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Profitable Investing Tips has been a member since April 20th 2008, and has created 170 posts from scratch.

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How Politics Will Affect Your Investments

The trade skirmish between the U.S.A. and China threatens to become a permanent trade war. Many investors have come to realize that the trade war is really not about the balance of trade but rather about global economic and technological leadership. We discussed this issue in our article about the trade war becoming permanent. The decline of U.S. power after the post-World War II era was predictable as the Japanese and European economies mended. And, it was hastened by ill-advised military involvement from Southeast Asia to the Middle East. Along the way, the “Asian Tigers” became technological and economic powerhouses throughout Asia and then there was the rise of China. The Americans and the Europeans were naïve in believing that if they gave China greater access to global markets that the country would gradually liberalize and the Communist Party would give way to a mixture of Capitalism and Socialism. That did not happen. And, as we noted in our permanent trade war article, China is aiming for global dominance on all fronts and does not intend to return to the “turning inward” of the European Colonial Era. Political concerns are now dominant both with the U.S.A. and China. So you need to wonder, how will politics affect your investments?

Best Places to Invest Money in a Prolonged Trade War

Market Watch suggests which stocks to buy if the trade war worsens and becomes permanent.

Goldman’s analysts, led by chief equity strategist David Kostin, are recommending that investors target services firms, which they describe as less exposed to trade policy (including retaliatory moves) and have better corporate fundamentals, as a group that could help to insulate investors from tariff-fueled volatility.

Goldman expects companies within services to outperform those that provide goods, including consumer products and hardware, like iPhone maker Apple Inc. AAPL, +0.88% and Johnson & Johnson JNJ, +0.64% for example. Shares of Apple have gained nearly 30% this year, while those for J&J are up 8.8%.

In addition, they suggest Microsoft, Alphabet, and Amazon as good choices.

Although the big tech companies that have led the market since the Financial Crisis would seem to have over-extended their rallies, their strength in services, as opposed to products (think of Boeing, Caterpillar, and Deere), is a reason to stay with these investments. Good returns on investments will be more likely to come from the services sector as the trade war drags on and gets worse.

In regard to national defense and reducing American dependence on Chinese products we might consider the ABC (anywhere but China) movement of production facilities to continue. We recently wrote about investing in non-Chinese rare earth producers as such businesses may end up benefiting from subsidies or other forms of government support to avoid a Chinese embargo on the elements so critical to high tech these days. This sort of niche investment may be particularly vulnerable to how politics will affect your investments.

What Happens to Your Investments if the U.S.A. Caves in and Makes a Bad Deal?

When political decisions are so critical to your investments, you need to worry about when the politicians will do things simply to get themselves re-elected. This fact has been a huge contributor to the ever-expanding U.S. budget deficit. Politicians know that when the economy is doing well and employment is strong that people are happy and that they, the politicians, are more likely to remain in office. So, they pass bills to increase spending, putting off things like repaying the national debt to the next generation. If Trump believes that he needs a “trade war victory” to get reelected, will he cave in and let the Chinese win? If that is the case, the stock market will be happy, stocks will go up, and U.S. economic and technological leadership will gradually dwindle over the years. It that is the case, you need to start looking at long term investments in China in hopes that the Chinese Communist party will throw a few scraps your way.

When you find yourself looking at the front page headlines more than at the business pages, you are wondering how politics will affect your investments. Good luck.

How politics will affect your investments is that  trade war could be devastating to the farm implement manufacturer, Deere.

Deere Combine Harvesting Soybeans

FANG Investments at Risk

Government regulators are taking a look at FANG stocks in regard to monopolistic and anti-competitive practices. This realization just took the stocks down by several percent each. In fact, all of the FANG darlings are substantially off from their highs a year ago. Are your FANG investments at risk? If so, what are the factors to consider when deciding to ride it out, sell to lock in some of your gains, or buy more shares in hopes of a comeback? CNBC looks at FANG stocks, their recent losses, and what is in store for them.

Fears of increased government scrutiny just crushed FANG stocks.

