Financial Review

Unleash the Hounds

…Tariffs on EU, Canada, Mexico; a pall on animal spirits due to uncertainty over possible trade war. Waymo goes for liftoff. Sears going down the drain.

Financial Review by Sinclair Noe for 05-31-2018

DOW – 251 = 24,415
SPX – 18 = 2705
NAS – 20 = 7442
RUT – 14 = 1633
10 Y – .02 = 2.82%
OIL – 1.11 = 67.10
GOLD – 3.00 = 1298.90


After a momentous day on the international trade front, Wall Street closed lower for the fourth time in the past 5 sessions. While stocks ended May on a sour note, major indexes still posted monthly gains, with the small-cap Russell 2000 outpacing its large-cap rivals. For the month of May, the Dow Industrials gained 1%, while the S&P 500 advanced 2.2% and the Nasdaq booked a 5.3% increase. The Russell 2000 index of small-cap stocks left its large-cap rivals behind with a 6% May advance. The index finished at an all-time high on Wednesday, up 1.4%, to 1,646.36, and rose in early action Thursday before retreating 0.8% on the day.


The tariff issue cast a pall over the animal spirits. Late yesterday we heard a warning that the White House would announce tariffs would kick-in. And that was the official announcement today. The latest moves include the imposition of steel and aluminum tariffs on allies that seemed likely to gain exemptions, including Canada, Mexico and the 28 countries of the European Union. Trump has now made clear: No exemptions. Steel imports from those places will be taxed at 25 percent and aluminum imports at 10 percent. Those are huge numbers; the average tariff rate on US-EU traded goods is under 3 percent.


The targeted countries responded almost immediately. Mexico announced it will impose tariffs on American imports in retaliation. EU Trade Commission said in a statement that Europe would “impose rebalancing measures,” likely meaning some kind of retaliatory tariff on US imports, and take any other “necessary steps to protect the EU market.” Possible European targets for tariff increases include American bourbon, jeans, and motorcycle exports. The EU, Canada, and Mexico are (respectively) the United States’ first-, third-, and fourth-largest trading partners. And don’t forget China, which may or may not be facing up to $150 billion in tariffs on imports to the US, or not – nobody seems certain from day to day.


While steel and aluminum tariffs alone aren’t the end of the world, a trade war — defined as the two sides getting locked in a cycle of retaliatory tariff increases — well, that is a problem. A serious decline in trade between the US and these three partners could do immense damage to the US economy and create major consequences for the rest of the world. One study, from the Council on Foreign Relations, estimates that the steel tariffs will destroy 40,000 jobs in America’s automobile manufacturing industry alone, one-third of the entire domestic steel industry. While that might be reason to rein in the dogs of a trade war, there are very real problems with global steel markets. There are too many factories making too much steel. When a country has a lot of steel and not enough people to sell it to, its government has an incentive to engage in unfair trade practices that give its steel producers a leg up on their international competition. But the biggest over-producer is China – not the EU, Canada, or Mexico – and this action does very little, if anything, to affect China. Instead, we’re hitting our closest allies and partners with a set of tariffs under the justification of national security. Trump has put more tariffs on longtime U.S. allies than he has on China, his supposed “bad guy” on trade.


And we are already seeing retaliation from our trading partners. The president of the European commission, Jean-Claude Juncker, promised immediate retaliation. French president, Emmanuel Macron, called the US tariffs illegal and a mistake, while the Canadian prime minister, Justin Trudeau, issued an immediate dollar-for-dollar response – announcing tariffs of up to 25% on US imports worth up to 16 billion Canadian dollars, which was the total value of Canadian steel exports to the US last year. The tariffs will cover steel and aluminum as well as orange juice, whiskey and other food products. The tariffs are expected to take effect on 1 July. With the White House having used national security legislation to introduce the tariffs, Trudeau called the measures an “affront” to Canadians who had fought alongside their American comrades in arms. “That Canada could be considered a national security threat to the US is inconceivable.” Mexico said it would adopt equivalent measures on a variety of products, including flat steel, lamps, pork legs and shoulders, sausages and food preparations, apples, grapes, cranberries, various cheeses, and other products, “up to an amount comparable to damage caused by the United States’ action”. Commerce Secretary Wilbur Ross blamed insufficient progress in talks with Mexico and Canada to renegotiate NAFTA for the US’s decision to slap tariffs on its two neighbors.


