pfizer $32.48 3.94%
Dec. 2016 Verizon $46.22 4.89% Pfizer $32.28 3.72%
Dec. 2015 Verizon $46.78 4.70% Pfizer $31.15 3.60%
Dec. 2014 Verizon $49.14 4.31% Pfizer $30.63 3.40%

I think that Cisco is strong buy. Cisco has been a Dog of the Dow for the past 4 years and their share price continues to increase in value. During those years, Cisco has maintain a consistent 3% dividend yield by increasing their annual dividend.

Dec. 2018 Cisco 38.3 3.03%
Dec. 2017 Cisco 30.22 3.44%
Dec. 2016 Cisco 27.16 3.09%
Dec. 2015 Cisco 22.43 3.03%

Unfortunately, past performance is no guarantee of future returns. Please do your own research, this post is for educational purposes only!

 

Santa Claus rally, No, No, No?

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Is there any hope for a Santa Claus rally this year? What are the chances the markets could reverse the worst December since 1931?

A Santa Claus rally, which would begin on Monday, is a very specific event. It is the tendency for the market to rise in the last five trading days of the year and the first two of the New Year. According to the Stock Trader’s Almanac, it is good for an average gain of 1.3% in the S&P since 1950.

What caused the Dow Jones Industrial Average to have its worst week since the financial crisis in 2008, down nearly 7 percent and cause the Nasdaq to close down into bear market territory?

  1. The Federal Reserve’s rate hike on Wednesday drove the losses this week and investors were hoping for a more dovish tone regarding future rate hikes. Despite the fact that Chairman Powell reduced the projected number rate hikes from three to two and reduced the neutral rate to 2.8% from 3%.
  2. In my humble opinion, President Trump is partly to blame for the severity of the losses this week due to his criticism of the Fed.  He backed Powell into a corner and forced him to show that the Fed is an independent institution. (the Fed could have put more emphasis on being data dependent) According to some reports, Trump has also discussed firing Powell privately because of his frustration with stock market losses in recent months.
  3. In an extensive interview at the White House on Thursday, Trump’s trade adviser, Peter Navarro said that it would be “difficult” for the U.S. and China to arrive at an agreement after the 90-day period of talks unless Beijing was prepared for a full overhaul of its trade and industrial practices.
  4. Political chaos in Washington with partial government shutdown, sudden withdrawal of troops out of Syria and the resignation of Defensive Secretary Mattis.

Investors are still worried about:

  • A slowdown in economic growth as more companies scale back their sales growth and profit outlook for 2019
  • Fear that a flat yield curve will invert if the Fed continues to hike short-term interest rates
  • The unwinding of the Fed’s balance sheet will reduce the availability of credit for corporations
  • The trade war with China will escalate causing more inflation
  • More economists are jumping on the recession bandwagon for 2020
  • Political chaos in Washington will get even worse when the Democrats take power in January

A dead cat bounce is a possibility in January

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dead cat bounce is a small short-lived recovery from a prolonged decline or a bear market that is followed by the continuation of the down turn. You need nerves of steel to trade a dead cat bounce but for long-term investors it could be a good time to reduce market risk and re-balance your portfolio.

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Blame Yellen and Trump for rapid raising U.S. interest rates

  

I believe that the former head of the Federal Reserve, Janet Yellen, is partly responsible for rapid raising U.S. interest rates. Although, GDP growth wasn’t overheating during her term, she could have started to unwind the Fed’s balance sheet which had 4 trillion dollars’ worth of treasuries. Instead she bought more treasuries after they matured and expanded the balance sheet by buying more treasuries with the interest earned.

This kept long term interest rate extremely low and allowed corporations to borrow money at low rates to buy back their shares. The Fed’s lack of action has help fuel the longest bull market in history.

Sorry Trump supporters but your man is also to blame. His policies are inflationary!

  1. The trump’s administration decision to pull out of the Iran deal has cause oil prices to rise. One million barrels of oil a day is being taken off the market.
  2. Trump’s tariff war with China and other trading partners will force corporations to increase prices because their costs are going up. Costs could go up even higher if Trump increases tariffs on imports from China from 10% to 25% in January 2019
  3. The corporate tax cuts and government spending has juiced the economy causing unemployment to fall to the lowest level in nearly fifty years sparking fears of raising wage growth.