Facebook, Amazon, Netflix and Alphabet tanked Monday, shedding nearly $130 billion in market cap collectively. Those losses sent Facebook, Netflix and Alphabet into a bear market, having dropped at least 20% from recent records.

The drop came on the first trading day after The Wall Street Journal reported that the Justice Department is readying an antitrust investigation against Google over its search practices and other issues. Alphabet declined to comment.

They go on to say that having to deal with regulators takes management away from making effective decisions for company growth and, by itself, could be damaging.

Gina Sanchez, CEO of Chantico Global, says just the threat of increased regulatory oversight could stymie the FANG trade for some time.

“These companies will be very, very mired in the process of being scrutinized,” Sanchez said during the same segment. “They could actually keep these companies so involved in this process over the next two years that they won’t be able to effectively run and do the things that growth companies do.”

And, of course, the look at anti-competitive practices could end up with any of these companies getting broken up as happened to the venerable AT&T in the 1980s.

Are Your FANG Investments at Risk for Other Reasons?

Regulatory concerns are not the only reason that the FANG stocks have cooled off. The group has led the bull market to higher and higher levels since the economy emerged from the financial crisis and Great Recession. There is always a point at which the market price of a stock exceeds its intrinsic value so much that even the most optimistic investor will sell a few shares. The trade war with China affects some of these stocks but not others. And, there is no guarantee that their prices will continue to rise as they may not continue to buy back shares indefinitely.

Are All FANG Stocks in the Same Boat?

To the extent that passive investors are investing in FANG stocks through an ETF, it makes no difference which FANG stock is most strongly threatened by the risk of government regulation. However, Alphabet (Google) is a different business than Netflix and Amazon.com is different than either. Facebook is a totally different animal as well. However, all of these companies have grown large and have the capacity to limit competition in various ways. As such, they become targets for regulators. It seemed such a shame when the old AT&T was broken up but, in fact, the breakup ushered in a great new era of telecommunication in which the better companies with better ideas succeeded and the one who continued in the staid ways of AT&T failed and were absorbed by the competition.

 

Are FANG investments at risk from regulators?

FANG Stocks

 

Google is far and away the leading internet search engine. Because of the importance of internet searches in an era where no one used the yellow pages or phone book anymore, it is a major concern for society that this system be fair to all users and not meant to manipulate to hide information.

Facebook has become a major social force and also a hiding place for terrorists and crazy people. This will be regulated at some point as we discussed in our article about FANG regulatory risk.

Netflix is essentially a monopoly but always runs the risk of a newer technology passing it by. Just think of how video cassettes were such a big deal and how Blockbuster controlled the content on movies that it rented. Then everything went to disk and then it was downloaded and then Blockbuster just went away. We are not sure what technology might make Netflix obsolete but there is probably one out there. To give Netflix credit, they have become a movie production and content generator which will always give them something to sell even if they are not the major viewing platform.

Amazon.com is unique in how they have displaced so many brick and mortar businesses but they have also followed the John D. Rockefeller approach of undercutting competition until there is none and then they have the capacity to raise prices. At some point, this behavior will be broken up or regulated.

In the end, we think the FANG investments at risk include all of them. This is a doomsday scenario of these great companies going out of business but the world changes and that simply makes yesterday’s winners change or fade.

 

Of the FANG investments at risk, Alphabet is perhaps the safest as they diversify into things like autonomous vehicles.

Waymo Self-driving Car

Investing in Non-Chinese Rare Earth Producers

The trade war shows more and more signs of becoming a permanent fixture in our lives and especially in the world of investments. In our article about the possibility of the trade war becoming permanent, we discussed how both China and the U.S.A. view this issue in the broader scope of global power and homeland security. As such, both sides are ramping up their tariffs and making no-so-hidden threats about what comes next. One of the things that especially caught our attention was the Chinese threat to cut off the export of rare earth metals to the U.S.A. At this point, investing in non-Chinese rare earth producers might be a really good idea. The Street’s Real Money has an informative article about how rare-earth stocks strike gold at the prospect of a Chinese rare earth export cutoff.

Rare-earth miners toil in obscurity, operating a fancy-sounding but grungy business. They have hit pay dirt on the stock markets late this month, with it looking increasingly likely that China will restrict U.S. supply of the minerals they produce.

