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.

 

 

 

 

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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!

 

 

 

 

 

 

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.

 

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?

 

 

 

 

 

 

Home bias adds sector risks for investors

 

 

 

 

 

 

 

Legendary investor Warren Buffett, among others, is notorious for telling investors to buy what they know. Basically, Buffett and his enthusiastic followers suggest investing in companies that you really understand or at least know enough about them to be able to explain how they make money.

That is fairly good advice if you are an American since the S&P 500 generates nearly half of its revenue from outside of the United States. However, there is still a lot of risk in the form of sector concentration. For example, the tech sector accounts for nearly 21% within the S&P 500.  Do you remember the bursting of the dot com bubble?

Home bias for Canadian investors is really risky. Seventy–five percent of the Toronto stock market is dominated by three sectors, energy, materials and financials. There are only a handful of companies in other sectors that are available to further diversify your portfolio. Year to date, the Toronto stock exchange is only up 5% compared to the S&P 500 which is up 18.5%, see chart below:

The Canadian market has under-performed when compared to the U.S. markets for the past five years. The main reason is the decline in oil prices which has effected many non-energy sector companies which still rely energy prices in determining their revenue growth. For instance, Canadian banks may rely on loans to energy companies to drive their growth rates. See the 5 year performance chart below:

Why home bias exists

Vanguard’s Investment Strategy Group identified a range of reasons why investors might not embrace global diversification, including concerns about currency risk and an expectation that their home country will deliver out sized returns.

One factor we identified—preference for the familiar—seems particularly relevant. With so much global uncertainty about geopolitics, monetary policy, and the economic outlook, it’s understandable why investors may not want to stray too far from home.

Why Canadian markets may continue to under perform the U.S.

  • Oil and gas exports are land locked and selling at a huge discount!
  • The housing market is slowing down due to a 15% foreign buyers tax, tightening mortgage rules and higher mortgage rates.
  • Tariffs on softwood lumber and airplanes from our largest trading partner (U.S.) has put the success of re-negotiating NAFTA questionable.
  • Passing of the U.S. tax reform legislation will make investing in Canada less attractive (plus we have a carbon tax and high electricity rates).
  • Canadian consumers are carrying high levels of debt which will slow down spending.

Exchange traded funds are a low cost way to diversify your portfolio outside of North America. Many providers offer the ability to hedge fluctuations in foreign currencies. 

The markets are due for a correction, I would recommend slowly increasing your exposure to the U.S. stock market.

Two Bad Choices in Tax Debate

I found this article very informative and I think it is worth sharing.

 

https://i2.wp.com/www.mauldineconomics.com/images/uploads/dp/about-patrick-watson.jpg

By Patrick Watson

Remember when everyone wanted to cut the federal deficit? Fiscal policy was much simpler back then: balanced budget good, deficits bad. Times change. Now the House and Senate are considering tax legislation that, according to their own numbers, will add $1.5 trillion to annual deficits over the next 10 years.

This is okay, we’re told, because the tax cuts will stoke economic growth, thereby delivering added tax revenue that offsets the rate reductions.Note the bigger point here. Republicans still say they don’t like deficits—but apparently, this particular plan lets them cut taxes without adding more debt. It’s a miracle.

Is their claim really true? Will the GOP tax plans boost economic growth?

That’s the 1.5-trillion-dollar question.

Theory vs. Reality

The Republican plan’s centerpiece is a reduction in corporate tax rates from a 35% top bracket to only 20%. That would put the US more in line with other countries.

What you seldom hear is that most other developed countries also have value-added tax (VAT), a kind of consumption tax. The US doesn’t. Our tax system will remain different, and not necessarily better, under the new proposal.

Anyway, the theory is that lower tax rates will entice businesses to bring back operations they currently conduct overseas. They will build new factories and hire more US workers. Those workers will spend their higher incomes on consumer goods, and we’ll all be better off.

Unfortunately, that thinking has several flaws.

For one, as we saw in the NFIB Small Business Economic Trends report that business owners say that finding qualified workers is their top challenge right now. Reducing corporate tax rates won’t make new workers magically appear, nor will it improve the skills of those already here.

What increasing labor demand might do is spark that inflation the Federal Reserve has wanted for years. There’s also a good chance it could spiral out of control, forcing the Fed to hike interest rates even faster than planned—which could offset any benefit from the tax cuts.

Fortunately, such added labor demand will appear only if businesses respond to the lower tax rates by expanding US production capacity.

Will they? Let’s ask.

“Why Aren’t the Other Hands Up?”

This month, in one of its regular business surveys, the Atlanta Federal Reserve Bank asked executives, “If passed in its current form, what would be the likely impact of the Tax Cuts and Jobs Act on your capital investment and hiring plans?”

Here are the results.

Image: Federal Reserve Bank of Atlanta

Only 8% of the executives surveyed said the bill would make them increase hiring plans “significantly.” Only 11% said they would significantly increase their capital investment plans. A solid majority answered either “no change” or “increase somewhat.”

Other surveys reached similar conclusions.

White House Economic Advisor Gary Cohn had an awkward moment last Tuesday at a Wall Street Journal CEO Council meeting. Sitting on stage to promote the tax cuts, Cohn watched as the moderator asked the roomful of executives whether their companies would expand more if the tax bill passed.

