Late March Bullseye Newsletter
by Timothy Guthrie on Mar 26, 2018
As I mentioned in my last newsletter, the market hates trade tariffs or any whiff of a trade war. Large companies, financial institutions and institutional investors greatly prefer very low costs to move capital, goods and even needed labor inputs around the world to fit their own needs. Often, national borders have no real value to these institutions except to play tax arbitrage. Make the product in a low wage country and sell it in high wage counties and repeat. Most large companies have shareholders all over the world and sell products in many countries. The executive suite may be occupied by citizens of many different nations. National borders may just become an obstacle to the efficient movement of money, products, and tax liabilities to these large organizations.
There are tariffs today, that have been in place for a long time, and the global economy gets used to them. For example, there is a 25% tariff on pickup trucks imported to the USA. Ever wonder why a nice car costs $35K, and nice pickup costs $55K? The tariff has a large part in that calculation. US automakers benefit from this protection. While the long-term trend has been for a reduction of tariffs globally, tariffs still exist. The markets really dislike CHANGE. If the costs change, then a lot more can change: The profit margin of a company, the route a product takes to get here, the preferred suppliers, the new winners (protected by a tariff) and the new losers, new transportation routes, new demand relationships for raw material suppliers, new financial relationships, a change in consumer purchasing habits, the list goes on and on. The economy is really like an ecosystem, and every change, has many ripples.
Famers know this: The USA exports A LOT of production. China reportedly buys 60% of our soy beans. Farmer’s have a lot political clout, and soybeans are grown commercially in many states. If China quits buying our soy beans, we would eventually sell them, but it would cause disruption. Famers might have a bad year or two. After all, Brazil or Ukraine would be happy to step in and fill the void and sell beans to China.
It is generally the consensus (and I concur) that “free trade” creates the most benefit around the world. Of course, free trade has winners and losers, but it does tend to produce more winners. You are hurt if your industry now must compete with products coming in from the low wage nation of Cheapistan (Cheapistan is an imaginary country far away where people work for $1 an hour and there are no labor standards, environmental standards, or rule of law and represents the various low wage nations we must compete against). The past 30 years, little has been done to address these issues. Some people see the pain coming, or once the pain starts move on to a new industry or new region of the country, and others stay put unable to transition for a host of reasons. Still others benefit and sell the Cheapistan goods here at a nice profit.
Of course, in all systems with rules, there are those that use the rules when it works for them and ignore the rules when it doesn’t. The past few decades this largely meant Asian industries often dumping goods in the US at prices below production cost because our nation believed in “free trade”. Machine tools, steel, memory chips, utility tractors, textiles, electronics and more. Most of the time the US response has been week. Southern towns lost their textiles mills and the Great Lakes region lost their steel mills. It becomes hard to rally folks and chant, “we don’t want cheap stuff, we want to pay more to preserve the jobs of people we don’t know who don’t live around here”. Maybe it would help if it rhymed.
All of this is complex and every change, regardless of the increase or decrease in tariffs create domestic and international winner and losers.
The Investment Markets
So far, last week, the trade issue created losers in the market. Uncertainty. Further, President Trump is replacing ‘mainstream’ republican thinkers in his circle with folks (like John Bolton) who appear to think more like him. This is getting interesting, but not fun (I am not knocking John Bolton). Week one, Trump installed 10% tariffs on imported steel and 25% on aluminum. A few days later he exempted Canada and Mexico. Steel stocks flew up then down.
Week two, Trump seeing that he really failed to hit China with the first shot (his real target), he announced tariffs on $50 billion of Chinese goods. The Chinese talk tough (hint at airplane and agriculture tariffs) but in the end announce tariffs on only $3 billion of US goods. $50 billion vs $3 billion. Across the whole economy, these are small impacts. So small, they will be difficult measure, like taking $1.79 out of your monthly budget. While this looks like a victory for Trump, the market lost a trillion in stock value in what I believe is an overreaction at this point. If the actual tariffs stay at this level, the market should gain the losses back. Again, so far, these tariffs affect only a tiny sliver of the economy.
Everyone knows China has been stealing our chickens for decades. No one has done anything about it. I can sympathize with Trump’s goal but be unhappy with the fallout short term. To negotiate effectively one must appear to not care about the fallout. Trump must bluff the Chinese and convince them he does not care about the fallout, but he only wants to “make them pay”. China must appear tough, but they have more to lose than we do. Even autocrats need to keep people employed and can’t lose a customer that is effectively buying 20% of their national production every year.
In other news, people suddenly discovered that Facebook sells your personal data. When they give the data to Obama’s election machine Obama’s team are tech savvy heroes. When Trump’s team gets the data, it is a criminal enterprise, and a price must be paid. Facebook, Google and tech shares in generally fell last week. We own almost no Facebook, and currently own no Google (now Alphabet) directly, with some exposure in ETFs and mutual funds.
For the year so far, as of Friday, the S&P 500 is down 3.19%, the Dow is down 4.8%, the NYSE composite is down 4.9% and the Nasdaq is holding on to 1% gains. I will not have solid numbers till the end of the month, but a brief review looks like many accounts are hugging breakeven, or 1% in either direction.
What I am doing moving forward
I continue to believe that the best two sectors are medical devices and industrial automation. I will likely keep those allocations unless things look to get really ugly.
I will continue to keep the accounts diversified, adding new slices of assets, while the size of each slice gets thinner.
I will look to increase allocations to small and mid-cap stocks, as they are usually much more domestic in sales and sourcing and might be a possible safe harbor from trade issues. You will note I already added more mid cap stocks this year (often at 10% of accounts) so, most of the change will be adding the small capitalization exposure.
I will try to buy Google (alphabet) when it stops falling for larger accounts. They control 70% of global online advertising, and their growth should continue. Of course, when I buy it there is no guarantee that the timing will be perfect.
I may re-work my tech holdings a bit when I rebalance accounts to swap out FTXL for QTEC. FTXL is an ETF that only owns semiconductor stocks, and QTEC (which some still own, and most have owned) has some semiconductor allocation, but is much more diversified.
I can also increase the focus on investment income. While the markets are gyrating, earning a nice dividend can really help out our results, and we will collect that dividend no matter the direction of the market. This likely means adding EOI (the Eaton Vance Enhanced Equity Income fund), and other high dividend stock opportunities.
So far, the S&P has not touched the low it hit in February (it is 2% above that level). If it drops below that level, then we could have so more downside. If it turns around before hitting that level, that would a good sign of strength.
One thing to note is that earnings season will begin soon, and good corporate earnings (boosted by the tax cut) could really add confidence right now and change the headlines. This would be good.
We also need to think long term. This little tariff kerfuffle will pass.
I will be watching markets closely and making adjustments as new information becomes available.
As Always- Contact me with any questions or issues.