Hong Kong riots

a brief-ish history

During the first part of the 19th century the UK’s stores of gold and silver were being depleted (in effect contracting the country’s money supply) to pay for tea imported from China.  London suggested to Beijing that they barter opium from the British colony India instead.  Beijing sensibly refused.  So in 1841 the British army invaded China to force the change.  The UK seized Hong Kong to use as a staging area and kept it once China submitted to its demands.  During a second Opium War (1856-60), launched when China again balked at the mass shipment of narcotics into its territory, the UK seized more land.

In 1898, China granted the UK a 99-year lease over the area it occupied.  This legalized the status of Hong Kong, which remained under the practical control of the “hongs,” a newer form of the old British opium companies, for much of the 20th century.

In the late 1970s Deng Xiaoping made it clear that the lease would not be renewed but that Hong Kong would remain a Special Administrative Region, with substantial autonomy, for fifty years after its return to China on June 30, 1997.  (For its part, the UK parliament decided Hong Kongers would find the climate of the British Isles inhospitable.  So these soon-to-be-former British subjects would be issued identity cards but no other legal protections–citizenship, for example–within the Commonwealth on the handover.  This is a whole other story.)

Hong Kong’s importance today…

The conventional wisdom at that time was that while Hong Kong China’s main goal in triggering the return was to set the stage for the eventual reintegration of (much larger) Taiwan, where the armies of Chiang Kaishek fled after their defeat by Mao.

Today Hong Kong is much more important, in my view, than it was in the 1980s.  Due, ironically, to the sound, and well-understood worldwide, legal framework imposed by the UK, Hong Kong has become the main jumping-off point for multinationals investing in China.  It’s also an international banking center, a transportation hub and a major tourist destination.  Most important for investors, however, is that its equity market not only has greater integrity than Wall Street but is also the easiest venue to buy and sell Chinese stocks (Fidelity’s international brokerage service is the best in the US for online access, I think, even though the prices in my account are invariably a day–sometimes three–old).

…and tomorrow

Mr. Trump has begun to weaponize US-based finance by denying Chinese companies access to US capital markets, US portfolio investors and, ultimately, the dollar-based financial system.  China’s obvious response is accelerate its build up of Hong Kong as a viable alternative in all three areas.  As with the tariff wars, Trump’s ill thought out strategy will most likely galvanize these efforts.

the riots…

Hong Kong has 27 years left to go as an SAR.  For some reason, however, Xi seems to have decided earlier in 2019 to begin to exert mainland control today rather than adhering to the return agreement.  His trial balloon was legislation under which political protesters in Hong Kong whose statements/actions are legal there, but crimes elsewhere in China, could be arrested and extradited to the mainland for prosecution.  This sparked the rioting.  These protests do have deeper underlying causes which are similar to those affecting many areas in the US.

…continue to be an issue

The recent change in Hong Kong’s stock listing rules (to allow companies whose owners have special, super voting power shares) and the subsequent fund raising by Alibaba seem to me to show that Beijing wants Hong Kong to become the center for international capital-raising by Chinese companies.  From this perspective, Xi’s failure to minimize disruptive protests by withdrawing the extradition legislation quickly is hard to understand.

One might argue that Xi, like Trump, is trying to reestablish an older order, purely for the political advantage it gives.  In China’s case it entails reviving the Communist Party’s traditional power base, the dysfunctional state-owned enterprises that Deng began to marginalize in the late 1970s with his move toward a market-based economy (i.e., “Socialism with Chinese Characteristics”).   I find it hard to believe that Beijing is as impractical and dysfunctional as Washington, but who knows.

My bottom line:  I think the Hong Kong situation is worth monitoring carefully as a gauge of how aggressively China is going to exploit the opening Trump policies have haplessly given it to replace the US as the center of world commerce–sooner than anyone might have dreamed in 2016.

 

 

 

 

 

 

 

 

 

 

 

 

 

Keeping Score, November 2019

I’ve just updated my Keeping Score page for November.  Given the absence of mutual fund selling in October, not a bad result.

