trade, tariffs and Harley Davidson (HOG)

Modern economics has been founded in study of what caused the Great Depression of the 1930s, with an eye to preventing a recurrence of this devastating period.  We know very clearly that tariffs and quotas are, generally speaking, bad things.  They reduce overall economic activity in the countries that apply them.  Yes, politically favored industries do often get a benefit, but the cost to everybody else is many times larger.  We also know that the use of tariffs and quotas can snowball into a storm of retaliation and counter-retaliation that can do widespread damage for a long time.

My point is that it’s inconceivable that high-ranking public officials in Washington don’t know this.

 

HOG motorcycles are Baby Boomer counterculture icon.  The company’s traditional domestic male customer base is aging, however, and losing the strength and sense of balance required to operate these heavy machines.  At the same time, HOG has had difficulty in attracting younger customers, or women or minority groups to its offerings.  So it’s an economically more fragile firm, I think, than the consensus realizes.

HOG has been damaged to some degree by the Trump tariffs on aluminum and steel, which are important raw materials.  (As I understand them, the tariffs are ostensibly to address Chinese theft of US intellectual property, although they are being levied principally against Japan and the EU.  ???)

Completely predictably, the EU is retaliating against the tariffs.  In particular, it is levying its own 25% tariff on HOG motorcycles imported from the US.  This affects about 20% of Harley’s output.  HOG says the levy will cost it $100 million a year in lost income, implying that all of the EU-bound Harleys are now made in the US.  HOGs response is to shift production targeted for the EU to its overseas plants.  My guess is that this will take 1000+ jobs out of the US.

In contrast to the job loss from this one company, public reports indicate the total job gain from the steel/aluminum tariffs to be about 800 workers being recalled to previously idle steel/aluminum plants.

 

Mr. Trump’s response to the HOG announcement was to threaten punitive tariffs on any imports of foreign-made Harleys–a move that could threaten the viability of HOG’s network of around 700 independent dealerships.  7000 jobs at risk?

The stock market declined sharply on the day of the HOG announcement.  I think that’s because the HOG story is a shorthand illustration of how tariffs, and quotas, cause net losses to the country as a whole, although they may bring benefits to a politically favored few.

 

A second negative effect of trade protection is a long-term one.  My experience is that most often the protected industry, relieved of immediate competitive pressure, ceases to evolve.  After a few years, consumers become willing to pay the increased price to get a (better) imported product.  In my mind, General Motors is the poster child for this.

 

Stock market implications?  …avoid Industrials.  The obvious beneficiary of Washington’s ill-thought out trade policy is IT.  For the moment, however, I think that this group is expensive enough that Consumer Discretionary and Energy are better areas to pick through.

 

 

OPEC and $80 oil: last week’s meeting

$80 per barrel oil

Over the past year the price of a barrel of crude oil has risen from $50 to $80.  The latter figure is substantially below the $100+ that “black gold” averaged during 2011-2014, but hugely higher than the low of $25-minus thee years ago.

conventional wisdom upended

Two pieces of conventional wisdom about oil have changed during the past half-decade:

–effective shale oil production technology has shelved the previous, nearly religious, belief in the near-term peaking of world oil productive capacity.  More than that,

–the development of viable electric cars has won the world over to the idea that a substantial amount of future transportation demand is going to be met by non-petroleum vehicles.

new meaning for “peak oil”

The “peak oil” worry used to be about the day when demand would outstrip supply (as emerging economies switch from bicycles/motorcycles to several cars per household–just as conventional oil deposits would begin to give up the ghost).  The term now means the day (in 2040?) when demand hits a permanent peak, and then begins to fall as renewable energy supplants fossil fuels.

new OPEC solidarity

When Saudi Arabia, the most influential member of OPEC, said during the recent supply glut that its target for the oil price was $80 a barrel, I thought the figure was much too high.  Why?  I expected that the cartel wouldn’t stick to mutually-agreed output restrictions (totaling 1.8 million daily barrels) for the years needed for oversupply to dry up and the price of output to rise.  That was wrong.

