Markets are still reacting to Trump’s pledge to bring back tariffs. What markets have to decide is just how far the tariffs will cut into profitability as inputs increase, what impact it will have on inflation and to what extent a tariff increase cuts into people’s spending habits.
For Trump’s loyal supporters this is a magical triumph. For once, there is someone trying to work in their best interests. Or so they believe. For many of those workers in the steel industry, the moment has passed. For much of the steel capacity to come onstream and competitive, a significant amount of money needs to be spent.
The opportunity for those workers has long passed. And as technology boosts productivity, the likelihood of those people ever returning to work or higher paid work diminishes. What Trump missed was an opportunity to spend on R&D and more technical industries.
Equity markets, until the tariffs, were gorging on share buybacks and dividend increases all due to Trump’s tax cuts. Multiples rather than earnings were causing the share market to jump higher in value. Now with an increasing Vix, a possibility of a more aggressive Fed, tax bonus spent and less free money from central banks, equity investors have a lot to consider.
What we do know already is that spending in January has slowed. Much of Trump’s tax planning is based on the one-off bonuses not being a one off. And that is a very dangerous assumption. The Commerce Department estimated the bonuses as an annual rate. Of the 4-5 million Americans that received a one-off bonus, that bonus may not be repeated this year.
This week the S&P 500 was down 2%. That’s twice as much as any decline in 2017. The Dow fell 3.1% over the week. Much of that decline may be traced back to tariffs.
The problem with a trade war is that no one wins. World growth is expected to slow and many of the U.S. allies are given a wrong signal. Trump’s complaint about Europe is a misguided one especially in his comments relating to cars. If one wants to look at technology changes and what cars will have installed over the next five years one need look no further than the S-class Mercedes. They don’t look at U.S. car for innovation.
The U.S. has seen its equity growth for some time not through increased revenues gained through R&D. Growth has been through multiples gained from cheap cash. To use China or Europe as an example, significant sums are being spent on R&D whilst in many companies, GE for example, that opportunity has been wasted on senior executive salaries, share buybacks. None of which has led to increased productivity, profitability or innovation.
Since Trump announced his tax cuts some $200 bio of share buybacks have been announced in the U.S. A share buy back does nothing to enhance a company’s ability to compete in the future. It is a misspend of money that should be invested to ensure the viability of the company in the future.
Yes, it’s great for current investors and CEO’s who all benefit . But a large company can fall quickly too. One only needs to look at Woolworth’s U.S.A, once the largest consumer staples company globally. In a mere few years, it fell because of the emergence of a new major player. That player was Walmart.
In today’s world, innovation is the key and no amount of tariff will save you from a changing world built in innovation. That means jobs will be lost and things will become harder for those older folk. Under Trump, many workers are being sent packing and many of those are the necessary ants that are required to keep the wheels of innovation turning. That’s the flaw.
Markets now will become more obsessed with earnings and that’s a good sign. Markets will look at inflation and look to economic growth to see how the economy grows. A slow down will eventually cause a bond tantrum and until then markets are likely to remain choppy. The year 2017 was most likely the final year of easy money. All of a sudden volatility has returned, albeit at the margins and markets are already stressing. It will be interesting to see what happens over time.
To gain an insight into last years returns, almost 50% of S&P returns were made through the P/E going up. The P/E ratio at the end of January was 18.6 times and this represents the highest level for 15 years. The recent fall has P/E’s at 17 times. All, this with an expectation that 10-year bonds will hold sub 3%.
Now that the trade genie is out of the bag, and if GDP growth does not hit the target of 3%, bonds will be sold. And if that is not enough, bonds can also be used to retaliate against tariffs. The U.S is a massive debtor nation. Its ability to finance Government is dependent upon a number of countries financing its government through purchasing bonds. China, a country that owns about $1.2 tr and about 10% of the U.S.’s outstanding debt, could decide not to reinvest their trade dollars.
At the end of 2017, foreign governments owned about $4.03 tr or nearly 29% of the $14.47 tr in treasury securities outstanding. A mere change in attitude could see treasuries sold heavily. Some would argue that this would also affect investments that are held without gaining concessions. But then that becomes an argument based on pain.
Could the U.S. economy withstand an economy with a bond rate at 5%, an inflation rate at 3%, and the Fed tightening? China could certainly take a hit on its holdings. And in many ways, so what if $300 bio is initially lost when the reinvestment opportunities could be far greater and a Government far more dependent on foreign investment to rekindle a fallen economy?
A trade war is rarely if ever won. What Trump has to decide is if brinkmanship will bring any benefits. This is a path that must be stepped warily.
Equities: The S&P 500 rose 0.5% but the Dow fell 0.3 %. The Stoxx 600 fell 2.1% and the Vix closed at 19.59.
Currencies: The Bloomberg Dollar Spot Index fell 0.3% while the euro rose 0.5%
Bonds: The ten-year closed around at 2.86%. The 2-year closed at 2.246% and the 30-year closed at 3.142%. The ten-year bund closed at 0.648 and the UK gilt closed at 1.47% and the OAT closed at 0.92%. The U.S. curve closed 2/10 at 61.8 bp, 2/30 at 89.3 bp and the 10/30, closed at 27.3 bp while the U.S. 5-year closed at 2.632.
Commodities: The WTI rose 0.6 % and gold gained 0.4%
Bitcoin is trading around $11,396.00
Aussie Market Today.
Today looks likely to be a down day for equities. Expect some volatility.
The AUD is likely to be a little stronger.
The selloff in bonds is likely to continue. The Aussie bonds will remain vulnerable until details of how the tariffs in the U.S. will affect Australia. For the moment, bonds could back up a little. The nexus between Australian bonds and U.S. treasuries may be starting to break down.