Trumponomics—good for the economy?

Supporters of Donald Trump tend to excuse his white nationalism, his erratic policymaking, the paucity of his factual knowledge, the whiff of sadism in his treatment of immigrants, the apparent promotion of family business interests…by saying that at least he’s good for the economy.  They typically cite low unemployment, GDP growth and the stock market as proof.

Is that correct?

Yes, unemployment is low.  Yes, the economy is growing at trend–after receiving a boost from fiscal stimulation (the corporate tax cut) last year.  And the stock market did rally on the announcement of Trump’s election victory.  (We can quibble about stock market performance:  though significantly higher today, the US was pretty much the worst market in the world in 2017, when virtually everybody was up–and more than us; since the 20% boost in US corporate after-tax income it’s up another 10%–much better performance than markets where the tax rate has remained unchanged).

But I think this rationalization, offered typically by wealthy beneficiaries of income tax changes, simply deflects attention away from administration policies that can potentially do severe long-term damage to US prospects.  Here are a few:

–tariff wars.  Tariffs can be an important way to give industries of the future breathing room to develop, by insulating them from more sophisticated foreign competition.  The administration, however, is protecting low value-added manual labor jobs against competition from more efficient firms in China.  These tariffs have the perverse effect of retarding manufacturing development here while forcing China to turn to higher value-added work.  The latter is a perennial stumbling block for developing countries, so the excuse of Trump tariffs to force the move to higher value-added industry is a rare gift to Beijing.

In addition, the US has been a prime destination for multinationals’ advanced manufacturing because of the large local market and the experienced workforce.  The possibility of tariffs–and their apparently unpredictable implementation–has stopped this flow.

–retaliatory tariffs.  Tariffs don’t go unanswered. China responded to US levies by shifting purchases of soybeans to Brazil and other countries.   As/when tariff wars end, the soybean market will most likely not revert to the status quo ante; once in the door, other, arguably more dependable, suppliers will doubtless retain market share.  By the way, when the administration withdrew from the TPP, it also made US soybeans more expensive in another Pacific market, Japan.

–restrictions on immigration.  The solution for tech companies who are unable to hire foreign scientists to work in the US because they can’t get visas is to move R&D operations to, say, Canada.  Also, the administration’s white supremacism has made foreigners question whether they will be safe in the US as tourists or students, hurting both industries.  Chinese citizens may also feel it’s unpatriotic to travel here.  A bigger worry:  will this force US-based multinationals to begin to regard themselves as no longer American?

–zero/negative interest rates.  This is a weird situation in financial markets, which, to my equity-oriented mind, is bound to end badly. Ultra-low rates are also trouble for risk-averse savers, including traditional pension plans.  In the US, downward pressure on rates comes both from foreign bond arbitrage and administration demands that the Fed offset tariff damage to growth with looser money policy.

 

Meanwhile, what’s not being addressed:  infrastructure, health care including drug prices, education, retraining displaced workers (where we’re worst in the OECD)

 

 

 

autos, emissions and Trumponomics

I’ve followed the auto industry since the early 1980s, but have rarely owned an auto stock—brief forays into Toyota, later Peugeot (1986) and Porsche (2003?) are the only names that come to mind.

 

The basic reasons I see to avoid the auto manufacturers in the developed world:

–chronic overcapacity

–continuing shift of intellectual property creation, innovation, brand differentiation—and better-than-commodity profits–from manufacturers to component suppliers

–the tendency of national politics to influence company operations and prospects.

 

In addition, the traditional industry is very capital intensive, with a high capacity utilization required (80%?) to reach breakeven.  The facts that unit selling prices are high and new purchases easy to put off for a year or two mean that the new car industry is highly cyclical.

More than that, today’s industry is in the early stages of a transformation away from units that burn fossil fuels, and are therefore a major source of air pollution, to electric vehicles.  The speed at which this change is happening has accelerated over the past decade outside the US because pollution has become a very serious problem in China and because automakers in the EU have been shown to have falsified performance data for their diesel-driven offerings in a poorly thought out effort to meet anti-pollution rules.