I think the main reason for OPEC’s uncharacteristic sticktoitiveness (first time I ever typed that word) is the realization that petroleum is going to yield to renewables as firewood was supplanted by coal in the mid-nineteenth century and coal was replaced by oil in the mid-twentieth.

There are other factors, though.  The collapse of the Venezuelan government means that country now produces about a million barrels a day less than two years ago.  Also, Mr. Trump’s aversion to all things Obama has prompted him to pull the US out of the Iranian nuclear agreement and reinstate an embargo.  This likely means some fall in Iranian output from its current 4.5 million or so daily barrels, as sanctions go back into effect.  Anticipation of this last has upped today’s oil price by something like $10 a barrel.

adding 600,000 barrels to OPEC daily output

Just prior to the Trump decision on Iran, Russia and Saudi Arabia were suggesting publicly that the coalition of oil producers eventually restore as much as 1.5 million barrels of daily production, as a way of keeping prices from rising further.  Mr. Trump has reportedly asked the two to make any current increase large enough to offset the $10 rise his Iran action has sparked.

Unsurprisingly, his plea appears to have fallen on deaf ears.  Last Friday the cartel announced plans to put 600,000 barrels of daily output back on the market–subject, I think, to the condition that the amount will be adjusted, up or down, so that the price remains in the $75 – $80 range.

optimizing revenue

The old OPEC dynamic was Saudi Arabia, which had perhaps a century’s worth of oil reserves and therefore wanted to keep prices steady and low vs. everyone else, whose reserve life was much shorter and who wanted the highest possible current price, even if that hastened consumers’ move to alternatives.

Today’s dynamic is different, chiefly because the Saudis now realize that the age of renewable energy is imminent.  Today all parties want the highest possible current price, provided it is not so high that it accelerates the trend to renewables.  The consensus belief is that the tipping point is around $100 a barrel.  $80 seems to give enough safety margin that it has become the Saudi target.

 

 

 

 

 

 

Disney (DIS), Comcast (CMCSA) and Fox (FOX)

I started watching the Murdoch family in the mid-1980s, when I was managing a large Australian portfolio.  The original business of News Corp, the parent of FOX, was politically-oriented media targeted at right-of-center blue collar workers in Australia.  As I saw it, News consistently traded positive news coverage to its right-of-center audience in return for regulatory favors.  Rupert Murdoch’s genius was to replicate this model on successively larger stages, first in the UK and then in the US.

Today–again, as I see it–Rupert is moving to turn the family business over to his two sons, on the idea that they will follow in his footsteps as he did his father’s.  This desire has two implications for the bidding war between DIS and CMCSA for  the FOX media assets:

–the Murdoch family wants equity, not cash.  That’s only partly for tax reasons (because taking cash would presumably trigger a big capital gains bill, while taking equity in the successor company wouldn’t).  Just as important,

–the next generation of Murdochs wants to continue to have a seat at the media table.  The fact that they would own a lot of DIS stock and the fact that there’s no clear successor to the current DIS chairman make it an ideal landing spot.  Comcast, in contrast, is another family-controlled company.  The last thing Comcast wants is to let in a potentially powerful internal rival.  This means CMCSA issuing stock is probably out of the question–and certainly not the favored class of stock the Roberts family uses to maintain control.  So Comcast doesn’t suit the Murdochs at all.

 

Most institutional investors don’t pay taxes, so they’re indifferent to whether they get stock or cash.

 

I don’t think it’s an accident that the Comcast offer for FOX is at a level that more than compensates any long-term holder of FOX for the tax he would owe on selling.  In other words, FOX directors can’t use the grounds that they’re “protecting” shareholders from tax by rejecting the Comcast offer in favor of DIS.  After the Supreme Court ruling allowing the ATT/Time Warner merger, they may not be able to argue that a Comcast/Fox merger would run afoul of regulators, either.

