Financial Review

Escalation

…Dow down year-to-date. Trade wars escalate. How it could play out. Senate squashes ZTE deal. Another cut to Obamacare. FedEx and Oracle beat earnings. Starbucks sales slip. GE booted from Dow.

Financial Review by Sinclair Noe for 06-19-2018

DOW – 287 = 24,700
SPX – 11 = 2762
NAS – 21 = 7725
RUT + 0.98 = 1693
10 Y – .03 = 2.89%
OIL + .07 = 65.14
GOLD – 3.50 = 1275.40

 

The Dow Industrial Average has now dropped for six consecutive sessions, the longest losing streak since March 2017. The Dow has now lost all gains for 2018. The small-cap Russell 2000 index, whose components are more domestically focused than large-cap companies, edged up by just a fraction. The only groups in positive territory were utilities, telecommunications, real estate, and consumer staples, all of which are seen as defensive groups. Materials and industrials stocks, both of which have an outsize impact to trade uncertainty, both tumbled 2%. Shares of Boeing, which has been a proxy for trade-war tensions with China, fell 3.8 percent, weighing the most on the Dow. Construction equipment maker Caterpillar closely followed with a 3.6 percent drop. The declines weighed on the S&P industrials index, which fell 2.1 percent, its biggest one-day percentage drop in nearly two months.

 

A trade dispute with China could easily slip into a trade war. Trump announced tariffs on up to $50 billion of Chines goods. China said it would retaliate, and China has published a list of 659 U.S. products to be targeted, with tariffs on the first group of 105 to begin on July 6, including soybeans, whisky, orange juice, salmon, cigars and automobiles. Moreover, China has scrapped the agreement Commerce Secretary Wilbur Ross recently secured to lower their huge trade surplus with the U.S. by purchasing up to $70 billion of additional U.S. agricultural products, natural gas and other goods.

 

This morning, Trump threatened to sharply escalate a trade conflict with China, asking his administration to identify $200 billion in imported goods from China to be penalized with tariffs. Trump directed U.S. trade representative Robert Lighthizer to identify $200 billion more in products for tariffs of 10%. Should China retaliate to those additional tariffs (and early indications are that they will; China’s commerce ministry quickly responded to Trump’s new tariffs, calling his practices “blackmailing.”), Trump promised to escalate even further by placing tariffs on another $200 billion in Chinese goods.

 

Trump’s tariff threats are already hurting the Chinese economy: On Tuesday, China’s currency, the yuan, depreciated in value, and the Shanghai stock market plunged to its lowest numbers in two years. But China could actually benefit from a devalued currency. China also has a much longer economic outlook than the US, and they do not have midterm elections this year. Jacking up consumer prices ahead of an election probably won’t play well in Peoria. The Chinese government has also been known to take official and unofficial steps to encourage its citizens and businesses to boycott foreign goods when trade disputes flare up. Trying to get American consumers to toe the line is like herding cats. For the US, we will be looking at a hit to GDP, plus higher prices. We already see signs of strain in global supply chains, rising prices for crucial raw materials, stagnant shipments and the possibility that the impact of these disputes on business confidence may well foreshadow larger economic disruptions.  The imported products subject to 25 percent (or higher) tariffs will act like a tax on those products, and the products into which they are incorporated, making them more expensive to U.S. consumers and producers.

 

China can’t go toe to toe with the U.S. in a widening tariff war because it simply doesn’t buy enough stuff from America. Last year, China shipped $505.5 billion worth of goods to the U.S. but only imported $129.9 billion in American-made products. Even if Trump goes on to impose tariffs on $300 billion or even $400 billion of Chinese goods, Beijing could only levy duties on a total of $100-plus billion of U.S. products.

 

To escalate the trade war, China would have to turn to non-tariff measures. China can hurt U.S. companies doing business there – that list includes: Boeing, Apple, Starbucks, AO Smith, Tiffany, Coach, and many more – tie them up in red tape.  I’m sorry but there’s a problem with your license. They can also intensify inspections. If it takes two weeks to inspect agricultural products at Chinese ports, you might just as well turn the boat around. If this escalates and gets a bit out of control, China has a couple of wildcards. It can just stop buying U.S. Treasury debt. China is the world’s biggest Treasury investor, keeping U.S. borrowing costs low, helping us buy more stuff from China. Ending this symbiotic relationship just when U.S. budget deficits are soaring would devastate the US economy – but it could blow up China’s too. And China has another wildcard – they could just stop honoring US intellectual property rights. Companies from Pfizer to Apple to Microsoft could see their products pirated around the world. This would likely violate WTO rules, and it could backfire on China, but if they are backed into a corner…, well. The point is that this could get real nasty, real fast. Back in March, Trump tweeted that trade wars “are good, and easy to win.” No, wrong. Trade wars can be devastating.

