Summer Pickles

361 Capital Market Commentary | June 3, 2019

Lots of them. It was only a matter of time before White House policy making was going to become more volatile than the stock market. Ignoring the wishes of his top advisors, the POTUS elected to slap tariffs on Mexico. Starting at 5%, then escalating to 25%. If Mexican tariffs hit 25%, Nomura forecasts a +0.75% increase in U.S. inflation. This is not insignificant in an economy with inflation struggling to hit 2%. This decision on Mexico pushed Kevin Hassert (head of the Council of Economic Advisers) to quit over the weekend as he is a supporter in free trade and immigration. Maybe the new strategy is to tariff any country that upsets the White House so that American citizens can pay more taxes to the U.S. government until the offending country falls back into line. Just wait until you see the price of your 4th of July watermelon.

Washington D.C. has opened a second war this weekend on the large technology and social media companies. Looking at the stock prices today, it appears that the DoJ and FTC are going to attempt to divide and conquer Google, Facebook, Amazon and Apple. So four-fifths of the FAANG are under assault which will help put a summer chill on the markets. Ongoing data we are observing is a further inverting yield curve, melting economic data and some breaks in the credit market. So, if there was a good time to look away and take a vacation, now is it.

Of course with the market this oversold, a sharp snap upward could be in the cards at any moment. Remember what happened at Christmas? The White House went on an offensive when the market declined 20%, helped by the reversal at the Fed. This could happen again as some Fed members are setting the stage for future easing. The markets have moved to a 98% chance for one rate cut and 80% for two rate cuts, so they are ready for the Fed’s help. What happens next will depend on Washington’s policy makers and the Fed. Which brings us back to pickles – where we import over a billion pounds of cucumbers from Mexico each year. Feel free to stock up before the tariffs hit.

It appears that the top advisors are no longer doing their job in challenging the President…


President Trump pushed ahead with plans to impose tariffs on Mexico over the objections of several top advisers, including his son-in-law, Jared Kushner, opting to side with hard-line officials who were advocating the move, according to multiple administration officials and people briefed on their plans.

For several weeks, Mr. Trump’s top economic advisers have been urging the president not to use tariffs to punish Mexico for failing to stop the flow of migrants into the United States. Mr. Kushner, along with Steven Mnuchin, the Treasury secretary, and Robert Lighthizer, Mr. Trump’s top trade negotiator, has warned the move would imperil the president’s other priorities, like passage of a revised North American trade agreement with Canada and Mexico…

“I want to do this,” Mr. Trump would say when aides raised concerns.

While many of his advisers believed the move was risky and could hurt American consumers, businesses and the stock markets, few wanted to directly challenge the president.


Looks like the White House advisors turtled on India also…


President Donald Trump opened another potential front in his trade war on Friday, terminating India’s designation as a developing nation and thereby eliminating an exception that allowed the country to export nearly 2,000 products to the U.S. duty-free.

“I have determined that India has not assured the United States that India will provide equitable and reasonable access to its markets,” Trump said in a proclamation. “Accordingly, it is appropriate to terminate India’s designation as a beneficiary developing country effective June 5, 2019.”


Pantheon’s Ian Shepherdson calculated an impact to GDP from the Mexican tariff move…


“The chance of a self-inflicted, unnecessary weakening in the economy this year, and perhaps even a recession, has increased markedly in the wake of the president’s announcement on Friday that tariffs will be applied to all imports from Mexico, from June 10.

“In the 12 months through March, U.S. imports from Mexico totalled $351B, so 25% tariffs would cost $88B per year, or 0.4% of GDP. … [M]ost of the burden will fall on the shoulders of U.S. consumers, as prices of imported vehicles, food, clothing, and other consumer goods rise.”


Total U.S./Mexican trading alliances are now a pickle…


In the short term, the tariffs would mean lower profits for American importers and higher prices for American consumers on everything from avocados to Volkswagens. In the long run, they could force companies to reconsider the continent-spanning supply chains that have made North America one of the world’s most interconnected economies. That disruption, experts warn, could be far more damaging to the United States economy than the cost of tariffs themselves.

