Why China will outlast the U.S. in trade war

In the political terms, President Xi Jinping runs a communist country that has just granted him the ability to rule for life. He enjoys advantages that may allow him to cope with the economic fallout far better than President Trump. His authoritarian grip on the news media and the party means there is little room for criticism of his policies, while Trump must contend with complaints from American companies and consumers before important midterm elections in November.

The Chinese government also has much greater control over their economy, allowing it to shield the public from job cuts or factory closings by ordering banks to support industries suffering from American tariffs. It can spread the pain of a trade war while tolerating years of losses from state-run companies that dominate major sectors of the economy. In addition, China is also sitting on top of about $3 trillion in surplus cash.

At best, the American actions could shave one-tenth of a percentage point off China’s economic growth. Not enough to force a drastic reversal of policies, given the enormous benefits that Chinese leaders see in the state-heavy economic model they have relied on in recent decades.

Chinese tariffs on the American agricultural sector is very influential in the Congress. Many states that have voted republican in the past will be hardest hit by these tariffs.

Hopefully the president is just blowing off steam again but, if he’s even half-serious, this is nuts,” said Senator Ben Sasse, a Republican from Nebraska, “China is guilty of many things, but the president has no actual plan to win right now. He’s threatening to light American agriculture on fire.”

In addition to agriculture, China threatened to retaliate with tariffs on American cars, chemicals and other products. The 106 goods, many produced in parts of the country that have supported Mr. Trump, were selected to deliver a warning that American workers and consumers would suffer in a protracted standoff.

The mere talk of a possible trade war has sent investors on a rolling coaster ride of uncertainty. The six month chart of the S&P 500 below clearly illustrates increased volatility.

China also has the upper hand because it holds $1.2 trillion dollars of American debt. Trump’s tax cuts and infrastructure spending will require issuing more debt. The U.S. government has relied on foreigners to purchase treasuries to finance their spending because American saving rates are so low and they can’t participate fully. Add the fact that the biggest buyer of treasuries was the Federal Reserve which has started to sell it’s holdings.

What would happen to the bond yields if China doesn’t buy additional American debt?

The economic law of supply and demand dictates that more supply will cause prices to fall. If bond prices fall then yields will go up, causing interest rates to raise. Wage and price pressures are already rising, higher tariffs would only intensify these pressures forcing the Fed to raise interest rates even more.

A worst case scenario, the talking war turns into a trade war that could slow U.S. growth, tank the stock market and cause a U.S. recession.

 

President Trump is approaching this like does everything else, by talking tough and expecting his opponent to give in. Unfortunately for Trump, it’s not the 80s anymore. China was dramatically underdeveloped then and it wanted access to Western technology and manufacturing techniques. China is relatively mature today and it can easily obtain what it needs from other vendors outside the United States. While the U.S. market looked enticing a few decades ago, Beijing is more interested in newer emerging market countries.

Trump is not only gambling his political future but the financial well-being of Americans if he starts a trade war.

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Trudeau is whistling by the Canadian graveyard

According to Wiktionary:  “whistle-past-the-graveyard” is to attempt to stay cheerful in a dire situation; to proceed with a task, ignoring an upcoming hazard, hoping for a good outcome.

In my humble opinion, this idiom describes our Prime Minister perfectly. The Canadian government missed a golden opportunity to respond to the Trump tax cuts in the February 2018 federal budget.  The United States, our largest trading partner, has made investing in the U.S. more attractive than Canada. Corporate tax rates in the U.S. are 5% lower than Canada and more important is the 100% deduction for new capital spending.

The Canadian dollar has fallen in value from $1.2586 at the end of February to $1.3079 today. A clear sign that foreigners are taking their money out of Canada.  The uncertainly regarding the successful re-negotiation of NAFTA is hurting our dollar and is also responsible for the lack of capital spending in Canada.

Our factors that make Canada less competitive than investing in the U.S.