When only a few hands rose, Cohn looked surprised and said, “Why aren’t the other hands up?”

So maybe they were distracted or needed a minute to think. Fair enough. A few hours later, White House Economist Kevin Hassett appeared at the same event and asked the same audience the same question.

He got the same result: only a few raised hands.

Pocketing Profits

None of this should surprise us. Tax rates are only one factor businesses consider when deciding to expand. The far more important question is whether consumers will buy whatever the new capacity produces.

Think about it this way: if you’re a CEO and you have difficulty selling your products profitably now, why would lower taxes make you produce more? Even a 0% tax rate is no help if you lack customers.

Former Brightcove CEO David Mendels explained how big companies view this:

As a CEO and member of the Board of Directors at a public company, I can tell you that if we had an increase in profitability, we would have been delighted, but it would not lead in and of itself to more hiring or an increase in wages. Again, we would hire more people if we saw growing demand for our products and services. We would raise salaries if that is what it took to hire and retain great people. But if we had a tax cut that led to higher profits absent those factors, we would ‘pocket it’ for our investors.”

By “pocket it,” Mendels means executive bonuses, share buybacks, or higher dividends. That’s what 10 years of Federal Reserve stimulus produced. A corporate tax cut would likely have a similar effect.

Choose Wisely

As I’ve said for months, I don’t think the House and Senate can agree on any significant tax changes. The two chambers have different political incentives they probably can’t reconcile.

So I think we’ll be stuck with the current tax system. The economy will limp along like it has been and eventually go into recession. The hope-driven asset bubble will pop, hurting many investors.

If I’m wrong and the GOP plan passes in anything like the current form, we will get higher deficits but little additional growth. The tax cuts will flow to asset owners and shareholders, probably blowing the market bubble even bigger. That will make the inevitable breakdown even more painful.

 

Do you agree with Patrick?

Scary Financial Facts for Halloween

 

It’s that time of year when scary things come out on Halloween. However, when you open your door on October 31, will you be confronted by anything scarier than these hair-raising financial horror stories?

Will debt destroy your future?

  1. Student loan debt has reached $1.45 trillion dollars in the U.S. and $42.9 billion in Canada. U.S. graduates owe on  average of $37,712 and $27,000 for Canadians.
  2. Credit card debt is increasing in both countries. Americans carry an average of $16,000 and $4,100 for Canadians
  3. 107 million Americans have auto loans for a total outstanding debt of $1.2 trillion. It is estimated that 40% of the 120 billion dollars in auto loans in Canada are financed for 7 years or longer.
  4. Mortgage debt in Canada is a bigger problem than the U.S. because mortgage interest is not tax deductible. Average mortgage in Canada is around $200,000 (much higher in cities like Toronto & Vancouver) and $192,000 in the U.S.

Will someone steal your identity? 

First we find out that the Yahoo hack in 2013 exposed the information of every single one of their 3 billion accounts and then we find out that a data breach at Equifax exposes the personal information of 145.5 million people. Is there a single American who hasn’t been hacked yet?

The odds are great that your personal information is for sale to identity thieves or already in their hands. Can you foil them with credit freezes and other ID protection measures before it’s too late? Is it already too late? Does your VISA card contain mysterious purchases for 10 large screen TVs from Best Buy?

U.S Health Care Nightmare

Who knows what horrors await you if you become sick and your insurance premiums are too high for you to afford? Average out-of-pocket medical costs continue to rise, topping $10,000 in 2016. Meanwhile, premiums continue to rise on the health care exchanges.

Over the past four years, premiums in the individual marketplace have more than doubled. As insurers back out of some markets and political uncertainty reigns, premiums on the state insurance exchanges continue to rise rapidly. For example, rates in Georgia are up by 57%.

Scary lack of retirement savings

According to a report from the Economic Policy Institute (EPI), the mean retirement savings of all working-age American families, which the EPI defines as those between 32 and 61 years old, is $95,776. Almost 40 million households have no retirement savings at all.

Only 65% of Canadians are saving for retirement and on average have about $84,000 in retirement accounts. (RRSP & TFSA)

Frightening Canadian Energy Policies

  1. No access to foreign markets for oil & gas (besides the U.S.)
  2. Cancellation of Energy East pipeline (buying oil from the Middle East, selling discounted oil to the U.S.)
  3. Construction delays in Trans Mountain & Keystone XL pipelines
  4. No accountability for carbon tax revenue (how is this money spent?)
  5. 4 billion dollars of extra interest payments for reduced hydro rates in Ontario

Release the Nukes

What list of potential horrors would be complete without the prospect of nuclear war? The current tense relations between the U.S. and North Korea make that horrible concept more plausible and in addition to the terrible death toll and destruction of property, the financial impact on the world economy would be hard to imagine.

Remember the famous quote of Albert Einstein, “I know not with what weapons World War III will be fought, but World War IV will be fought with sticks and stones.”

Now remember the leaders who have their fingers on their respective nuclear buttons. ARE YOU FRIGHTENED YET?

HAPPY HALLOWEEN!