California, which had a nineteenth-century-like city pollution problem around Los Angeles as late at the mid-1970s, has led the US charge for clean air.  It helps its clout that CA is the country’s largest car market (urban legend:  thanks in part to GM’s aggressive lobbying against public transport in southern CA in the mid-20th century).  CA has also been joined by about a dozen other states who go along with whatever it decides.  The auto manufacturers have done the same, because the high capital intensity of the car industry means building cars to two sets of fuel usage specifications makes no sense.

 

Enter Donald Trump.  His administration has decided to roll back pollution reduction measures put in place by President Obama.  CA responded by agreeing with Ford, VW, Honda and BMW to establish Obama-like, but somewhat less strict, requirements for cars sold in that state.  Trump’s reposte has been to call the agreement an anti-trust violation, to claim the power to revoke the section of the law that permits CA to set state pollution standards and to threaten to withhold highway funds from CA because the air there is too polluted (?).

 

Other than pollical grandstanding, it’s hard to figure out what’s going on.

Who benefits from lower gas mileage cars?     …Russia and Saudi Arabia, whose economies are almost totally dependent on selling fossil fuels; and the giant multinational oil companies, whose exploration efforts until recently have been predicated on demand increasing strongly enough to push prices up to $100 a barrel.

Who gets hurt by the Trump move?     …to the degree that it prolongs widespread use of inefficient gasoline-powered cars, the biggest potential losers are US-based auto firms and the larger number of US residents who become ill in a more polluted environment.  Why the car companies?  Arguably, they will put less R&D effort into developing less-polluting cars, including electric vehicles.  The desertification of China + disenchantment with diesel will have Europe and Asia, on the other hand, making electric cars a very high priority.  It wouldn’t be surprising to find in a few years a replay of the situation the Detroit automakers were in during the 1970s—when cheap, well-built imports flooded the country without the Big Three having competitive products.

It’s one of the quirks of the US stock market that it has very little direct representation of the auto industry.  So the idea that profits there will be somewhat higher as the firms skimp on R&D will have little/no positive impact on the S&P.  Even the energy industry, the only possible beneficiary of this Trump policy, is a mere shadow of its former self.  Like Trump’s destruction of the American brand—Apple has dropped from #5 in China to #50 since his election—all I can see is damaging downside.

I think the Trump policy is intentional, like his trade wars and his income tax cut for the super-rich.  The most likely explanation for all these facets of Trumponomics is either he doesn’t realize the potentially grave economic damage he’s doing or it’s not a particularly high priority.

 

 

 

 

 

 

 

 

Trump’s economic “plan”

So far the Trump administration has launched two countervailing economic thrusts:

income taxes.   

Starting in 2018, the corporate tax rate was reduced from a highest-in-the-world 35% to a more nearly average 21%.  The idea was to remove the incentive for highly taxed US-based multinationals, like pharmaceutical firms, to shift their businesses elsewhere.  In the same legislation the ultra-wealthy received a very large reduction in their income taxes, as well as retention of the carried interest provision, a tax dodge by which private equity managers convert ordinary income into less highly taxed capital gains (this despite Mr. Trump’s campaign pledge to eliminate carried interest).  Average Americans made out less well, receiving a modest reduction in rates coupled with loss of real estate-related writeoffs that skewed the benefits away from heavily Democratic states like California and New York.

Washington made little, if any, attempt to end special interest tax breaks to offset the lower corporate rates.  The result in 2018 was a yoy increase in individual income tax collection of about $50 billion, more than offset by a drop in corporate tax payments of about $90 billion.  Given the strong economy in 2018, the IRS would likely have taken in $150 – $175 billion more under the old rules than it did under the new.

What I find most surprising about the income tax legislation is that the large deficit-increasing fiscal stimulus it provides came at a time when none was needed–after almost a decade of continuous GDP growth in the US and the economy at very close to full employment.

the tariff wars.

