…Trade wars backfire. Who pays? Retail sales up. Productivity up. Inventories up (a little). Homebuilder confidence slips.
Financial Review by Sinclair Noe for 08-15-2018
DOW – 137 = 25,162
SPX – 21 = 2818
NAS – 96 = 7774
RUT – 21 = 1670
10 y – .04 = 2.85%
OIL – 2.16 = 64.88
GOLD – 19.00 = 1175.70
Earlier, the Dow Industrial Average dropped under 25,000 – the Dow was down more than 300 points at session lows. The problem du jour is Turkey, which just keeps getting worse. And Turkey is just the tip of the iceberg; beneath the troubled waters, we can dip into the rest of the emerging markets; and beyond that we can look at the failed attempts to impose protectionist trade policies on our trade partners and allies. Turkey doubled tariffs on some U.S. imports, and China lodged a complaint with the World Trade Organization against American trade policies.
New data provides tangible evidence that some elements of Trump’s trade wars are backfiring. Prices for agricultural exports fell 5.3% in July, the biggest drop since 2011. The price of soybeans fell 14.1%, accounting for most of the overall drop. There were also small declines in the price of corn, wheat, fruit and nut exports. Overall export prices fell 0.5%, the biggest drop in more than a year, with agriculture causing most of the decline. Beginning July 6, China imposed 25% tariffs on a variety of American agricultural products, including soybeans, corn, poultry and pork. Tariffs are a tax that instantly raise the cost of the targeted product, so $100 of soybeans would cost $125 with China’s 25% tariff. The tariffs have led some purchasers in China to cancel orders for U.S. agricultural products and seek cheaper commodities from other nations not subject to the new tariffs. Diminished demand pushes down prices and lowers farmers’ incomes. Although soybean farmers in Brazil are happy. There’s some evidence that the trade wars are rattling Chinese leaders and taking a toll on economic growth in China. But the same thing is happening here. And it is still early. Most of the tariffs are threatened rather than in force but export numbers back up anecdotal reports of the economic pain borne by farmers and select businesses directly affected by the tariffs. Victims include soybean farmers, dairy farmers and fisherman. Trump has pledged $12 billion in aid for farmers who lose overseas business. But the administration hasn’t yet spelled out who will get what, and farmers worry about long-term disruptions to valuable business relationships.
US farmers aren’t really benefiting from the aid: Trump is merely compensating them for the losses created by his trade war, at least when the aid package is actually implemented. So who does win out? Ultimately, the Chinese government—and other countries with tariffs on US farm products. To understand how this works, consider China’s soybean imports. China imports more soybeans than any country in the world, with the majority of the product coming from the US. Last year, American soybean farmers sold around $12.4 billion worth of soybeans to China—nearly three-fifths of the total US soybean exports.
On July 6, China retaliated against US tariffs with a 25% tariff on American soybeans. In effect, this means that when a Chinese pig-feed processor orders US soybeans, he has to pay the Chinese government 25% of the value of his import order. The pig-feed processor doesn’t want to pay that extra money. So instead, he’s going to buy cheaper soybeans from Brazil or Argentina, or maybe start making feed from domestically-grown corn instead. For US soybean farmers, finding alternative buyers is tough: China is far and away their biggest market. And so, in order to compete with other countries for Chinese buyers, US farmers slash their prices enough to offset the cost of the tariff. To get back to their pre-tariff market price, they’d need to cut their soybean prices by enough to offset 25%. All else equal, Chinese buyers wind up paying the same price for their soybeans as before, while US farmers lose a chunk of their income to the Chinese government.
So how does Trump’s bailout change things? The price distortion created by China’s soybean tariff is still there. The Chinese government is still pocketing 25% of soybean imports from the US. But instead of farmers taking the hit, Trump has simply assigned the cost to someone else: the American taxpayer.
