Financial Review


…More on tariffs. Individual stocks resist tweet attacks. Amazon’s R&D. Dimon’s letter. Lula’s sentence.

Financial Review by Sinclair Noe for 04-05-2018

DOW + 240 = 24,505
SPX + 18 = 2662
NAS + 34 = 7076
RUT + 11 = 1542
10 Y + .04 = 2.83%
OIL + .36 = 63.73
GOLD – 6.60 = 1326.20


Yesterday’s bounce continued today. On Tuesday evening, the Trump administration announced 25% tariffs on more than 1,000 industrial technology, transport, and medical products amounting to about $50 billion in 2018 imports. China swiftly countered with proportional tariffs of up to 25% on more than 100 U.S. goods. The latest move followed a previous round of reciprocal tariffs worth about $3 billion. These might be considered the early skirmishes of a potential trade war, but it is a war the US should avoid because China has a couple of advantages. First, China is still an authoritarian government with a long-term economic outlook. President Xi Jinping no longer has term limits. He’s going to be there long after Trump is gone. Trump faces pressure that don’t exist for Xi, including criticism for market turmoil and political risks in the run-up to 2018 midterm elections. China may actually encourage a trade fight, believing this will damage U.S. economic leadership around the world. As the Trump Administration ratchets up trade tensions with China, it is quickly abandoning its most hardline positions during NAFTA renegotiations with Canada and Mexico. The same bellicosity that President Trump used to elevate trade agreements to an issue of national importance also served to make it impossible for the Canadians and Mexicans to be seen as giving up anything of value in NAFTA renegotiations. Meanwhile the constraints of the political calendar, with Mexican presidential elections on July 1st and U.S. congressional elections this fall, have created a very short window for substantial negotiations to occur.


And China has another strategic advantage – they hold $1.17 trillion in US Treasury bonds. China holds about 20 percent of U.S. debt held by foreign countries. If the trade dispute escalates, China could decide to sell those bonds, which would likely cause fixed income prices to fall and cause yields to rise. If yields climb, then it would become more expensive for U.S. companies and consumers to borrow and that would cause the U.S. economy to slow down. It will also become more expensive for the U.S. government to issue debt — they’ll have to pay higher rates to borrowers — while the $15 trillion of treasuries held by itself and investors would fall in value. Equities would be sent crashing, too, as yields climb. Higher interest rates would ripple through the entire economy. Not that it would be a pure advantage to China. If they sell, they would face possible losses on their US Treasury holdings. Also, a slowdown in the US economy would likely lead to a weaker dollar, which could increase US exports.


China could take a more measured approach, and not buy new bonds as old ones mature. With the United States also reducing its quantitative easing-related bond purchases, supply would then slowly rise and potentially push rates to more extreme levels. Or China could devalue its own currency, which would then make exports even more attractive and increase the trade deficit that Trump has railed against.


The hope is that all of this will die down before any drastic measures are taken. But one thing is certain – there is nothing easy or safe about a trade war.


Stocks just capped their first three-day rally since the start of March, with the S&P 500 Index surging 3.1 percent over the period. the Trump administration has been trying to downplay the $50 billion in tariffs on Chinese goods, saying they may never go into effect and are little more than a negotiating ploy. It looks like concerns about a trade war might not be a big concern. Why worry? This rally looks more and more like a short squeeze. If the rally is solid, we should see confirmation when we get the Jobs report tomorrow – then look for further confirmation as we move into earnings season. The S&P 500 hit a closing low of 2581 on Feb. 8 and matched that low on April 2. A double bottom can be a bullish pattern but support has to hold. A drop below 2581 is still possible and represents significant risk. However, if the S&P can fill the gap to 2711, it would be a very bullish sign.


The U.S. trade deficit increased to a near 9-1/2-year high in February, with both imports and exports rising to record highs in a sign of strong domestic and global demand. The Commerce Department said the trade gap increased 1.6 percent to $57.6 billion in February, the highest level since October 2008; with China accounting for just over $29 billion of that deficit. The deficit has now increased for six straight months. Most of the rise in the trade deficit in February reflected commodity price increases.