The Global Times, a mouthpiece for the Communist Party on foreign affairs, has run an article stating that it’s only a matter of time before China will “weaponize” its rare-earth exports in the trade war.
The shares of the listed miners operating in this space have surged. The CSI Rare Earth Industry Index (index code 930598) tracks 50 of these stocks, companies that mine, extract, process, trade or apply the minerals. The index is up 45.4% so far this year.

Real Money goes on to state this.

There are 17 rare-earth elements, metals used to make magnets for electric cars, earphones and computer hard drives. China accounts for 90% of global production and 80% of worldwide export shipments.

They go on to talk about a Chinese rare earth producer whose stock trades on the Hong Kong Exchange. We don’t think that Chinese producers will be a good investment choice in this situation because they stand to lose if 1) they cannot export to the U.S.A. and 2) if more and more companies follow the ABC (anywhere but China) course for outsourcing their manufacturing. We think that investing in non-Chinese rare earth producers may be a better idea in case Chinese exports get cut off. And, if the trade war becomes even uglier, we may see countries like the U.S.A. find ways to subsidize rare earth producers through tax incentives and more.

Investing in Rare Earth Mining Operations

There are rare earth mining operations scattered across the globe. Here are the companies in the U.S.A, Australia, and Canada that mine rare earth elements and produce rare earth metals.

Rare Earth Producers in the U.S.A.

The one active rare earth mining operation in the U.S.A. is Alkane Resources Limited. (Mining Feeds Rare Earth U.S.A.)

This company has been a penny stock for the last twenty years with the exception of 2011 and 2012 when it “surged” as high as $2.52 a share before falling back. Its mining operation was shut down for a while about a year ago but is open and producing again.

Rare Earth Producers in Australia

Australia has seventeen companies that do rare earth mining as part of their operations. (Mining Feeds Rare Earth Australia)

 

For investing in non-Chinese rare earth producers, Australian mining companies are a good choice.

Rare Earth Mining Operations Australian Companies

 

The list of Australian stocks is a better place to look for investing in non-Chinese rare earth producers because it includes mature and strong mining operations that are not totally dependent on profitable rare earth extraction and processing for their survival.

Rare Earth Producers in Canada

There are seventeen Canadian mining companies that extract and process rare earth elements as part of their operations. (Mining Feeds Rare Earth Canada)

 

 

Canadian mining companies are good choices for investing in non-Chinese rare earth producers.

Canada Rare Earth Mining Companies

 

As with the Australian companies, investing in non-Chinese rare earth producers will work better with Canadian companies that are large, have been in business for years, and have operations in numerous countries extracting numerous metals.

Rare Earth Elements Are Not Really Rare

Rare earth elements are not rare. They simply don’t occur in the kinds of concentrations seen for copper, gold, silver, and other minable metals. This makes them more expensive to mine because a lot more ore needs to be extracted and processed than with other metals.

For more insight into Australian rare earth elements and rare earth production, you can look at information about rare earths published by the Government of South Australia.

Rare earths were named by Johann Gadolin in 1974 for a group of chemically similar, metallic elements with atomic numbers 57 through to 71.

In order, these are lanthanum (La), cerium (Ce), praseodymium (Pr), neodymium (Nd), promethium (Pm), samarium (Sm), europium (Eu), gadolinium (Gd), terbium (Tb), dysprosium (Dy), holmium (Ho), erbium (Er), thulium (Tm), ytterbium (Yb) and lutetium (Lu).

These elements are commonly known as the lanthanide series and are divided into light rare earths (lanthanum–gadolinium) and heavy rare earths (terbium–lutetium). Scandium (Sc, atomic number 21), yttrium (Y, atomic number 39) and thorium (Th, atomic number 90) are also generally included in the rare earth group because of their similar chemical properties.

The rare earths were originally thought to be rare in crustal abundance but this is now recognised not to be the case and they have a similar crustal abundance to elements such as nickel, copper, silver, lead and tin. However, mineable concentrations are less common than for most other ores.