Right after his inauguration, Mr. Trump pulled the US out of the Trans-Pacific Partnership, a trade group aiming to, among other things, fight China’s theft of intellectual property.  However, exiting the TPP for a go-it-alone approach hurt US farmers, since it also meant higher (and escalating each year) tariffs on US agricultural exports to TPP members, notably Japan.

Next, Trump presented the tortured argument that: (1) that there could be no national security if the economy were not growing,  (2) that, therefore, the presence of foreign competition to US firms in the domestic marketplace threatens national security,  (3) that Congress has given the president power to act unilaterally to counter threats to national security, so (4) Trump had the authority to unilaterally impose tariffs on imports.  So he did, in escalating tranches.

No mention of the fact that tariffs slow GDP growth, so under the first axiom of Trump logic are themselves a threat to national security.

Not a peep from Congress, either.

Recently, Mr. Trump has announced that he also has Congressional authority, based on a 1977 law authorizing sanctions against Iran, to order all US-based entities to cease doing business with China.

Results so far:

–the predictable slowdown in economic growth in the US

–retaliatory tariffs that have slowed growth further

–higher prices to consumers that have for all but the ultra-wealthy eaten up the extra income brought by the new tax law

–a sharp drop in spending on new capital projects in the US by both foreign and domestic firms

–tremendous pressure by Trump on the Federal Reserve (in a most un-Republican fashion (yes, I know Nixon did the same thing, but still…)) to “debase” the dollar.

Why?

A falling currency can temporarily give the appearance of faster growth.  But it can also do serious, and permanent, damage to a country by reducing national wealth (Japan is a good example).  Its only “virtue” as a policy measure is that it’s hard to trace cause and effect–politicians can deny they are mortgaging the country’s heritage to cover up earlier mistakes, even though that’s what they’re doing.

–an apparent shift in the goal of US trade negotiators away from structural reform in China to resuming purchases of US soybeans

my take

–if there had been a plan to Trump’s actions, tariffs would have come first, the tax break later.  The fact that the reverse happened argues there is no master strategy.  Again no surprise, given Trump’s history–which people like us can see most clearly in his foray into Atlantic City gaming.

–what a mess!

A better way to combat China?    The orthodox strategies are to strengthen the education system, increase scientific research spending and court foreign researchers to come to the US.  Unfortunately, neither major domestic political party has much interest in education–Democrats refuse to fix broken schools in large urban areas and Republicans as a party are now against scientific inquiry.  The white racism of the current Washington power structure narrows the attraction of the US in the eyes of many skilled foreigners.   The ever-present, ever-shifting tariff threat–seemingly arbitrary levies on imported raw materials and possible retaliatory duties on exported final products–means it’s very risky to locate plant and equipment in the US.

For what it’s worth, I think that were the political situation in the US different there would be substantial Brexit-motivated relocation of multinationals from London to the east coast.

investment implications

To my mind, all this implies having a focus on software companies, on low-multiple consumer firms that focus on domestic consumers with average or below-average incomes, and on companies whose main business is in Asia.  Multinational manufacturers of physical things for whom the US and China are major markets are probably the least good place to be.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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America: a weakening brand

When I first became interested in Tiffany (TIF) as a stock years ago, one thing that stood out was that the company was doing a land office business in almost all facets of its rapid international expansion.  One exception:  the EU.  I quickly became convinced that the reason was because TIF is an American company.

For Europeans, France, Germany, Italy, and to a lesser extent the rest of the EU, are the font of all knowledge and culture.  As local literature and philosophy make clear, being situated on the sacred soil of (fill in any EU country) is the key to its superiority.  The US,  lacking requisite hallowed ground, is a semi-boorish johnny-come-lately.  Sporting a piece of jewelry from an American firm therefore implies one has suffered a devastating reversal of fortune that puts “authentic” jewelry out of reach.

 

In the rest of the world, however, the US is a symbol of aspiration.  America stands for freedom, opportunity, cutting-edge technology, the best universities and an ethos that prizes accomplishment not heritage.  It’s “all men are created equal”  “give me your …huddled masses yearning to be free” and “I am not throwing away my shot.”  Wearing, or just owning, a piece of American jewelry becomes a symbolic linking of the holder to these national values.  It hasn’t hurt, either, particularly with an older generation (paradoxically, ex the EU) that the US made a monumental effort to help heal the world after WWII.

