Investing in a Prolonged Trade War

Fortune just published an article about how to invest during a trade war. They start by looking at Amazon versus Apple.

Goldman Sachs gave its take early last week, forecasting that services-oriented companies (think Amazon, Google, and Microsoft) that are “less exposed to trade policy” will likely have an easier time than goods-producing companies (such as Apple, ExxonMobil, and Johnson & Johnson) that are more vulnerable to trade headwinds.

While that’s a largely accepted view, equity and investment strategists who spoke to Fortune noted that it’s a little more complicated than that.

“The key questions to ask are: what’s priced into the market right now, what’s the direct earnings and [price-to-earnings] multiples impact, and what’s the long-term impact?” according to Savita Subramanian, head of U.S. equity and quantitative strategy at Bank of America Merrill Lynch.

Has a Trade War Been Priced into the Stock Market Already?

The first issue to consider with any investment is how much has a prolonged trade war already been priced into that investment? The fact that the market fell in response to the recent tit for tat increases tells us that not all of the risk of a trade war had been priced into the market! But, to the degree that companies have adjusted their supply chains and where they are trying to sell their products (not in China), those investments will better weather the coming storm.

Which Stocks Will Be Hurt the Most by Higher Tariffs?

In general, service companies like Google, Amazon.com, or Microsoft will tend to have fewer problems than companies that sell tangible things. These would include ExxonMobil, Johnson & Johnson, and Apple. Obviously, companies like 3M that are highly diversified to all corners of the globe will do better than companies that are trying to focus entirely on China.

Safe Haven Investing in a Trade War

Are your investments safe from tariffs if the companies only do business in the USA? Here we are talking about utility stocks, real estate investments like REITs or home builders who work exclusively in the USA. Health Care is another promising sector despite the Medicare for all possibility being talked about by Democratic candidates for president. Defense stocks are another possibility for safe haven consideration, especially if trade tensions spill over into heightened military threats.

Investing without Losing any Money, Trade War or Not

Are you investments safe from tariffs when both the USA and China seem to be digging in for a prolonged fight? How do you handle your risk when a single tweet by a Twitter-obsessed president can send stocks dramatically up or down? In the context of investing in general we have written about how to invest without losing any money. The first answer is to put money in an FDIC insured account at your bank, preferably a ladder of CDs. Next, you can buy US Treasuries, again laddered. AAA corporate bonds come next. There are only two US companies that have this rating, Microsoft and Johnson & Johnson. And, the fourth choice in our article was to apply the concept of intrinsic stock value as well as you can to this situation and your particular investments with the idea of investing for the very long term. And, in the cases of bank CDs, Treasuries, or AAA bonds, they should be held to maturity. Of course, in the case of Treasuries or AAA bonds, interest rates could plummet and suddenly make them profitable to sell.

How Long Could the Trade War Last / How Badly Could It Hurt Your Investments

Trump, and many others in the USA, are tired of funding the rise to power of China. China is viewed as not only an economic threat to the USA but an existential threat to the democracies of Europe, the Americas, and elsewhere (India especially). The trade war, according to Trump has been going on for decades and the USA has been steadily losing. However, there two previous major power issues that bear on the current trade war. One is the cold war between the USA and the Soviet Union. The other is the rise Japan as an economic power and its near collapse. The common thread in how these situations worked out has to do with money and debt.

Winning the Cold War by Driving the USSR Farther and Farther into Debt

During the 1980s the USA ramped up its “Star Wars” missile defense program forcing the USSR to spend money that it could ill afford to spend. When social unrest in Eastern Europe became overwhelming, the USSR essentially told the leaders of its puppet Communist states that there was no money to support them, keep the borders policed, or send in the tanks, such as was done in Hungary and Czechoslovakia years before. Today the USA has put sanctions on Russia to ramp up the pressure and is also playing the money and finance card with China.

Japan’s Economy Collapsed Due to a Huge Debt Load

This is the other example that comes closer to why the USA is pursuing a trade war with China. Japan was rising towards dominance as an economic power. Although they were and are US military allies, they were an economic threat. What happened to Japan was not orchestrated by the USA but it was instructive. Japan had a mountain of debt, much of it “off the books” as deals between private parties or hidden debts within the banking system. When this debt situation collapsed, almost 30 years ago, Japan went into a period of economic stagnation from which it has still not recovered.

Applying Japan’s Collapse and Cold War Strategy to China’s Threat to US Dominance

China has a stronger economic system that the USSR had but they have a mountain of debt and it is increasing. Their economic miracle has been funded by borrowing, manufacturing, selling to the world, and then borrowing more. In recent years, their debt has accelerated. The risk to China is that their entire financial system will collapse, taking their social contract with the people along with it. The fact of the matter is that people in China are not in love with the Communist Party leaders unless the economy is growing. If the financial system in China collapses there is a risk that the social system will collapse as well. Thus, the Chinese are digging in to protect the dominance of the Communist Party at the same time that their largest customer is putting tariffs on their products.