  • Carbon taxes have increased energy costs.
  • February budget increased taxes for small businesses and individuals.
  • Canadian oil is being sold at a discount by $20 to $25 a barrel costing billions of dollars in lost revenue to Canadian oil companies and loss of tax revenue.
  • Kinder Morgan’s Trans Mountain pipeline expansion is being delayed by protesters.
  • Many LNG projects have been scrapped. Meanwhile, this sector is booming in the U.S.
  • The housing market is slowing down due to a 15% foreign buyer’s tax, tightening mortgage rules and higher mortgage rates.
  • Tariffs on softwood lumber, pulp & paper and solar panels. (Steel & aluminium tariffs could become permanent if Trump doesn’t like the NAFTA deal)

No surprise that the Toronto stock exchange is down 4% year to date while the S&P 500 is flat and NASDAQ is up 6%. The Trump tax cuts have already boosted employment and capital spending should kick in the second half of 2018. However, there are still are plenty of risks investing in the U.S. with the Trump circus in Washington. Possible trade wars leading to inflation and higher interest rates.

It is going to be very challenging to make money in 2018!

I am still a Canadian Bear

Trump Tariffs are all about politics and not national security

 

Canada and Brazil are likely to bear the brunt of any tariffs on steel imposed by President Donald Trump. According to the department’s International Trade Administration, Canadian and Brazilian steel comprised 16 percent and 13 percent of U.S. steel imports as of September 2017. China is not one of the top 10 importers of steel to the U.S. (take a good look at the above pie chart)

Top foreign sources of aluminum included Canada (56 percent), Russia (8 percent) and the United Arab Emirates (7 percent) between 2013 and 2016, according to the United States Geological Survey.

In my humble opinion, there is little justification on applying a 25% tariff on steel and a 10% on aluminium based on national security. The majority of steel and aluminium that the U.S. imports comes from military allies.

Now, the timing on this tariffs are somewhat suspect with a congressional election in the 18th district of Pennsylvanian next week. In case you didn’t know, Pennsylvania manufactures a lot of steel. This is Trump country, he carried this district by 20% in the 2016 election. The race is so tight that Trump had a rally in Pennsylvania supporting Rick Saccone.

“Do me a favor,” he said to the large crowd gathered in a hangar at the Pittsburgh airport. “Get out on Tuesday, vote for Rick Saccone, and we can leave right now.”

Trump also using tariffs as a bargaining chip in NAFTA negotiations

Canada and Mexico received a temporary exemption from the tariffs. It will depend on whether the changes that are made to NAFTA will satisfy Trump.  The seventh round of talks in Mexico produced very little process. The final round of NAFTA talks are schedule in Washington sometime in April. The Trump tariffs will put extra pressure on Canada and Mexico to give Trump a deal that will help him get republicans elected this November.

President Trump’s decision to impose tariffs on foreign steel and aluminum likely precedes an exit from NAFTA, according to Goldman Sachs.

Stock Markets don’t like tariff wars

Tariffs will artificially boost input costs and increase the cost of imported finished products. The fear is an increase of inflation, leading to raising interest rates which would dampen economic growth. The other fear is that corporations will be unable to pass on an increase in input prices which could lead to job cuts.

I expect more tough talk on trade from President Trump because many American voters think that the wealthy will benefit the most from tax cuts. I believe that stock market volatility will intensify over the next few months.

 

It may be a good time to raise some cash and pick up some bargains.

 

Shedding some light on the violent stock market moves

Have you ever heard of the saying Be careful what you wished for? It turns out that traders wished to see some growth in average hourly wages, some inflation over deflation and yields on long duration bonds to go up. They got their wish which started a violent market correction.

Market watchers remain at odds over what tripped the sell switch. Primarily, the conversation comes down to fundamental vs. technical. In the days since the correction began the markets have recouped more than half the downside since the low point.

Plenty of theories, I call mine “The Domino Effect”

Inflation fears was the first domino to fall hitting the fear of raising interest rates. The next domino to fall was money managers and institutional investors were caught with a lot of leveraged positions. The sharp fall triggered margin calls causing massive sell orders. This initiated sell orders from funds that use technical analysis better known as quantitative funds. The last domino to fall was retail investors (who haven’t seen a correction in over two years) did some panic selling.

The Dow suffered two drops of 1,000 points. The fall seems big but the actual percentage was not extraordinary. There have been larger percentage drops in the past. In my 35 years of investing, I have experienced some worse percentage downward moves.

Rank Date Close Net change % change
1 October 19,1987 1,738.74 −508.00 −22.61
8 October 26, 1987 1,793.93 −156.83 −8.04
9 October 15, 2008 8,577.91 −733.08 −7.87

 

Is the correction over?