 

The “brand” of the United States has taken a real beating since Mr. Trump has become president.  Surveys, one of which is reported in INC magazine, show a sharp drop in US prestige right after his victory and continuing deterioration since.   I don’t think the biggest negative issue is the president’s insecurities, his constant prevarication, his very weak record as a real estate developer or his (hare-brained) economic policies while in office.  I see the worst damage coming instead from his love of leaders with poor human rights records and his disdain for women and people of color …plus the whiff of sadism detectable in his treatment of both.

 

Whatever the precise cause may be, the deterioration of the America’s reputation under Mr. Trump is a very real worry for domestic consumer companies.  Damage will likely show itself in two ways:  weaker sales to foreign tourists, and the absence of positive surprises from foreign subsidiaries.  For domestic retail firms, it seems clear that economic recovery has finally come to the less wealthy parts of the US over the past year or two–witness the profit performance of Walmart or the dollar stores.  On the other hand, it seems to me that people who have trusted Mr. Trump in the past–like the banks that lent him money, the contractors who built his casinos, those who bought DJT stock and bonds, farmers who voted for him–have all ended up considerably worse off than the more wary.  So while they may be good temporary hiding places, holders should be nimble.

One final thought:  brands don’t deteriorate overnight but the cumulative damage can be enormous.  The first to react will be younger consumers, who have the least experience with/of the “old” brand.   They will be the most difficult to win back.  As well, as time passes, their views will be increasingly important in commerce.

 

 

 

yield curve inversion, external shock and recession

Stock markets around the world sold off yesterday in wicked fashion after the yield on the 10-year Treasury “inverted,”  that is, fell below the yield on the 2-year.  This has very often been the signal of an upcoming recession.  Typically, though, the inversion happens because the Fed is raising short-term interest rates in an attempt to slow too-rapid economic growth.  So it’s first and foremost a signal of aggressive Fed tightening, which has in the past almost always gone too far, causing an economic contraction.

In the present case, this is not the situation.  The Fed is signalling ease, not tightening.  Arguably, arbitrage between long-dated US and EU government bonds is suppressing the 10-year.

While trading robots, unleashed by the inversion, may have been behind the negative stock market action yesterday, my sense is that this is not all that’s going on.  I think the market is beginning to step back and focus on the bigger economic picture.  It may not like what it sees, namely:

–worldwide, economies are now being hit by a significant negative external shock.  It’s not a tripling of the oil price, as was the case in the 1970s, nor a collapsing financial system, as in 2008.  Instead, this time it’s the Trump tariffs, which appear to be reducing growth in the US by more than expected (not that anyone had extremely precise thoughts)

–the 2017 tax bill is not paying for itself, as the administration claimed at the time, but is adding to the government deficit instead–implying that further fiscal stimulation is less likely.  Giving extra cash to the ultra-rich, who tend to save rather than spend, and keeping tax breaks for industries of the past hasn’t bought much oomph to growth, either

–channeling his inner Herbert Hoover, Mr. Trump is trying to export the weakness he has created by devaluing the dollar.

 

Stepping back a bit to view the larger picture,

–pushing interest rates near to zero, depreciating the currency and defending the politically powerful industries of the 1970s all seem to mirror the game plan that has produced thirty years of stagnation in Japan and similar results in large parts of the EU.  Not pretty.

–on a smaller scale, this brings to mind Mr. Trump’s fundamentally misguided and ultimately disastrous foray into Atlantic City gaming, a venture where he appears to have profited personally but where those who supported and trusted him by owning DJT stock and bonds were financially decimated.

 

It seems to me that Wall Street is starting to come to grips with two possibilities:  that there may be only impulsiveness, and no master plan or end game to the Trump trade wars; and that Congresspeople of all stripes realize this but are unwilling to do anything to thwart the president’s whims.  In other words, the real issue being pondered is not recession but Trump-induced secular stagnation.