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.

 

 

 

Trumponomics and Huawei

Effective May 16th, the Trump administration placed Chinese tech company Huawei on the entity list, meaning no American company can sell products, hardware or software, to Huawei without government permission.  In addition, the presumption of the administrators of the list is that permission will be denied.

Being on the entity list seems to mean no Intel or ARM-based microprocessors for Huawei-built computers and telecom equipment, and no Android software for its cellphones.

The US  had already been putting pressure on US telecoms, big and small, as well as allies around the world not to purchase Huawei offerings, especially of next-generation telecom infrastructure equipment–a difficult sell, given that Huawei products are better and cheaper than EU or US alternatives.  But the entity list move is a huge escalation.  It seems to pretty much put Huawei out of business unless/until it develops alternate sources of supply.

It seems to me that this decision is qualitatively different from taxing Chinese products entering the US.  The near-term effects are likely to be strongly negative for Hauwei; long-term consequences, in contrast, are likely to be strongly negative for the US, in a number of ways:

–by saying the US will not tolerate significant Chinese competition in tech industries, Mr. Trump is reframing a dispute about terms of trade into a struggle for cultural/economic dominance.  Arguably, this is what is really going on anyway, but making it explicit gives China a cause to rally around

–Beijing’s response to the Huawei decision will presumably be to try to jump start its domestic chip business, an area that is (oddly, to my mind) totally unimpressive despite having been a national priority for decades.  The obvious course for the US today, it seems to me, is to retrain workers and improve our education system, with emphasis on STEM subjects.  That, of course, is a non-starter for both major political parties

–US tech companies must now begin to think about whether they are American enterprises (meaning: willing to forgo Chinese business as/when Washington dictates) or multinationals based in the US.  This may not be a burning issue for mature US firms like Microsoft or Google, although Washington’s white supremacism and nativism are already compelling companies like this to locate research centers outside the US (either because the US will not admit accomplished foreign scientists or they fear for their safety).  For startups, however, Mr. Trump is making a compelling case that, say, Canada is a better place to establish themselves

–tech companies of all stripes will have to think long and hard before building new manufacturing capacity in the US

 

Pre-Huawei, one main consequence of the Trump trade strategy has been to substantially weaken the Chinese status quo’s resistance to shifting that economy away from low value-added exports.  With developing economies, such resistance is, in my experience, an almost insurmountable obstacle to progress.  Huawei gives Beijing a clear mandate to create a high-tech component industry, however.  Making it a victim of malign foreign influences only increases its power, given China’s century of humiliation (at foreign hands) historical narrative.

Taking Huawei off the entity list, which the administration now seems to be in the process of doing, does not, I think, return us to the status quo ante.  The barn door has already been opened.

 

So far as I can see, the US stock market has not reacted negatively to what I consider to be a collosal blunder.  Wall Street does continue to deal with the possibility of more tariffs principally, I think, by focusing on firms it sees to be the most immune–software, especially cloud-based, and potentially industry-transformative new market entrants in a variety of fields.

 

 

 

 

 

Trumponomics and tariffs

Note:  I’ve been writing this in fits and starts over the past couple of weeks.  It doesn’t reflect whatever agreement the US and China made over the past weekend.  (More on that as/when details become available.)  But I’m realizing that it’s better to write something that’s less than perfect instead of nothing at all..  I think the administration’s economic plan, if that’s the right word for a string of ad hoc actions revealed by tweet, will have crucial impacts–mostly negative–for the US and for multinational corporations located here.  I’ll post about that in a day or two.

 

On the plus side, Mr. Trump has been able to get the corporate income tax rate in the US reduced from 35% to 21%, stemming the outflow of US industry to lower tax-rate jurisdictions (meaning just about anyplace else in the world).  Even that has a minus attached, though, since he failed to make good on his campaign pledge to eliminate the carried interest tax dodge that private equity uses.  The tax bill also contained new tax reductions for the ultra-wealthy and left pork-barrel tax relief for politically powerful businesses untouched.

 

At its core, international Trumponomics revolves around the imposition of import duties on other countries in the name of “national security,” on the dubious rationale that anything that increases GDP is a national security matter and that tariffs are an effective mechanism to force other countries to do what we want.  (Oddly, if this is correct, one of Mr. Trump’s first moves was to withdraw the US from the Trans-Pacific Partnership, thereby triggering an escalating series of new tariffs on farm exports to Japan by  our “Patriot Farmers,” many of whom voted for Mr. Trump.  I assume he didn’t know.)

If the Trump tariff policy has a coherent purpose, it seems to me to be:

–to encourage primary industry (like smelting) and manual labor-intensive manufacturing now being done in developing countries to relocate to the US (fat chance, except for strip mining and factories run by robots)

–to encourage advanced manufacturing businesses abroad that serve US customers to build new operations in the US, and

–to retard the development of Chinese tech manufacturing by denying those companies access to US-made components.