By handing $12 billion to farmers, Trump is essentially reimbursing them for cost of the tariff. Again, farmers have not yet seen the $12 billion in aid actually being handed out, but let’s assume it will be. Farmers are compensated for their losses this growing season – they see long-term customers lost. American farmers are then seen as an unreliable supplier; that, in turn, makes next season a bit of a crap shoot for everybody. And taxpayers have given a bunch of money to the Chinese government. That’s a little simplistic, even if it is accurate. The decrease in prices is unlikely to translate one-to-one with the Chinese tariff rate. For example, as Latin American soybean farmers cash in on higher prices in China, they’ll open up markets for US soybeans in other countries, which could help buoy US prices somewhat. There are also a slew of external factors that could change this dynamic, not least of which is the fall of the Chinese yuan against the dollar (which, all else equal, amplifies the losses to US farmers). There’s also the offsetting impact of US tariffs to consider. As Americans buy exports that Trump has placed tariffs on, US businesses either pay the cost of those tariffs to the US government, or pass that cost on to consumers. To the extent that these tariff payments collected by the US Treasury fund the $12 billion in aid to farmers, it’s not US taxpayers left footing the bill. Rather, it’s US consumers and businesses.
Economic data today includes a report on retail sales – up a healthy 0.5% in July, even as June’s numbers were revised down to 0.2% from 0.5%. Retail sales have increased 6.4% over the past 12 months, close to the long-run average since 1980. Clothing stores and restaurants posted a 1.3% increase in sales to lead the way. Sales also rose 1.2% for department stores and 0.8% for both Internet retailers and gas stations.
The productivity of American businesses surged to a 2.9% annual pace in the second quarter, reflecting the biggest gain in more than three years. Companies boosted output more than twice as much as the increase in hours workers spent on the job. That helped to keep labor costs down despite a tight labor market. Output — or goods and services produced — rose 4.8%. That’s the biggest increase in almost four years. The amount of time employees worked rose 1.9%.
The Commerce Department reports inventories rose 0.1% in June. Sales increased a sharper 0.3% in the month. The ratio of inventories to sales, meanwhile, dropped to 1.33 from 1.34. That’s how many months it would take to sell all the inventory on hand. An increase in inventories adds to gross domestic product and is usually a sign of an expanding economy.
The National Association of Home Builders’ monthly confidence index ticked down one point to 67 in August. Builders continue to monitor how tariffs and the growing threat of a trade war are affecting key building material prices, including lumber. Another builder industry group, the Associated General Contractors of America, earlier in August released an analysis of input prices for builders. Lumber and wood plywood costs increased 16.3% over the past 12 months, and other raw materials, like aluminum, also saw double-digit increases. Buyer demand is firm, but builder supply has waned. The Commerce Department will release July housing starts data – a count of the number of new homes on which builders broke ground – Thursday.
Cisco Systems reported quarterly revenue came in above estimates. The company’s net income rose to $3.8 billion, from $2.4 billion a year earlier. Cisco stock rose more than 6 percent.
Meanwhile, Macy’s shares dropped nearly 16 percent. The company posted better-than-expected quarterly earnings and revenue, but its sales still fell on a year-over year basis.
U.S.-listed shares of Canada-based Canopy Growth soared almost 30%, after liquor seller Constellation Brands said it will invest about $4 billion, in the cannabis company. Canada is gearing up for full legalization of the substance after the Senate passed a bill in June. The Canadian government is expected to select a date sometime in September for the official launch. In the U.S., 30 states have approved medical cannabis, while nine states and the District of Columbia have approved it for recreational use.
The Securities and Exchange Commission has served Tesla with a subpoena after CEO Elon Musk tweeted that he was considering taking the company private and that he had the necessary funding lined up.
The dollar traded near its highest level in more than a year, pushing the euro, Chinese yuan and other major currencies lower. The dollar’s rise also pushed down industrial metals like copper, which hit its lowest level in more than a year. Copper is often seen as a leading indicator of future economic trends since it is used in a number of different sectors. Freeport McMoRan dropped 7.7%.
Meanwhile, oil prices dropped more than 3% after government data showed a big, unexpected jump in stockpiles of U.S. crude. The Energy Information Administration reported commercial crude inventories rose by 6.8 million barrels in the week through Aug. 10. The jump in stocks occurred as the nation’s crude imports surged by 1 million barrels a day, while its exports fell by more than 250,000 bpd. That offset record activity at American refineries, which ran at 98 percent capacity.