The United States imported more than $345 billion in goods from Mexico last year, and shipped $265 billion the other way. But if anything, those numbers understate the interdependence. American refiners process crude oil from Mexico, then sell it back as gasoline. Automakers ship parts back and forth repeatedly during manufacturing. About 30 percent of the content of Mexican exports originated in the United States, according to a recent study.


If you are going to shoot yourself in the foot, why not use a machine gun?


The US – Mexico manufacturing supply chains are highly integrated, with two-thirds of US imports taking place intra-company (between factories owned by the same firm). Some manufactured items cross the border more than once, which will become cost-prohibitive. Moreover, Mexico may retaliate.

67% of US imports from Mexico are intra-company trade

A single avocado will soon replace a bottle of wine as a dinner host gift…


And this move was before the incoming 5-25% Mexican tariffs!

Prices for Hass avocados have already soared

Mohamed El-Erian thinks the Fed is in a pickle…


Markets are now pricing in another major dovish re-orientation of Fed policies, including multiple rate cuts this year and next. If the Fed refuses to validate this quickly by again changing its policy guidance, markets may deem this as a policy error. The resulting selloff in stocks and corporate bonds would tighten financial conditions, threatening both investment and consumption. But if the Fed were to go along and succumb once again to pressures from the markets, this would fuel the narrative of a flip-flopping central bank that lacks proper strategic underpinning. Also, the effectiveness of the policy transmission mechanism to the economy is far from assured, raising doubts on the extent to which a looser Fed would boost growth.


The Fed’s Clarida is opening the door to interest rate cuts…


“Let me be very clear that we’re attuned to potential risks to the outlook,” Mr. Clarida said Thursday during a moderated discussion at the Economic Club of New York.

“And if we saw a downside risk to the outlook, then that would be a factor that could call for a more accommodative policy.”


And the Fed’s Bullard is walking through the door…


“A downward policy rate adjustment may be warranted soon to help re-center inflation and inflation expectations at target and also to provide some insurance in case of a sharper-than-expected slowdown.”

“The direct effects of trade restrictions on the U.S. economy are relatively small, but the effects through global financial markets may be larger,”.

“However, an environment of elevated uncertainty surrounding the global trade regime may be a negative factor for global growth that could feed back to U.S. macroeconomic performance,”.


J.P. Morgan’s model based on economic data sees a 43% chance of recession starting within one year…


Their two-and-three year probabilities make me really want to shed risk.

Recent history of recession probabilities

If you think the U.S. economic weakness will persists, then your 10-yr Treasuries will continue to do well…


ISM versus 10-year

It was a rough week for U.S. based risk last week…


U.S. stocks performed worse as the markets decided that a trade war-induced global slowdown would hurt American companies the most. Makes sense since our companies have the highest growth rates and highest valuations.

Stocks 5-31-19

Among the sectors, it was all red for the week…


It was nearly all red for the month of May with only the REITs ending higher. Now we will see if the 2019 returns will begin to turn negative.

Sectors 05-31-2019

All the intelligence in the world will not help you in this current market…


Right now, rational thoughts and perceived outcomes are useless to the near-term decision making process. If you are afraid of expanding trade wars, a growing economic slowdown, and a second Trump term as President, then cut some risk. If you think that some rationality will prevail as the economic data and the markets dive, then you try and stay long your favorite stocks, sectors and geographies.

This is a tough market. If you do not know what to do you are not alone. Be thankful that you can at least reallocate your portfolio at a small commission cost to reflect your change in risk appetite. Less lucky are the managers running companies making long-term investment planning decisions in the current uncertain global trade environment. Think of GoPro who moved their camera production from China, to avoid the new tariffs, only to place them in Mexico. They are not the only company that made this unfortunate shift.

While living in the markets last week, I could not stop thinking about Philip Seymour Hoffman’s performance in “A Most Wanted Man”. If today’s market resembled any movie character, I think that this would be the one. Smoking, drinking, exhausted while having all the intelligence and IQ at his disposal. I won’t say anymore for those who have not seen it. Definitely put the movie on your summer watchlist if you haven’t.

Phillip Seymour Hoffman in A Most Wanted Man
(Kerry Brown/Roadside Attractions)

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