All of this having been said are your investments safe from tariffs? Our point in this discussion is threefold. This could be a long trade war for it has to do with basic national interests. It could become even nastier. And, you need to consider how to arrange and protect your investments as it plays out.

Small and Medium-sized Business Downsizing in China

The South China Morning Post is beginning a series about the China economy.

Chinese President Xi Jinping warned on January 21 that the Communist Party needed to pay particular attention to the risks to social stability from rising economic problems, as evidence increasingly suggests that the nation’s employment situation is deteriorating rapidly, particularly among small and medium-sized businesses.

An important aspect of this situation in China is that the prospect of a significant economic downturn is not just that there could be a recession or even an “economic hard landing” but that it could lead to significant social unrest. The article goes on to give examples of companies that have reduced their labor forces by more than 75%! The end result is survival, not repayment of debts or prosperity.

Chinese economic statistics have always been suspect, so anecdotal evidence is often relied upon to get an accurate picture of what is going on. What is known is that China has taken over a lion’s share of production in many industries from the rest of the world. Seventy percent of world electronic production capacity now is in China and the risk of a permanent trade war is taken very seriously, especially considering the amount of debt that companies and whole industries have taken on. As noted in the South China Morning Post article, many smaller Chinese businesses got into the habit of simply borrowing, expanding, and having enough money to service their debts. Now the world is changing and companies are downsizing very rapidly.

How Do Job Cutbacks in China Relate to Your Investments?

China ADRs

The first point of concern would be investments that you might have in Chinese companies. Investing.com lists 403 Chinese companies with ADRs available in the USA. If you are invested in any of these, you need to do your fundamental analysis and make sure if you want retain the investments in your portfolio or not. If you do not believe that you can do an accurate job at this because of sparse data, it might be better to sell.

Offshore Investing

The next issue is any other investment you might have offshore from the USA. We recently wrote about how offshore investment in Brazil was starting to look promising with the new government. But, Brazil and other exporters of raw materials will all have the same problem if China experiences a significant economic slowdown and quits importing at its current rate. The resource curse of boom and bust cycles is inherent in commodity exporters. There are relatively secure value investments offshore but you need to do your homework to find them and to assess their intrinsic value.

Direct Foreign Investment as a Guide

To know where to put your money offshore, a useful resource is the World Bank’s Foreign Direct Investment page of statistics. The most recent figures show that worldwide foreign direct investment was $2 Trillion in 2017, down from $2.5 Trillion in 2016. China received $168,223.58 million ($168 Billion) in 2017 versus $354,828.00 ($355 Billion) for the USA.

Meanwhile the European Union as a whole received $604,920.21! And Brazil came in at $70,685.05. It would appear that as the world economic situation worsens that money is flowing into developed economies more so than developing economies. Since this is where the smart money is going, smart investors will probably follow suit.

The World Bank updates these figures every year so it is always a useful resource for those wanting to invest offshore.

How Investments in the USA Will Be Affected

An old friend of ours recalled when the stock market crashed in 1929 and all of the businessmen in his small Midwestern town were not worried. New York was a long ways away and what happened there would never affect the prices of corn, soybeans, beef, pork, or eggs. Three years later our friend was burning corn cobs in his stove to keep the office warm because corn was cheaper than coal. The US Congress has picked a trade war with the Smoot Hawley Act and the US economy entered the Great Depression.

If you think that what happens in the country that consumes more natural resources than anyone else does not matter in the rest of the world you are dead wrong. Companies like Boeing, 3M, Procter & Gamble, Deere, Caterpillar, Apple, and many many others derive a substantial portion of their incomes from trade with the rest of the world and with China in particular. When a company in China lays off 700 of its 1,000 workers, those workers have no jobs or take lower-paying temp jobs. The effects ripple through the economy and more companies lay off more workers and the downward cycle continues. The growing Chinese economy has been a consumer of many Western products. We in the West would like to have more access their economy and that is a lot of what the looming trade war is all about. The risk is that China will not open up to the West but will look inward instead. Apple already downgraded its projections for China for the coming year. This is how job cutbacks in China relate to your investments if you have multinationals in your stock portfolio. Trouble in China will spread to many developing nations and sales of goods by the USA will suffer.

The one bright spot for the USA and other developed economies is that foreign direct investment and cash via the Forex market will seek safe havens in these economies.

What Can You Do?

Some time back we wrote about how to invest without losing any money. As economic risks increase a wise investor will rotate part of his or her holding into AAA bonds (Microsoft and Johnson & Johnson, US Treasuries, and even CDs at the local bank. Any stock investments should be value investments until the economic situation in China and elsewhere improves. If the economy and market worsen, there will likely be quite a number of deep value investments for those willing to do their homework.