The market fundamentals haven’t really changed. U.S. corporate earnings are getting better and the Trump tax cuts should boost economic growth. Plus there is systematic economic growth happening in both developed and emerging markets.

I am not an expert on technical analysis and I don’t believe in buying or selling based on lines on chart. However, pension funds, hedge funds and quantitative funds use technical indicators to manage a large amount of investors’ money. 

Analysis from Kensho, a quantitative analytics tool used by hedge funds, looked at seven occasions of similarly sharp drops in the S&P 500 beginning in 1987. The study found that following such a drop, stocks tended to fall further, with a median decline of 2.29 percent one week later and a drop of 1.68 percent two weeks later.

 

This is the ABCD bullish chart:

This is the year to date chart of the S&P 500:

In my humble opinion, corrections tend to last more than nine days. I put some money to work last week and plan on dollar cost averaging on some more positions. If you are new to my blog, consider reading:  Dollar-cost averaging using an option strategy

What do you think? Are you buying the dips or selling into the rallies?

Market correction when Trump sends a NAFTA withdrawal letter

FILE PHOTO: Canada’s Foreign Minister Chrystia Freeland (centre) Mexico’s Economy Minister Ildefonso Guajardo (Left) and U.S. Trade Representative Robert Lighthizer (right) REUTERS/Chris Wattie/File Photo

I disagree with most media and political pundits that believe Trump is unpredictable. He campaigned on America first which includes being tough on illegal immigration and ripping up NAFTA. His voting base believes that these two issues are responsible for low wages and poor job opportunities in the United States.

It was obvious to me that the U.S. government shutdown was caused by Trump who set the March 5th deadline for DACA (Deferred Action for Childhood Arrivals). He is using Dreamers as a bargaining chip to get funding for more border security and for his idiotic wall. Eighty per cent of Americans don’t want Dreamers to be deported. If Trump really cared, he would have informed the House of Representatives to draft a by partisan bill to solely deal with DACA.

In my humble opinion, Trump is just looking for an excuse to rip up NAFTA. Donald Trump’s protectionist leanings have been obvious since before the U.S. presidential election. U.S. negotiators are showing few signs of backing down from unrealistic demands on automotive content rules, the chapter 19 dispute mechanism and a five-year sunset clause that have left NAFTA teetering on the brink.

Canada and Mexico have rejected most of the U.S. proposals for NAFTA reforms, leaving officials with a big job if they are to bridge the large differences in Montreal. Negotiations are due to wrap up at the end of March.

Protectionist moves as U.S. imposes tariffs on the following imports

  • Softwood lumber (Canada)
  • C-series planes (Canada)
  • Pulp & Paper (Canada)
  • Washing machines (South Korea)
  • Solar cells & modules (China)

Canada is firing back by bringing a trade complaint to the World Trade Organization (WTO) despite the fact that the president has been particularly critical of the WTO and its system for dispute settlement.

A former U.S. trade representative says he’s hoping that a recent wide-ranging trade complaint launched by the Canadian government against the United States won’t “end up blowing up in their face” at the NAFTA negotiating table.

Adding more fuel to the fire, Canada has agreed to a resurrected a version of the Trans-Pacific Partnership (TPP) and will sign on to the deal. The deal, renamed the Comprehensive and Progressive Agreement for Trans-Pacific Partnership, comes after talks in Japan this week with the 11 countries (including Mexico) that are still committed to the deal.

“We are happy to confirm the achievement of a significant outcome on culture as well as an improved arrangement on autos with Japan, along with the suspension of many intellectual property provisions of concern to Canadian stakeholders,” said International Trade Minister Francois-Philippe Champagne in a statement.

Will these moves strengthen Canada’s position at the negotiation table with the United States or will it force Trump to play his withdrawal card?

My bet is that picking a fight with Trump will result in him sending a NAFTA withdrawal letter to both Canada & Mexico which will cause a stock market correction.  In my humble opinion, it is only a question of when!

Are tax cuts already priced in U.S. stocks?

Many stock market pundits have conflicting opinions as to how much of the tax cuts are baked into current stock prices. Some experts believe that a selloff in the stock market will occur in January as money managers rotate out of technology and into other sectors that will benefit the most from tax reform.

Their rational is tech companies were in a low tax environment before tax reform was passed and it is better to take profits when lower personal tax rates take effect in 2018.

