musings (iii)–the presidential election

If the US is to retain a leading position in world commerce today we need better infrastructure, better schools and the ability to harness the efforts of all Americans in support of economic growth. Washington has fallen down badly on all three fronts for a very long time. Discontent with the status quo has resulted in the election of Donald Trump as president, as I see it, on the idea that things couldn’t be worse.

Whoops!

Though a Barnum-like showman, Trump is, unfortunately, a popular former reality show host but not much else. He’s an incompetent businessman and a white racist who appears to relish the suffering of others. His economic “vision” is for a return to the TV sitcom world of the 1960s, to be achieved by creating a Depression-era tariff wall that will prevent better-made or cheaper products from reaching the US.

In my view, this is suicidally crazy. As far as I can tell, mine is the consensus view in the rest of the world, which is appalled by the severe turn for the worse in the US. Even now, though, my sense is that Americans in general have been surprisingly complacent the damage Trump is doing.

So far, the stock market reaction has been to shun stocks tied closely to the US economy and bid up shares of companies with global franchises or with intellectual property that could just as easily be held in, say, Canada. Over the past month or so, foreign stocks have also begun to outpace US equities for the first time in years.

What if Trump is reelected?

Let’s ignore the messy possibility the Financial Times, for one, is now beginning to discuss–that Trump will “steal” a close election, again losing the popular vote, in a contest marred by voter suppression in red states. Without that complication, the results of a Trump victory would be pretty straightforward.

First and foremost, it would be read worldwide as a national endorsement of his loony-tunes economics, as well as his racism, sadism and eagerness to use the military to violently suppress civil dissent. Not a pretty picture.

The current trend toward stocks with substantial non-US businesses, innovative technology and/or the ability to transfer operations elsewhere would likely continue. Presumably, we’d also begin to see downward pressure on the dollar for both economic and ethical reasons, as fixed income investors as well as equity holders sought to reduce their US exposure.

US brands would likely begin to lose their aspirational appeal, if they have not already. Tourism, both to the US and to US-operated attractions, would wane, even if the coronavirus is brought under control. Global businesses would feel pressure from customers and from employees to relocate. The working population of the US would begin to shrink, as a result and as 1930s Germany became a more plausible analogue for the US. Even Japan might start to look good.

US self-destructive impulses would also open the door wide to China to supplant the US as a cultural and economic world leader. At the very least, capital and portfolio investment diverted from the US would have to find a home somewhere.

more on Monday

the Trump economy

Recent election polling seems to show that potential voters don’t approve of anything in the Trump administration except its handling of the economy. One might argue that in comparison with supporting white racism, subverting the Justice Department, causing tens of thousands of Americans to die needlessly from the coronavirus and trying to corrupt the military, blunting economic growth is the least bad thing Trump has done.

It appears, however, the common belief is that Trump has actually done good things for US economic growth during his time in office and that on economic grounds he would be a better presidential choice than Joe Biden. (Personally, I think it’s a sign of the extreme poverty of domestic politics that the Democrats can’t come up with a better candidate than Biden but that’s another issue.) My opinion is that Trump is worse than economically clueless; I think he has been doing potentially incalculable damage to the long-term economic prospects of the country. If so, why don’t people realize this?

I think the explanation is in the financial results of Walmart (WMT), the largest retailer in the US. WMT’s target market is Americans of average and somewhat below average income. The company started in the midwest. Political action by incumbent retailers in California and the Northeast have limited its exposure to those areas. So it’s a reasonable thermometer for economic health in the rest of the country.

EPS growth for WMT over the past seven years is as follows:

year yoy eps growth

2019 +6.3%

2018 +11.1%

2017 +2.3%

2016 -5.5%

2015 -9.9%

2014 -0.8%

2013 +1.8%.

Note: Like many retailers, WMT’s fiscal year runs from February through January of the following calendar year. So, for example, what I’ve labeled as 2019 is actually 2/19 – 1/20.

What I read from these numbers is that recovery from the financial crisis of 2007-09 didn’t reach the large chunks of America that WMT services until almost eight years after the overall economy bottomed. This coincided with Trump’s election.

Did Trump cause this pickup or is it simply the “trickle down” of recovery to a a part of the country neither major party cared that much about? I don’t see anything in Trump’s past or present performance record to make me think it’s the former.

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.