And, the lack of easily minable concentrations is what has hindered mining operations outside of China. China still has a lower wage scale than countries like Australia, Canada, or the U.S.A. And, the government heavily subsidizes these operations in various ways, not all of them plainly visible from outside the country.

Investing in Non-Chinese Rare Earth Producers

Our considered belief is that threats of cutting off rare earth exports by China will at least temporarily drive up stock prices and make investing in non-Chinese rare earth producers more profitable. Over the longer term, governments in countries like the U.S.A., Australia, and Canada will be able to mine these elements because they are common and can be extracted from things like coal deposits. Higher prices will make these operations more profitable and to the extent that their production is seen as critical to national economies and national defense, governments will find ways to subsidize such operations to ensure their long term survival and success.

Swine Fever Risks to Investment in U.S. Agriculture

African swine fever has killed about 200 million pigs in China and U.S. hog and soybean farmers are worried. A good measure of the swine fever risks to investment in U.S. agriculture is the fact that local news outlets are featuring this story in farm country. The Herald Sun, published in Durham, North Carolina writes about the spread of African swine fever in China.

It first appeared in China last August and since then it has spread like wildfire, decimating China’s pork industry and affecting millions of pigs across that entire country.

From there, African swine fever has spread to Vietnam and crept into Cambodia, killing even more pigs.

Now, farmers in North Carolina watch nervously, hoping the disease doesn’t make it across the Pacific Ocean.

“I am terrified. Every pig farmer I know is terrified,” said Jan Archer, an owner of Archer Farms in Goldsboro, which has more than a thousand pigs.

African swine fever isn’t harmful to humans, but it is especially fatal to pigs and spreads quickly. Rabobank, a Dutch bank, estimated the disease will affect 150 million to 200 million pigs in China, the biggest pork producer in the world, this year.

One side of the coin is that China’s loss could be a huge gain for U.S. pork producers as they could export massive quantities of pork to China to make up for their production shortfalls. The other side of the coin is that this disease could spread to the USA to hog producing areas and devastate herds just like is happening in China.

Even if just a few cases occur in the USA and the disease is otherwise contained, it would kill U.S. hog exports. That is because African swine fever is a “trade-limiting” disease.

If just one outbreak were reported in the nation, then exports of that product from anywhere in the nation would halt, until further studies could be done or the disease is cleared. Concern is so high that the disease could travel to the U.S. that the World Pork Expo in Iowa was canceled for just the second time in its history.

North Carolina hog producers export about 25% of their product. Having to store instead of export hog products would drive many farmers and meat packers out of business. Farmers are gearing up for strict quarantines where anyone coming onto a farm will need to strip, shower, and change clothes. They won’t even be able to bring their glasses onto the farm.

Soybean Farmers and Others Are Hurt by African Swine Fever in China

Pigs need to eat and soybeans are a major part of a hog’s diet. Because China has (or had) three times as many pigs as the USA, they need to import soybeans to feed their herds. The reduction in the pig population in China translates into a lesser demand for soybeans and reduced U.S. soybean exports. This means that U.S. soybean farmers will be hurt but so will allied industries. CNN reports that Wall Street fears could hit Deere and other stocks.

A trade fight with the U.S. isn’t the only war China is fighting. African swine flu has decimated the pig population in China and sent pork prices soaring. As many as up to 200 million Chinese pigs have reportedly been lost due to the disease.

Now, Wall Street analysts are scrambling to assess the fallout from the fast spreading illness and how to invest around it.

J.P. Morgan has downgraded Deere to underweight on concerns about the “rapidly deteriorating fundamentals in U.S. agriculture.” This is due not only to the trade war, but also the decline in soybean demand in China as a result of the reduction in the hog herd due to the outbreak of the African swine flu.

Swine fever risks to investment in U.S. agriculture include companies like Deere. Deere makes tractors, combines, and other farm machinery. If U.S. soybean farmers lose customers in China because they have fewer pigs, they will buy less equipment from Deere. If U.S. pig farmers are hit with the swine fever and have to cull their herds, the results for companies like Deere will be even worse.

 

One of the Swine Fever Risks to Investment in U.S. Agriculture is sales of Deere farm equipment.