In comparison, sectors like transportation, telecom, retailing and banking have high tax rates. In addition, the new tax bill also offers substantial write offs for new capital expenditures. Industrials, energy as well as telecom companies require large capital expenditures in order to grow their businesses. However, it is difficult to predict if and when these expenditures will occur.

“In a special report to clients, Barclays Capital analyst Maneesh Deshpande and team calculate that the benefit is less than it appears: While the statutory corporate tax rate is set to fall from 35 percent to 21 percent, the effective rate for S&P 500 companies (the rate companies actually pay after all the accounting trickery) is set to fall from 26 percent to 20.7 percent.”

On the other hand, some market watchers believe that tech companies should still be in your portfolio. There is still room to run higher because they have an opportunity to take advantage of the repatriation tax holiday which reduces the tax rate from 35% to 15.5%. The top 5 U.S. tech companies that have cash overseas:

  1. Apple – 230 billion
  2. Microsoft – 113 billion
  3. Cisco – 62 billion
  4. Oracle – 52 billion
  5. Google – 49 billion

Although, the last repatriation tax holiday was at a much lower tax rate. The money was mostly given back to shareholders in the form of higher dividend payments and share buybacks.  Should you invest hoping for history to repeat itself?

Secretary of the Treasury, Steven Mnuchin said:

“There is no question that the rally in the stock market has baked into it reasonably high expectations of us getting tax cuts and tax reform done.”

I tend to agree that a large portion of tax cuts are already priced in most U.S. stocks. For example: Charles Schwab (SCHW, $52.04) has had enough of the tax man. The online stock broker and banker has paid out a stunning 37% of its income in taxes over the course of the past five years, versus a rate in the mid-20% range for most other American companies. It was trading around $45.00 in Nov and it is up $7.00 or 15.5% in just a few short weeks.

The chart below contains the one year return for tech (xlk), financials (xlf), industtials (xli) and energy (xle):

Three of those sectors have already had above average returns for 2017. The energy sector has lagged but tax reform alone will not be enough to propel the energy sector higher. The price of oil is still the main factor in increasing the value of oil stocks.

Another factor to consider is the labor market is extremely tight and the post-recession surplus of economic potential may have run out. The tax reform bill may end up boosting inflation by more than it lifts economic growth encouraging the Fed to be more aggressive with interest rate hikes in 2018.

I am cautious optimistic that U.S. stock market returns will be positive in 2018. I believe that volatility will come back next year and offer some good buying opportunities. It could turn out to be a stock pickers market.

Are you buying the dips or selling the rallies?

 

 

 

 

 

 

A fun exercise: Stock picking verses indexing

The average person is afraid of investing in individual stocks and 61 percent of millennials say they’re afraid of even getting started. Despite the fact that investing in the stock market has been shown to be the most efficient and effective way of turning money into more money.

Financial website How Much took a look at some popular stocks in 2007 to find out how much a $1,000 investment in each would be worth now, as of October 31.

In the above picture, the blue dots are equivalent to the $1,000 initial investment, so they are the same size for each company. The pink ones represent the current total value of the investment, so each of those varies.

The larger the pink circle, the more your investment is worth,” according to How Much. “If the pink fits inside the blue, then you lost money. The graphic assumes that you took any dividend paid out in cash and did not reinvest into the company by buying more stock.”

Warren Buffett, Mark Cuban and Tony Robbins all agree index funds are a safe bet, especially for new investors, since they fluctuate with the market, stay pretty constant and eliminate the risk of picking individual stocks. However, if you were lucky enough to pick these 15 American stocks, your $15,000 would have been worth $99,291 compared to $26,741 for the S&P 500 (SPY).

What if you missed owning the two top performing stocks Netflix & Amazon? Your total return would have been $34,927 assuming that you didn’t panic during the great recession. There are other household names like Facebook or Visa that could have help you beat index returns.

Keep in mind, it is easy looking backwards! I do remember getting phone calls and emails from formal clients and co-workers looking for advice during the market meltdown of 2008-09. It is hard to do nothing and hold on to your investments when markets are down 35% to 45%!

My point is simple, even with the worse meltdown (2008-09) since the great depression of the 1930’s, you would have still made money investing during the past ten years. Investing in the stock market is still the most efficient and effective way of turning money into more money.