 

The results so far:

–the portion of tariffs on imported goods (paid by US importers to the US customs authorities) passed on to consumers has offset (for all but the ultra-wealthy) the extra income from the 2017 tax cuts

–the arbitrary timing and nature of the tariffs Trump is imposing seems to be doing the expected —discouraging industry, foreign and domestic, from building new plants in the US.  BMW, for example, had been planning on building all its luxury cars for export to China here, because US labor costs less than EU labor.  The threat of retaliatory tariffs by China for those imposed by the US made this a non-starter.

–Huawei.  This story is just beginning.  It has a chance of turning really ugly.  For the moment, inferior US snd EU products become more attractive.  Typically, such protection also slows new product development rather than accelerating it.  (Look at the US auto industry of the mid-1970s, a tragic example of this phenomenon.)   US-based tech component suppliers are doing what companies always do in this situation:  they’re  finding ways around the ban:  selling to foreign middlemen who resell to Huawei, or supplying from their non-US factories.  Even if such loopholes remain open, Mr. Trump is establishing that the US can’t be relied on as a tech supplier. Two consequences:  much greater urgency for China to create local substitutes for US products; greater motivation for US-based multinationals to locate intellectual property and manufacturing outside the US.

 

 

 

 

 

 

Trump, tariffs, trading

There’s no solid connection among the three topics above, but the title gives me the chance to write about three only-sort-of connected ideas in one post.

The crazy up-and-down pattern of recent stock market trading in the US is being triggered, I think, by Mr. Trump’s tweets about trade–and about tariffs in particular.  I think a lot of the action is being caused by computers trading on the President’s tweets themselves, or some derivative of them–likes, media mentions, reflexive response to stock movements (or a proxy like trading volume).

my thoughts

–it’s hard to know whether the misinformation Mr. Trump is spewing about tariffs is art or he simply doesn’t know/care.

Tariffs are paid to US Customs by the importer.   In some small number of instances, a Chinese exporter may have a US-based, US-incorporated subsidiary that imports items from the parent for distribution here.  In this case, a Chinese entity is paying tariffs on imported Chinese-made goods.  To that degree. Mr. Trump is correct.  Mostly, however, the entity that pays a tariff on Chinese goods is not itself Chinese.

This is not the end of the story, however.  The importer will attempt to recover the cost of the tariff through a higher price charged to the US consumer and/or through a discount received from the Chinese manufacturer.  In the case of washing machines, which I wrote about recently, for example, all US consumers ended up paying enough extra to cover the entire tariff  …and some paid more than 2x the levy.  The prime beneficiaries of this largesse were Korean companies Samsung and LG.

–one of the oddest parts of the current tariff saga is that Mr. Trump has decided not to work in concert with other consuming nations.  In fact, one of his first actions as president was to withdraw from the international coalition attempting to curb China’s theft of intellectual property worldwide.  The Trump tariffs are only bilateral, so there’s nothing to stop a Chinese company from shipping a partially assembled product to, say, Canada, do some modification there and reexport the now-Canadian item to the US.

The administration has been artful in selecting intermediates rather than consumer end products for its tariffs so far.  This makes it harder to trace price increases back to their source in Trump tariffs.  However, the fact that the administration has taken pains to cover its trail, so to speak, implies it understands that tariff costs will be disproportionately borne by Americans.

 

–in trading controlled by humans, a lot of tariff developments should have been baked in the cake a long time ago.  Continuing volatility implies to me that much of the reacting is being done by AI, which are learning as they go–and which, by the way, may never adopt the discounting conventions humans have employed for decades.

 

–I think it’s important to examine the trading of the past five days (including today as one of them) for clues to the direction in which the market will evolve.  Basically, I think the selling has been relatively indiscriminate.  The rebound, in contrast, has not been.  The S&P and NASDAQ, for example, are back at the highs of last Friday as I’m writing this in the early afternoon.  The Russell 2000, however, is not.  FB is (slightly) below its Friday high; Netflix is about even; Micron is down by 4%.  On the other hand, Microsoft and Disney are 1% higher than their Friday tops, Paycom is 2.5% up, Okta is 5% higher.

No one knows how long the pattern will last, and I’m not so sure about DIS, but I think there’s information about what the market wants to buy in these differences.   And periods of volatility are usually good times for tweaks–large and small–to portfolio strategy.  This is especially so in cases like this, where the movements seem to be excessive.

One thing to do is to confirm one’s conviction level in laggards.  Another is to check position size in winners.  In my case, my largest position at the moment is MSFT, which I’ve held since shortly after Steve Ballmer left (sorry, Clippers).   I’m not sure whether to reduce now.  I’d already trimmed PAYC and OKTA but if I hadn’t before I’d certainly be doing it today.  I’d be happiest finding areas away from tech, because I have a lot already.  On the other hand, I think Mr. Trump is doing considerable economic damage to American families of average or modest means, with no reward visible to me except for his wealthy backers.  Retail would otherwise be my preferred landing spot.