The Trump’s administration spin that the tax cuts will pay for themselves is simply not true. Both the Reagan and Bush tax cuts added to the fiscal deficit.

The new Fed chairman, Jerome Powell has a difficult job of unwinding the Fed’s balance sheet by buying less treasuries just as the federal government is issuing more debt to cover the Trump’s tax cuts. Trump will add another trillion dollars to the deficit. More supply of treasuries plus less buyers equals raising interest rates.

Trump blaming Powell for the massive drop in the stock market last week is ridiculous. No one knows for sure what caused investors to hit the sell button. Was it fear of raising interest rates, a forecast of slower global growth by the IMF, fear of an escalating trade war with China or fear of runaway inflation.

My guess is all or none of the above. Maybe the stock market was just due for a correction.

 

 

 

 

Option traders are benefiting from trade war fears

Last year was among the least volatile in the history of the stock market. The VIX which measures market volatility averaged a little over 11 for 2017. It was the lowest level for the index since it was introduced in 1986.

Fear is back in the markets as talk of tariffs dominate the financial news media. Choppy markets increase option premiums so it is a good time to write options. The reward for giving someone else the option to buy or sell something has gone way up this year.

Option-writing strategies range from conservative (covered calls and collars) to extremely risky (naked puts). With the virtually unlimited variations of strike prices and expiration dates available, investors can customize their risk/reward parameters with remarkable precision.

Here are three common option strategies that can generate income or limit losses from an investment portfolio.

1. Covered calls and collars

The most common, conservative way to take advantage of rich option premiums is to write call options on securities you already own. If you’re invested in stock funds, you can write on stock indexes although the premiums are generally less than on individual stocks.

For example, say you own 100 shares of Apple at $190.00 and you wanted to generate some income.  Selling a call option expiring on Aug. 17 to buy 100 shares of Apple at the strike price of $195 provides $3.40 of income. That amounts to a 1.7 percent return on a monthly basis, roughly 20 percent annually, assuming you can repeat the process for 12 months.

The risk in the strategy is that the stock rises significantly and your shares are called away at the strike price. In other words, you limit your potential upside from owning the stock in return for the premium income you receive. The option premium also provides a small cushion against losses, but if the stock or index falls dramatically, so will the value of your holdings.

If investors want downside protection, they can buy puts on the position simultaneously. A collar, often called a costless collar, is a strategy that uses the premiums from writing call options to purchase out of the money puts that limit the downside risk on an investment. In the Apple example, you would sell one $195 call option for $ 3.40 and use the money to  buy one Aug 17 put at 185.00 for $3.30

Two things to keep in mind:

  1. The longer the term on a call option, the more premium you’ll receive, but the greater the risk that your investment is called away.
  2. Single stock options pay better premiums than those on an index such as the S&P 500. They are also riskier and more volatile.

2. Straddles are for speculating on short-term price movements

Option straddles are not writing strategies that generate premium income, but rather pure plays on volatility.If an investor believes that a stock or index is going to have a big move either up or down, a straddle can help them benefit from it while limiting the potential risk. The strategy involves buying a put and call option with the same strike price and maturity on a single security or index.

The chart below is the three month price movements of the Dow Jones index which has been very sensitive to fears of a trade war.

For this example I will use the  Dow Jones index (DIA) which closed at 249.30 today so you could buy one Aug 17 $250 call option for $3.10 and one Aug 17 $250 put option for $4.15

Option traders hope that one of the options expires worthless and the other results in a windfall. The worst-case scenario is that the underlying index doesn’t move at all and both options expire worthless. You lose your entire investment in that scenario. The break-even point is when the value of one of the options equals the cost of buying the two contracts. We could get lucky and sell the call option if the Dow suddenly moves up in a short period of time and sell the put option if the Dow moves back down just as fast.

3. Writing cash secured put options or writing put spreads

Financial advisors agree that writing put options when you don’t have the cash to fulfill the contract, is a recipe for disaster. That doesn’t mean you have to avoid writing put option contracts. But you do need to have the cash to buy the shares if the market falls and the option is executed by the buyer. The advantage of writing puts is that they generally carry higher premiums than call options do.