Deere Combine Harvesting Soybeans

 

Other companies mentioned in the CNN article include the venerable meat packer, Hormel as well as Philbro, Darling Ingredients, and Blooming Brands.

Trump Trade War Multiplies Risks for U.S. Agriculture

Forbes writes that handouts from Trump won’t save soybean farmers. The swine fever epidemic in China is not the first problem for American soybean farmers. But, it may be the nail in the coffin for many.

The price of soybeans has plummeted over the past year since Trump started putting tariffs on Chinese products and China retaliated. The USDA estimates that the average price per bushel fell from $9.33 in 2017 to $8.60 last year. At 4.54 billion bushels that was a $3.3 billion impact to soybean farmers. However, the shortfall should be worse this year since last year farmers were able to forward sell a portion of their crops at $10 per bushel.

As the chart shows below shows with a per bushel price in the low $8 area, unless prices turn up soon 2019 will be a disastrous year for soybean farmers. For a business that runs on low margins losing over 20% of revenue with high fixed costs is a recipe for bankruptcies.

Here is their chart.

 

One of the swine fever risks to investment in U.S. agriculture can be seen in the fall of soybean prices.

Soybean Prices Fall

 

The key to understanding this problem for soybean farmers is that soybean farming works on margin. When there are heavy rains, like this year in the Midwest, farmers plant later and get less of a yield. When the price falls because demand is less, they make less even with a bumper crop. And, when a trade war cuts off their largest foreign customer, many soybean operations working on margin go bankrupt.

Investments in U.S. Agriculture and Tracking Bankruptcies in Farm Country

American Banker writes about soaring bankruptcies in Farm Belt and how banks need to become more defensive or get dragged down by debt defaults.

Banks that serve U.S. farmers are increasingly restructuring existing loans and boosting the collateral needed for new ones as the numbers of late and missed payments have risen.

While regional banks are healthy, they’re clearly boosting their defenses against the risks they face. In March, a report by First Midwest Bank in Chicago showed past-due agricultural loans up 287% in 2018 over the previous year. Meanwhile, cases handled by the Iowa Mediation Service involving farmers unable to make payments rose 20%.

Farmer bankruptcies in six Midwest states rose 30% to 103 in 2018, according to the Federal Reserve Bank of Minneapolis. To hold back the tide, Farmers National Bank in Prophetstown, Illinois, is restructuring more and more loans to keep growers solvent while trimming the bank’s own risk.

The point here is that this situation is a threat to the banking industry as well. This problem for investment in U.S. agriculture predated even the Trump trade war. But, reducing orders from the largest market for U.S. farm exports like soybeans made things worse. Now the swing fever risks to investment in U.S. agriculture have compounded the dilemma along with an unusually wet spring, late planting, and a smaller-than-hoped-for crop. The swine fever risks to investments in U.S. agriculture may be felt very widely and bear close attention.

FANG Regulatory Risk

One of the many concerns in today’s stock market has to do with potential regulation of FANG stocks. Facebook has come under heavy criticism for not policing its social media against Russians interfering in the US elections, data privacy breaches, and terrorists posting videos murdering innocent people. Now Market Watch believes that FANG stocks are going to be “smacked down” by regulators.

Stock-market investors live by the FANGs, and they die by the FANGs.

That may be one takeaway from recent comments made by Savita Subramanian, head of US equity and quantitative strategy at Bank of America Merrill Lynch. The strategist said investors should wean themselves from off the handful of fast-growing techy companies known by the acronym FANG and sometimes FAANG that represent a cadre of highfliers that have helped to supercharge the current bull market run for equities.

The stocks in question are Facebook, Amazon.com, Netflix Inc., and Google’s parent company, Alphabet. Sometimes Apple is included in this bunch and the name is changed to FAANG. The companies are world leaders in technology and especially its application to social media. And, that is where the regulatory concern lies.

Have FANG Stocks Run Too Far and Too Fast?

The opinion of the analyst from BoA echoes that of many who believe that the rally of these stocks is not sustainable, purely on fundamental and technical grounds. Their prices have been bid up based on their being the best bets in an otherwise stagnant market. But, at some point, investors will start to get out and start a stampede. The best bet according to the analyst is to take a little off the table now.

