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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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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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!

 

 

 

 

 

 

“Do nothing” is sometimes the best investment strategy

“Sell in May and go away” is a well-known trading saying that warns investors to sell their stock holdings in May to avoid a seasonal decline in equity markets. However, there are too many factors influencing the price of stocks and bonds. Trying to predict what the market is going to do is extremely difficult.

If you are an experienced investor, the term “timing the market” probably sounds familiar. It refers to the idea that investors should buy stocks low and sell them high shortly after. It’s a smart, swift and painless method … or is it?

While timing the market is not a new idea, even professional traders, with all the training, tools and time at their disposal, regularly post losses. Some perform well for a while but it’s very difficult to consistently win over the long term.

Nevertheless, there is no shortage of money managers who claim to know how to beat the odds. You’ll find dozens of stock alert services on the internet, all offering to help you with timing the market. Be warned: the odds are very much stacked against you.

A smarter approach is to spend more time in the market by holding long-term investments rather than trying to time the market.

A perfect example is the recent price movements of Facebook after the privacy scandal involving Cambridge Analytica. The stock price fell from the $185 to $155 in a very short period of time. Many investors panicked and sold. The “Do Nothing” strategy would have been ideal in this case. See the year to date chart below:

Stock traders will argue that selling Facebook and buying it back again when the stock price hit a bottom would have been very profitable. In hind sight, it looks easy but it takes nerves of steel to buy a stock that is in a free fall.

We have all witnessed substantial market upheaval in the past. Many of us have had a window seat to watch how Wall Street responds to uncertainty and turmoil. The financial markets don’t like uncertainty. Why? Because it’s extremely difficult to try to predict the future. Take Tesla for example, lots of uncertainty and turmoil regarding this stock which is illustrated in their one year price chart below.

Odds are more traders lost money then made money trying to trade the ups and downs of Tesla over the past year.

Six tips for portfolio success

  1. The first thing to do is to set up your portfolio in a way that won’t keep you awake at night. For most people, a portfolio of stocks or index funds with some bonds probably works best. A good starting position is to consider a portfolio with 30 percent bonds (government bonds and corporate bonds, for instance) with the remainder in equities.
  2. The second thing to do is stop checking your investments frequently. Two to four times a year is all you need.
  3. Have faith, patience and discipline, markets rise and fall continuously. When they’re down it can be tempting to pull out. Commit to your long-term strategy and stay the course.
  4. Tune out the hypeIf you watch the markets every day and read all the opinions, it will drive you crazy.
  5. Remember that cash is an asset class. Look for buying opportunities when the markets are down.
  6. When in doubt, get sound advice. Even if you’ve decided to buy and hold, you still need to know which investment opportunities are proven performers with a likelihood of continued strength. The right advisor will  help you to wisely diversify your holdings.

 

Disclaimer: I do not own Facebook or Tesla at this time.

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.