–Even if you do nothing with your holdings now, make some notes about what you might do to rearrange things and see how that would have worked out.  That will likely help you to decide whether to act the next time an AI-driven market decline occurs.

washing machine tariffs

I’m not an expert on washing machines.  I am fascinated by the local Baby Bubbles laundromat, though.  I know how to get tokens, put them in the machines and push the right buttons.

What prompts me to write this post is the release by the University of Chicago of research findings about the tariffs placed on imported washing machines by the administration in Washington last year in the name of national security (?).

background

The US washing machine market has three leading competitors, each with a market share of around 15%: Whirlpool, a US-based company, and LG and Samsung, two Korean firms.

During the Obama administration, Washington applied tariffs to washing machines made in Korea.  LG and Samsung countered by shifting production to China, which is a typical “country-hopping” response.  Ironically, this made the two even more competitive in the US, and consumer prices here continued to decline.  The Trump administration took a more heavy-handed approach, by applying a blanket tariff of (to keep the story simple) 20% to all washing machine imports.  LG and Samsung responded this time by accelerating the completion of US factories.

winners and losers

Basic economic theory says that increased costs will either be absorbed by the manufacturer or passed on to consumers, in proportions determined by who has market power.  In this case, however, all three firms raised washing machine prices by close to 12%   …and they raised the price of dryers, which were not subject to tariffs (but which are typically paired with washers when people buy) by the same.  That meant both Korean firms recovered the entire tariff plus a bunch.

The net effects:  consumers paid $1.5 billion more for washer/dryers in 2018; market shares for LG and Samsung remained unchanged; the government collected $82 million in tariffs; 1,800 new jobs were created (in a workforce of 150 million+).  The yearly cost to consumers for each of these new positions?  $815,000+.  

The winners:  LG, Samsung and Whirlpool (although analysts think Whirlpool’s 2019 earnings will remain below 2017 levels).

The losers:  the American public.

my take

This is the way protection typically works.  It sounds good but has perverse effects.  A domestic firm flexes its political muscle to prevent better/cheaper products from entering the country from abroad.  In theory, this is supposed to buy time for it to innovate.  Most often, however, the protected firm uses government action as a substitute for creating new, better products. The poster children in the US for this type of behavior–and its negative consequences for the economy–are the Big Three automakers of Detroit.

There is a pressing issue in the trade arena–preventing the theft of intellectual property in areas like computer software, advanced electronic manufacturing and biotech.   The current administration seems to have abandoned any effort to do so, however, in favor of protecting the income of industries of the past.  As an American, this is a worry.  As an investor, it argues that one should make a greater effort to explore opportunities in greater China and in Europe.

 

 

 

the threat in Trump’s deficit spending

In an opinion piece in the Financial Times a few days ago, Gillian Tett points to and expands on a comment in a Wall Street advisory committee letter to the Treasury Secretary.  Although it may not have implications for financial markets today or tomorrow, it’s still worth keeping in mind, I think.

The comment concerns the changes in the income tax code the administration pushed through Congress in late 2017.  Touted as “reform,” the tax bill is such only because it brings down the top domestic corporate tax rate from 35%, the highest in the world, to about average at 21%.  This reduces the incentive for US-based multinationals (think: drug company “inversions”) to recognize profits abroad.  But special interest tax breaks remained untouched, and tax reductions for the ultra-wealthy were tossed in for good measure.  Because of this, the legislation results in a substantial reduction in tax money coming in to Uncle Sam.

Ms. Tett underlines the worry that there are no obvious buyers for the trillions of dollars in Treasury bonds that the government will have to issue over the coming years to cover the deficit the tax bill has created.

 

A generation ago Japan was an avid buyer of US government debt, but its economy has been dormant for a quarter-century.  Over the past twenty years, China has taken up the baton, as it placed the fruits of its trade surplus in US Treasuries.  But Washington is aggressively seeking to reduce the trade deficit with China; the Chinese economy, too, is starting to plateau; and Beijing, whatever its reasons, has already been trimming its Treasury holdings for some time.

Who’s left to absorb the extra supply that’s on the way?   …US individuals and companies.

 

The obvious question is whether domestic buyers have a large enough appetite to soak up the increasing issue of Treasuries.  No one really knows.