The next step for these evolving companies and technologies will be government regulation. This is a natural step as no one regulates a brand new business but regulation occurs when a business becomes large and has strong effects on the lives and welfare of the citizens of the country.

FANG stocks may have run too far and too fast from a stock market pricing perspective but they have also done so in terms of their out-sized effects on society. Thus, regulation to some degree is a certainty. The question for an investor is how does this FANG regulation risk affect stock prices and investment opportunities.

 

Is there a FANG regulatory risk today as these companies become monopolies controlling more and more personal and financial data?

FANG Stocks

 

Is It Time to Regulate FANG Social Media?

An interesting view of this subject comes from the oil and gas industry, which is highly regulated. Rigzone, a publication in that industry, asks if it is time to regulate social media’s FANG.

A number of newspapers have reported that policymakers are considering various options to regulate use of personal data by various social media and internet service providers. One of the options mentioned is that of treating the social media companies as “public utilities.” This leads to the question of what criteria has been used in the past to identify a private business as a “public utility” or using another historic term as a “public service” company. Could those criteria be applied to internet social media giants such as Facebook, Amazon, Netflix, and Google? These companies are sometimes collectively referred to as “FANG.”

This sort of useful, albeit boring, discussion of what constitutes a public utility and if that designation will be applied to the FANG is basic to understanding FANG regulatory risk. In their discussion, they quote for Principles of Public Utility Rates the two attributes of a company that typically lead to regulation.

Two attributes of public utility business have received emphasis in the literature. The first is the special public importance or necessity of the types of service supplied. The second is the possession of specific physical and human assets like utility plants, distribution networks and technical expertise that lead almost inevitably to monopoly or at least ineffective forms of competition.

Thus public importance and necessity are one factor and possession of specific and special assets making competition difficult is the other.

Some already believe that social media companies exhibit both “public utility” attributes thus leading to the “necessity of regulation”. The FANG companies clearly have “special public importance” and are considered by many, due to their high penetration rates, as “necessary.” They also own tangible and intangible “assets” hard to reproduce and “networks and technical expertise” difficult for competition to develop.

A basic concern is that these companies have become monopolies and their use (and misuse) of consumer data has become integral to their operations. This threatens to cross the threshold of what is acceptable in American society if it has not already. Thus, we may see regulation of FANG companies in the national interest. What does FANG regulatory risk do to the value of those investments, their ability to make profits?

Do Regulations Kill Growth?

Regulations in the extreme break up companies, like AT&T. However, the breakup of this monopolistic behemoth ushered in an era of fantastic growth and innovation in the communications sector. On a less aggressive level, regulations may or may not impede corporate profits and growth. Pitch Fork Economics asked the question, Do Regulations Kill Growth.

Deregulation for the powerful is a central tenet of the trickle-down myth, embraced by Democrats and Republican alike. Government regulations, we’re told, are costly and inefficient intrusions that slow grow and kill jobs. But Robert Reich explains that when thoughtfully applied, regulations are absolutely essential to growing a safe, secure, and broadly prosperous economy.

This is a forty-minute discussion of the issue in audio form with an attached transcript. The discussion is focused on deregulation but the argument works for supporting a degree of regulation. The basis of the discussion is that trickledown economics do not trickle down and help anyone except the very rich. And, the follow-up argument is that a reasonable degree of regulation results in an ordered society and a safer and more prosperous financial system.

Starting with the AT&T example, we can see that the extreme case of breaking up a monopoly results in financial and societal gains not previously envisioned. Like the banking rules that so long protected depositors and the financial system, rules that control information gathering, storage, transfer, and use will help stabilize society and protect both individuals and business. The result might be a loss of power and money for the FANG stocks but a greater benefit for society as a whole. As such, those investing in FANG stocks may be wise to hedge their risk a little with investments like those that don’t lose any money, ever.

 

With a FANG regulatory risk on the horizon, AAA bonds are a reasonable option until the situation becomes clear.

AAA Bond Rating


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