In the past week Trump has criticized Amazon five times over tax issues and CEO Jeff Bezos’ ownership of the Washington Post. Today, on Air Force One, Trump told reporters he will take a very serious look at Amazon and what he said is an “uneven playing filed” the retailer enjoys against competitors. By the way, former Postmaster General Patrick Donahoe “unequivocally stated” to UBS analysts today that Amazon is profitable for the U.S. Postal Service. Amazon shares lost 8% since Trump’s first tweet against the company. And while there are a host of reasons why this is problematic, it might not be a bad thing for Amazon shareholders in the longer-term. Many of the companies Trump criticized on social media since his election victory thrived following his negative tweets. For example, Trump repeatedly attacked The New York Times including a tweet on Nov. 13. 2016. Times shares rallied about 90 percent through Wednesday versus the S&P 500’s approximate 22 percent gain over that same period. Trump went after Boeing for its Air Force One price tag on Dec. 6, 2016. Boeing shares are up more than 110 percent since then. Today, Boeing was up 2.7%, the biggest gainer on the Dow.  Lockheed Martin was also criticized by Trump for its F-35 “cost overruns” on Dec. 22, 2016. Lockheed shares gained 35% since the tweet attack. So, a tweet induced pullback in Amazon may look like a bargain.


Amazon is constantly reinvesting in Amazon. The company is the world’s biggest R&D spending – nearly $23 billion in research and development last year; that’s $6 billion more than second place Alphabet. Amazon’s size, clout and aggressiveness do raise all sorts of legitimate public-policy questions. But its outsized R&D spending should be part of this discussion, too. Research on R&D spending has shown it to have a pronounced positive effect on economic growth, and also to be linked to more positive trade balances (that is, smaller trade deficits). The evidence is more mixed on whether individual corporations benefit in a big way from their own R&D spending, and there’s certainly anecdotal evidence of big companies failing to capitalize on their own quite valuable research. AT&T’s Bell Labs gave the world the transistor, the cellular telephone, the solar cell and lots of other inventions from which its parent captured a tiny fraction of the economic value. Researchers at Xerox’s Palo Alto Research Center developed technologies that, after significant tweaking, ended up being crucial to the success of Apple, which now has a market capitalization more than 100 times that of Xerox. Bezos is surely aware of that history. But while most companies are spending their extra cash on buybacks, Amazon is investing $23 billion on future growth.


Jamie Dimon’s annual letter to JPMorgan shareholders came out this morning. Dimon took a deep dive on public policy issues – everything from tax cuts to immigration policy to education standards to infrastructure and jobs. At 46 pages of commentary on everything from the bank’s performance to U.S. government policy, the letter is a sort of Rorschach test: It can be viewed as the common-sense observations of a titan of business, a self-indulgent ego trip or possibly even the start of a political campaign.


A Brazilian judge ordered former president Lula da Silva  to report to jail by tomorrow afternoon. The order was issued by Sérgio Moro, the main judge presiding over Brazil’s Car Wash or Lava Jato corruption investigation, who first convicted Lula on money laundering and corruption charges in 2016. This is all happening as Brazil prepares for a presidential election later in the year. Lula, the former president was considered a front-runner in the upcoming election. Under Brazilian law, his conviction bars him from running for public office, but Lula and the Workers’ Party he founded in 1980 have said his campaign will continue from behind bars. Despite his vow to preserve his candidacy, many expect Lula to anoint a successor to represent the party in October.


The Federal Deposit Insurance Corp. could collect the largest damage award ever against a global public accounting firm when a federal judge decides what to award the agency after a verdict against PricewaterhouseCoopers. The FDIC, acting as receiver for the failed Colonial Bank Group that collapsed in 2009, has asked for an award of $625 million in compensation for the net losses it sustained in paying depositors and other creditors of the bank from the federal deposit insurance fund. Taylor Bean & Whitaker and Colonial Bank collapsed in 2009, after federal regulators, not the auditors, found a $3 billion fraud involving fake mortgage assets. In 2012, the trustee of the Taylor Bean & Whitaker Bankruptcy Plan sued both TBW’s auditor, Deloitte LLP, and Colonial’s auditor, PwC, for negligence, seeking $7 billion in damages from Deloitte and $5.5 billion in damages from PwC.  In 2013, just weeks before starting a trial, Deloitte agreed to settle; the parties mutually agreed not to disclose the amount. On August 16, 2016, three weeks into a jury trial for the TBW Trustee’s claims, PwC stopped the proceedings by agreeing to settle for $306 million. The FDIC says that is not enough. The judge will decide whose numbers are correct.

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