Three additional observations (by me):

–the standard (and absolutely correct, in my view) analysis of deficit spending is that it isn’t free.  It is, in effect, a bill that’s passed along to be paid by future generations of Americans–diminishing the quality of life of Millennials while enhancing that of the top 0.1% of Boomers

–historically, domestic holders have been much more sensitive than foreign holders to creditworthiness-threatening developments from Washington like the Trump tax bill, and

–while foreign displeasure might be expressed mostly in currency weakness, and therefore be mostly invisible to dollar-oriented holders, domestic unhappiness would be reflected mostly in an increase in yields.  And that would immediately trigger stock market weakness.  If I’m correct, the decline in domestic financial markets what Washington folly would trigger implies that Washington would be on a much shorter leash than it is now.

 

Trump on trade

so far:

intellectual property…

One of Mr. Trump’s first actions as president was to withdraw the US from the Trans-Pacific Partnership, a consortium of world nations seeking, among other things, to halt Chinese theft of intellectual property.

…and metals

Trump has apparently since discovered that this is a serious issue but has decided that the US will go it alone in addressing it.  His approach of choice is to place tariffs on goods imported from China–steel and aluminum to start with–on the idea that the harm done to China by the tax will bring that country to the negotiating table.  In what seems to me to be his signature non-sequitur-ish move, Mr. Trump has also placed tariffs on imports of these metals from Canada and from the EU.

This action has prompted the imposition of retaliatory tariffs on imports from the US.

the effect of tariffs

–the industry being “protected’ by tariffs usually raises prices

–if it has inferior products, which is often the case, it also tends to slow its pace of innovation (think:  US pickup trucks, some of which still use engine technology from the 1940s)

–some producers will leave the market, meaning fewer choices for consumers;  certainly there will be fewer affordable choices

–overall economic growth slows.  The relatively small number of people in the protected industry benefit substantially, but the aggregate harm, spread out among the general population, outweighs this–usually by a lot

is there a plan?

If so, Mr. Trump has been unable/unwilling to explain it in a coherent way.  In a political sense, it seems to me that his focus is on rewarding participants in sunset industries who form the most solid part of his support–and gaining new potential voters through trade protection of new areas.

automobiles next?

Mr. Trump has proposed/threatened to place tariffs on automobile imports into the US.  This is a much bigger deal than what he has done to date.   How so?

–Yearly new car sales in the US exceed $500 billion in value, for one thing.  So tariffs that raise car prices stand to have important and widespread (negative) economic effects.

–For another, automobile manufacturing supply chains are complex:  many US-brand vehicles are substantially made outside the US; many foreign-brand vehicles are made mostly domestically.

–In addition, US car makers are all multi-nationals, so they face the risk that any politically-created gains domestically would be offset (or more than offset) by penalties in large growth markets like China.  Toyota has already announced that it is putting proposed expansion of its US production, intended for export to China, on hold.  It will send cars from Japan instead.  [Q: Who is the largest exporter of US-made cars to China?  A:  BMW  –illustrating the potential for unintended effects with automotive tariffs.]

 

More significant for the long term, the world is in a gradual transition toward electric vehicles.  They will likely prove to be especially important in China, the world’s largest car market, which has already prioritized electric vehicles as a way of dealing with its serious air pollution problem.

This is an area where the US is now a world leader.  Trade retaliation that would slow domestic development of electric vehicles, or which would prevent export of US-made electric cars to China, could be particularly damaging.

This has already happened once to the US auto industry during the heavily protected 1980s.  The enhanced profitability that quotas on imported vehicles created back then induced an atmosphere of complacency.  The relative market position of the Big Three deteriorated a lot.  During that decade alone, GM lost a quarter of its market share, mostly to foreign brands.  Just as bad, the Big Three continued to damage their own brand image by offering a parade of high-cost, low-reliability vehicles.  GM has been the poster child for this.  It controlled almost half the US car market in 1980; its current market share is about a third of that.

In sum, I think Mr. Trump is playing with fire with his tariff policy.  I’m not sure whether he understands just how much long-term damage he may inadvertently do.

stock market implications

One of the quirks of the US stock market is that autos and housing are key industries for the economy but neither has significant representation in the S&P 500–or any other general domestic index, for that matter.

Tariffs applied so far will have little direct negative impact on S&P 500 earnings, although eventually consumer spending will slow a bit.  So far, fears about the direction in which Mr. Trump may be taking the country–and the failure of Congress to act as a counterweight–have expressed themselves in two ways.  They are:

–currency weakness and

–an emphasis on IT sector in the S&P 500.  Within IT, the favorites have been those with the greatest international reach, and those that provide services rather than physical products.  My guess is that if auto tariffs are put in place, this trend will intensify.  Industrial stocks + specific areas of retaliation will, I think, join the areas to be avoided.

 

Of course, intended or not (I think “not”), this drag on growth would be coming after a supercharging of domestic growth through an unfunded tax cut.   This arguably means that the eventual train wreck being orchestrated by Mr. Trump will be too far down the line to be discounted in stock prices right away.