For example, you may like Apple stock but are worried that it’s overvalued at $190. If you write a put option with a strike price of $180, you get the premium income and the opportunity to buy the stock at a lower price.

A put spread is used when you don’t have the cash to buy the underlying stock if it falls. For example, you may not have the money to buy 100 shares of Apple but you think the stock price is stuck in a trading range around $180 to $190. You could sell the Aug 17 $180 put option for $1.95 and buy the Aug 17 $170 put option for $0.70 and net $1.25 if both option expire worthless. The caveat is that if Apple tanks, your potential loss on the contract is limited since you bought put protection at the $170 strike price.

Options are powerful tools that carry embedded leverage and are riskier than owning the underlying security. Premiums are richer now because volatility is higher. Buy a call option and it could become worthless overnight after a bad earning release. Sell a naked put and your potential losses can be catastrophic. Most financial advisors suggest that buying or selling options should be left to experts.

I believe that an investor with a good understand of simple mathematics and the willingness to learn can use options to protect their portfolios and earn some extra income.

Disclaimer: The option trades listed in this post are for educational purposes only and recommendations.

 

 

 

 

 

 

 

 

Sorry America, Canada is imposing retaliatory tariffs on U.S. goods

We have been good neighbours for 151 years and we share the longest unsecured international border in the whole world.  We have fought and died together in too many wars to even count. However, Canada’s foreign minister announced Friday that Ottawa plans to impose about $12.6 billion worth of retaliatory tariffs on U.S. goods on July 1, joining other major U.S. allies striking back in the escalating trade dispute.

Canada’s plan taking effect next week will include imports of U.S. products such as yogurt, caffeinated roasted coffee, toilet paper and sleeping bags. Canada’s announcement is part of larger fallout from U.S. President Trump’s tariffs on steel and aluminum imposed on Canada, the EU and other nations. As a result, some of the U.S.’ biggest trading partners have retaliated with counter-tariffs.

 “We will not escalate, and we will not back down,” Freeland said.

Mexico’s tariffs took effect June 5 on U.S. products such as pork, cheese, cranberries, whiskey and apples. The EU enacted tariffs Friday on more than $3 billion worth of U.S. goods including bourbon, yachts and motorcycles.

The White House’s stated goal in implementing tariffs is protecting U.S. jobs, but the initial business response suggests that U.S. companies are taking a hit. Companies are coping with the tit-for-tat tariffs by increasing prices or making business changes to cope with higher costs.

Harley-Davidson, an American Icon, is an example why Trumps’s protectionist agenda may not work.

In May 2017, Harley said it planned to build a plant in Thailand. Harley’s CEO, Matt Levatich, said the decision was made as part of a “Plan B” when Trump dropped out of the Trans-Pacific Partnership. The plant would allow Harley to avoid Thailand’s tariffs on imported motorcycles and help the company obtain tax breaks when exporting to neighbouring countries.

In January Harley announced plans to close its Kansas City plant, leaving 800 workers without jobs. It will shift operations to another plant in York, Pennsylvania, and hire some workers there, but ultimately there will be a net loss of 350 jobs. Days later it said it would spend nearly $700 million on stock buybacks that would benefit shareholders.

The company also announced on Monday it will shift the production of its Europe-bound motorcycles overseas as a result of the EU’s retaliatory tariffs. It’s not exactly clear which factories will take on the excess production for Harley. However, Harley’s Street-model bikes are made in India for Italy, Spain, and Portugal. More American jobs could be effected.

Harley-Davidson took its tax cut, closed a plant, and bought back stock.

The chart below is Harley-Davidson’s stock price from Trump being elected President to Friday’s closing prices. Is it safe to assume that both shareholders and workers are not benefiting from Trump’s protectionist agenda?

The automotive industry is Trump’s next target for imposing tariffs. Trump’s Commerce Secretary Wilbur Ross plans two days of public hearings on July 19-20 aimed to wrap up the probe into whether imported vehicles represent a national security threat by late July or August.

Two major auto trade groups warned imposing 25 percent tariffs on imported vehicles would cost hundreds of thousands of auto jobs, dramatically hike prices on vehicles and threaten industry spending on self-driving cars.

Lets hope that this trade war with our American neighbours will not accelerate! Wishing them a Happy 4th of July!