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.

 

 

 

 

 

 

 

 

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.

 

 

 

Macroeconomics for Professionals

Starting-out note:  there’s an investment idea in here eventually.

I’ve been going through Macroeconomics for Professionals:  a Guide for Analysts and Those Who Need to Understand Them, written by two IMF professionals, with the intention of giving it, or something like it, to one of my children who’s getting more interested in stock market investing.  I’m not finished with the book, but so far, so good.

counter-cyclical government policy

The initial chapter of MfP is about counter-cyclical government policy, a topic I think is especially important right now.

Picture an upward sloping sine curve.  That’s a stylized version of the pattern of economic advance and contraction that market economies experience.  Left to their own devices, the size of economic booms and subsequent depressions tend to be very large.  The Great Depression of the 1930s that followed the Roaring Twenties–featuring a 25% drop in output in the US and a decade of unemployment that ranged between 14%-25%–is the prime example of this.  National governments around the world made that situation worse with tariff wars and attempts to weaken their currencies to gain a trade advantage.  A chief goal of post-WWII economics has been to avoid a recurrence of this tragedy.

The general idea is counter-cyclical government policy, meaning to slow economic growth when a country is expanding at a rate higher than its long-term potential (about 2% in the US) and to stimulate growth when expansion falls below potential.

 

applying theory in today’s Washington

Entering the ninth year of economic expansion–and with the economy already growing at potential–Washington, which had provided no fiscal stimulus in 2009 when it was desperately needed, decided to give the economy a boost with a large tax cut. Although pitched as a reform, with lower rates offset by the elimination of special interest tax breaks, none of the latter happened.  Then, just a few days ago, Washington gave the economy another fiscal boost.  Mr. Trump, channeling his inner Herbert Hoover, is also pressing for further interest rate cuts to achieve a trade advantage through a weakened dollar.

This is scary stuff for any American.  The country faced a similar situation during the Nixon administration, which exerted pressure on the Fed to keep rates too low during the early 1970s.  Serious economic problems that this brought on didn’t emerge until several years later, when they were compounded by the second oil shock in 1978 (that was my first year in the stock market; I was a fledgling oil analyst).

why??

Why, then, is Mr. Trump trying to juice the US economy when he should really be trying to wean it off the drug of ultra-low rates?

I think it’s safe to assume that he doesn’t understand the implications of what he’s doing (the thing Americans of all stripes recognize, and like the least, about Mr. Trump, a brilliant marketer, is how little he actually knows).   If so, I can think of two reasons:

–as with many presidents a generation ago, he may see ultra-loose money as helping his reelection bid, and/or

–the “easy to win” trade wars may be hurting the US economy much more deeply than he expected and he sees no way to reverse course.

If I had to guess, I suspect the latter is the case and that the former is an added bonus.  I think the main counter argument, i.e., that this is all about the 2020 election, is that the administration seems to be systematically eliminating any parties/agencies that want to investigate Russian interference in domestic politics.

Either would imply that software-based multinational tech companies that have led the stock market for a long time will continue to be Wall Street winners–and that the weakness they are currently experiencing is mostly an adjustment of the valuation gap (which has become too large) between them and the rest of the market.

In any event, interest rate-sensitives and fixed income are the main areas to avoid.  If the impact of tariffs is an important motivating factor, then domestic businesses that cater to families with average or below-average incomes will likely be hurt the worst.

 

 

 

 

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.

 

 

 

 

 

 

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.

 

 

 

trade wars

Recently President Trump announced plans to impose tariffs of 25% on imported steel and 10% on imported aluminum, citing national security reasons.  He followed this up with a Twitter comment that, for the US, trade wars are good–and easy to win.

My take:

–much of modern economics stems from study of the causes of the Great Depression of the 1930s.  The key factors:  the wrong fiscal and monetary response, world wide; and the imposition of tariffs to “protect” local industry.  These did substantial economic damage, deepening and prolonging the global slump instead.  The idea that Mr. Trump may not be aware of this is the really worrisome aspect of the current situation.

 

–the first-order effects of the proposed tariffs will, in themselves, likely be miniscule.  Domestic prices for both metals will rise.  As a result of that, and of possible tariff payments to the government, income will shift from the users of the two metals to Washington and to domestic producers of steel/aluminum.  Because of this, at least some metal fabrication will shift away from the US to other countries.  One EU-based maker of appliances has already suspended plans to increase its manufacturing capacity in the US.

–second-order effects will likely be larger.  The EU, for example, is indicating it will retaliate by placing large tariffs on several billion dollars worth of goods that it imports from the US.   Presumably, other affected countries will do so as well.

 

–there was a similar incident during the Obama administration involving Chinese-made truck tires.  Economists estimate that it resulted in the loss of 3,000 American jobs.  If there was anything good about that situation, it was that it was isolated–Washington understood this was a one-off payment to a domestic union for its political support.  Today’s concern is that, despite overwhelming economic evidence to the contrary, Mr. Trump actually believes that trade wars are good–and will continue to act on that belief.

 

 

Employment Situation, July 2017

This morning the Bureau of Labor Statistics released the latest monthly installment of its Employment Situation report, a long-standing series that monitors the state of the labor market in the US.

The report, a compilation of data from a large number of employers around the country,  estimates that a total of +209,000 new jobs were created last month (I’ve corrected a typo from an earlier version of this post).  Revisions to the prior two months’ data added another +2,000 new positions to that.

The unemployment rate came in at an ultra-low 4.3% of the workforce.  This figure is in line with recent experience, but one which would traditionally be regarded as indicating full employment plus a lot (the idea being that there’s a certain level (4.5%?) of frictional unemployment, basically people quitting one job to take another but not having yet started).

 

In the past, reaching full employment has also made itself known by accelerating wage gains, as employers bid up the price of the additional workers they need and raise wages all around for existing employees to ward off job poaching from rivals.

In perhaps the most perplexing aspect of this recovery, however, there’s still no sign of wage acceleration.  Wages are rising by a tad more than inflation but the rate of growth has remained steady at about 2.5%/year for a long time.

Although the +220,000 figure is 20% higher than the consensus guess of Wall Street economists, the stock market is regarding the ES with a shrug of the shoulders.  Only a sharp uptick in wage growth will make an impact (probably negative, at least at first) on stocks and bonds from this point on.