 

Trump is moving from threats of trade sanctions to the reality of multiple simultaneous trade wars after imposing tariffs on steel and aluminum from the European Union, Canada and Mexico; and another conflict involving possible U.S. economic sanctions against European companies over the U.S. withdrawal from the Iran nuclear agreement. The EU, Canada and Mexico have all initiated WTO cases against United States “protectionism.” We are currently facing economic conflicts the likes and scale of which we have not seen in modern times.

 

Adding yet another layer to trade tensions, the Senate passed legislation on Monday to reinstate a ban on sales of U.S. components to ZTE Group, despite efforts by Trump to spare the Chinese telecommunications company. ZTE shares fell more than 25% in Hong Kong.

 

And now for a somewhat contrarian point of view – forget all about the trade wars; imagine for a moment that there are no tariffs on Chinese goods coming to the US or on American goods headed to China. Forget that there is a special place in hell for Justin Trudeau; forget that there is an election in Mexico. Maybe Wall Street was headed for a drop, despite all the trade bluster. Traders became overly optimistic and when sentiment swings too far one way or the other, we see the markets adjust, or in this case correct.

 

The Trump administration said it is withdrawing from the United Nations Human Rights Council. Secretary of State Mike Pompeo and U.S. ambassador to the United Nations Nikki Haley announced the U.S. withdrawal in an appearance at the State Department.

 

The Trump administration is releasing rules that would make it easier for small businesses and self-employed individuals to buy insurance that does not comply with Obamacare’s insurance regulations, another front in the White House’s attempts to undermine the law. Association health plans, the subject of the new rules, do not have to follow the same rules as individual policies sold under Obamacare, meaning they are not required to cover all of the essential health benefits mandated by the Affordable Care Act, like maternity care, an important piece of the law’s protections for people with preexisting conditions.

 

In economic news: Housing starts ran at a seasonally adjusted annual 1.35 million annual rate in May. Permits were at a 1.3 million seasonally adjusted annual rate. Builders broke ground on more homes in May, a good signal about the health of the economy and the housing market. At a 1.35 million pace, housing starts saw the fastest activity since 2007. It was 5% higher than April, and 20.3% higher than a year ago. One weak spot in the report was permits, which foreshadow future starts activity. They were at a 1.3 million pace, down 4.6% for the month, but still 8% higher than a year ago.

 

After the closing bell, FedEx reported net income of $1.13 billion, or $4.15 on a per-share basis. Adjusted earnings of $5.91 per share beat analysts’ expectations of $5.70. Revenue of $17.3 billion came out slightly ahead of estimates. Shares moved higher in extended trading.

 

Oracle reported a better-than-expected quarterly profit and revenue as more customers move toward its high-margin cloud business. Oracle, which has cloud deals with AT&T and Bank of America, is a late entrant to the cloud business and has been trying to catch up with rivals such as Amazon.com, Microsoft and Salesforce.com. Shares of Oracle rose as much as 3.7 percent in after-market trading.

 

Starbucks has issued a report card on itself, and the results are not strong. Starbucks says global same-store sales rose 1% in the most recent quarter, slowing from a 2% growth rate in the preceding quarter. Sales may have been hampered by the incident in May that took place at a Starbucks in Philadelphia.   The company will look to shutter 150 stores.  The company signaled it continues to have trouble battling cost increases, likely for wages, training and tech investments. Starbucks is seeking to license certain company-operated stores as a means to lower costs. Starbucks offered a consolation for investors – a 20% boost to dividends.

 

Netflix shares rose in a falling market as three analysts moved to raise their stock price targets and played down the competitive threat to the streaming giant from rivals. The stock ended the session up 3.7% at a record $404.98, closing above the $400 level for the first time.

 

Walgreens Boots Alliance will replace General Electric in the Dow Jones Industrial Average on June 26. General Electric was introduced to the blue-chip index in 1896 and was a member continuously since 1907.

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