 

At first blush, the Comcast position seems a lot weaker than DIS’s.  The Murdochs want to sell to DIS and, I think, actively don’t want to sell to Comcast.  As for DIS, it faces a continuing problem finding places to reinvest its huge media cash flows.  And opportunities like FOX don’t turn up every day.

What is Comcast’s strategy?   My guess is that it’s hoping to raise the offer price to a point where DIS drops out and public pressure forces FOX to sell itself to Comcast.  From what I can tell, it would likely need a partner to do so.

I’ve got no desire to participate, but this will be an interesting battle to watch.

 

 

a day like today

Stocks are down today.  The ostensible reasons are trade war fears + the administration’s distinctly un-American decision to seize and imprison the children of asylum seekers at the border.

It’s not clear to me that–important as these issues may be for the long-term attractiveness of the US as an investment destination–they are the reasons for the market’s decline.  (Personally, I think the mid-term elections will give us the first true read on whether ordinary Americans approve of the UK/Japan-like road Washington has set the country on.)

But I don’t want to write about macroeconomics or about politics.  Instead, I want to call attention to the useful purpose that down days, or strings of down days, for that matter, serve for portfolio management.

There are two:

 

–portfolio realignment.  This is as much about psychology as anything else.   Typically during a selloff stars go down more than the market and clunkers underperform.  Because of this, clunkers that have been hiding in the dark recesses of the portfolio (we all have them) become more visible.  At the same time, stars that we’ve thinking we should buy but have looked too expensive are suddenly trading a bit cheaper.  The reality is probably that we should have made the switch months ago, but a down day gives us a chance to tell ourselves we’re better off by, say, 5% than if we’d made the switch yesterday.

 

–looking for anomalies–that is, clunkers that are going down (for me, this is typically a sign that things are worse than I’ve thought, and a sharp spur to action), or stars that are going up.   Netflix, for example, is up by about 1.4% as I’m writing this, even though it has been a monster stock this year.  I already own enough that I’m not going to do anything.  But if I had none (and were comfortable with such a high-flier) I’d be tempted to buy a little bit and hope to fill out the position on decline.

 

 

$80 a barrel oil

cartel activity

About a week ago, Saudi Arabia and Russia, two of the three largest oil producers in the world (the US is #1), announced they were discussing the mechanics of restoring half of the 1.8 million barrels of daily output foreign companies have been withholding from the market since 2016.

the objective? 

…to stop the price from advancing above $80.

To be honest, I’m a bit surprised that oil has gotten this high.  But producing countries have held to their cutback pledges to a far greater degree than they have in the past, with the result that the mammoth glut of oil in temporary storage a couple of years ago is mostly gone.  In addition, the economy of Venezuela is melting away, turning down that country’s output of heavy crude favored by US refiners.   Also, the world is worried that unilateral US withdrawal from the Iranian nuclear agreement may mean the loss of 500,000 daily barrels from that source.

On the other hand, short-term demand for oil is relatively inflexible.  Because of this, even small changes in supply or demand can result in large swings in price.   An extra 1% -2% in production drove the price from $100+ to $24 in 2014-15, for example.  The same amount of underproduction caused the current rebound.  So in hindsight, $80 shouldn’t have been so shocking.

Why $80?

Two factors, I think.  There must be significant internal pressure among producing countries to get even a small amount more foreign exchange by cheating on quotas.  Letting everyone get something may make it harder for one rogue nation to break ranks.

More importantly, a $100 price seems to trigger significant global conservation efforts, as well as to shift the search for petroleum substitutes into a higher gear.  So somewhere around $80 may be as good as it gets for producers.  And it leaves some headroom if efforts to hold the price at $80 fail.

the stocks

My guess is that most of the upward move for the oils is over.  I think there’s still some reason to be interested in financially leveraged shale oil producers in the US as they unwind the restrictions their lenders have placed on them.