The immediate damage from the tariffs and retaliation from trading partners should be manageable. Prices for inputs like steel move around all the time, and businesses are generally pretty good at adapting. There will be a lot of focus in the weeks ahead on the direct, first-round effects of the steel and aluminum tariffs. No doubt certain products will cost a bit more. Supply chain managers will grab another cup of coffee and do what they need to do. The bigger problem is uncertainty arising from erratic policy.  It’s easy to imagine an escalating cycle of even more tariffs. That is how trade wars get started.


Steel and aluminum stocks rallied initially, but subsequently pared gains or turned lower. They remain down sharply from levels seen following the Trump administration’s initial tariff announcements in March. Shares of AK Steel fell 1.3%, while U.S. Steel advanced 1.7% and Nucor held on for a 0.1% gain.


Italy appeared to step back from the brink of a continent-rattling political crisis on Thursday night, with officials agreeing to a deal that averts the threat of fresh elections and puts two populist parties in charge of the eurozone’s third largest economy. The anti-establishment Five Star Movement and the far-right League will govern together, forming the first purely populist coalition to lead a core Western European country since the creation of the European Union. The new government will be under immediate pressure to improve economic conditions. Italy has struggled with low growth and high unemployment for the past decade. Meanwhile, in Spain, longtime prime minister Mariano Rajoy is expected to be forced out of office in a confidence vote on Friday. Rajoy’s center-right People’s Party has been snared in a series of corruption scandals, and on Thursday lost the support of a key ally. Rajoy is expected to be replaced by Pedro Sánchez, leader of the center-left Socialists.


Shares of General Motors jumped 12.9% after GM said the SoftBank Vision Fund plans to invest $2.25 billion in its self-driving unit. Shares Tesla dropped 2.4%. Meanwhile, Waymo, the driverless-technology company spun out of Google, has agreed to purchase as many as 62,000 minivans from Fiat Chrysler Automobiles for use in a ride-hailing service set to begin commercial operations later this year. The announcement is the latest sign that Waymo is counting on a rapid liftoff for the service. In March, it agreed to purchase up to 20,000 compact cars for the service from Jaguar Land Rover beginning in 2019. Both the Chrysler Pacifica minivans and the Jaguar cars will be equipped with the radars, cameras and sensors that Waymo has developed to enable the vehicles to drive themselves on public roads. Waymo plans to start its service in Phoenix, then expand to the San Francisco area and to other cities across the country.


Sears Holdings will be shuttering 72 more stores in 2018 by September and has identified 100 unprofitable locations in total that it plans to close over time. This is in addition to the 64 Kmart stores and 39 Sears stores that have already shut down this year. The company will end 2018 with fewer than 1,000 locations spread across the U.S. altogether. The store closures were announced in tandem with first quarter earnings results – a loss and revenue fell sharply. Sears shares dropped 12%. Sears is down over 60% over the past 12 months. The only Arizona Sears location slated to close is the department store at MetroCenter in Phoenix, the oldest major mall in the Valley. Liquidation sales start June 14th.


The National Association of Realtors’ index of pending home sales hit a three-month low in April. The index tracks real-estate transactions in which a contract has been signed, but the transaction hasn’t closed. Pending home sales fell 1.3%.


Consumer spending jumped 0.6% after a revised 0.5% gain in March. Americans increased spending by the biggest amount since last November, and outlays were strong even if inflation is taken into account. The news was not all good, though. Drivers had to spend more on gas because of rising prices at the pump. The PCE index, the Federal Reserve’s preferred inflation gauge, rose 0.2%, as did the core rate that strips out food and energy. The rate of inflation over the past 12 months, however, was unchanged at 2%. Similarly, the core rate was flat at 1.8%. That gives the Fed more room to pursue its current “gradualist” strategy of raising interest rates. A tight labor market and the lowest unemployment rate in nearly two decades are pushing up incomes, but households can’t keep drawing down their savings to increase spending. The U.S. savings rate dropped a few ticks to 2.8% and fell below 3% for only the third time since the end of the 2007-09 recession.




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