How Do Job Cutbacks in China Relate to Your Investments? PPT

• Investment in China could be profitable
• Anyone already invested in China may wish to consider selling
• A slowing Chinese economy hurts third world raw material manufacturers
• And, if the Chinese real estate bubble does not quit deflating it could drag China and much of the world back into recession

The Positive Side

China’s economy has been growing for nearly half a century and many have reaped huge profits from investing in real estate companies in China. Despite eight months of decreasing property values the government is instituting strong stimulus measures that just could save the day and drive prices back up. If that is the case then it would be a good time to invest at the bottom of the price curve. Two articles, one in the New York Times, offer contrasting views on the subject. There may be signs of hope.

The tentative rebound in some cities’ housing prices suggests that recent steps by policy makers are helping engineer at least a slight turnaround in the market. Last week, the central bank cut interest rates for the third time since November; it had already removed several restrictions on some home purchases.

“April’s home sales growth returned to positive territory, the first time since December 2013, following a slew of easing measures introduced to support the weak housing market,” analysts in Hong Kong at Bank of America Merrill Lynch wrote on Monday in a research note. “We expect home sales to remain robust in the coming months as the recent monetary and property easing measures continue to provide support.”

This point of view has it that investment in property in China might be a good idea as the market may have bottomed out, at least in the major cities.

The Alternative View

Reuters offers a contrasting view of investment property and home prices specifically in China.

China’s new home prices fell for the eighth consecutive month in April from a year earlier but were flat from March, adding to hopes that a property downturn which is weighing heavily on the economy is beginning to bottom out.

But analysts warned any recovery in the market will take some time given a huge inventory of unsold homes, and said the property sector remains the biggest risk to the world’s second-largest economy, which looks set for its worst year in 25 years.

That will keep pressure on policymakers to roll out more interest rate cuts and other stimulus measures later this year to boost activity.

Average new home prices in China’s 70 major cities dropped 6.1 percent last month from a year ago, the same rate of decline as in March, according to Reuters calculations based on official data published on Monday.

China is seeing its exports slow down and the government is pushing stimulus programs such as low interest rates as well as infrastructure projects. As the real estate market dwindles it further slows economic growth which many believe will resemble that in Europe or North America in a decade or so. The bottom line for investors interested in investment property in China is that the glory days are probably over. The bottom line for investors in general is that a continually slowing Chinese economy will drag down many third world countries that rely on raw material exports to China for growth. If the slowdown in generalized it will affect Europe and North America as well.

The Problem Is Broader than Just Real Estate

Business Insider looks at three indicators that point to a slowing economy,

• Electricity usage for the February/March period was up only 0.9% versus the same period last year. This is well off the mid-single-digit growth it had held for some years.

• Second, tax collections for the February/March period were unchanged versus the same period last year breaking its longstanding trend of solid mid-single-digit growth.

• The Shanghai Shipping Exchange freight index has fallen nearly 17% since mid-February and is now at levels not seen since 2011.

A recurring complaint of investors is that China tends to inflate number or hide info. The indicators above are probably accurate and an indication that things are not going well in the Middle Kingdom. Whether you are interested in investment property in China or any sort of investment, pay attention to where things are going.

Investment Property in China PPT

Brent crude oil fell by almost $2 on Wednesday after a new build in U.S. crude stock levels put a global glut back in focus, cutting short a four session rally that pushed prices up to a high of $59 on Tuesday.

The recent rebound had increased speculation that prices may have hit a bottom, after a seven-month rout slashed oil futures by nearly 60 percent and prompted major energy firms to cut spending on new production.

But a report from the industry group American Petroleum Institute showing U.S. crude stocks rose more than 6 million barrels last week pushed prices down on Wednesday.

Both the price of oil and the prices of oil stocks have fallen dramatically in the last six months. When will oil stocks recover? It all has to do with the law of supply and demand. And for the time being demand is falling due to economic stagnation while supply is plentiful.

How Bad Has It Been for Oil Stocks?

The Motley Fool writes about a $393 billion wealth wipeout.

The impact from the plunging price of crude oil is sending shockwaves across the globe. Nations dependent on oil production, like Russia, Venezuela and Saudi Arabia, have witnessed plummeting revenue that is pushing some to the brink of recession.

At the same time oil consumers, like American drivers, are rejoicing thanks to the saving being enjoyed at the pump. However, for many those savings at the pump are being wiped out as retirement and investment accounts are taking a hit from the big blow oil stocks have taken over the past few months. So far, downturn in the oil market has cost investors $393 billion in wealth, according to a report by Bloomberg, which is far above the $14 billion American drivers saved at the pump last year.

The sum total of value that has evaporated with the fall in oil prices and stock values runs close to $400 billion. The issue is, again, supply and demand. When the economies in China, Japan and Europe come back the demand for oil will go up and the price will go with it. When will oil stocks recover? They will come back when investors come to believe that a recover is imminent.

Buying on Anticipation

When oil stocks recover those who profit the most will be investors who successfully anticipate the recovery and buy when stocks are still cheap. We saw a taste of that the other day with an aborted oil rebound. ABC News reports the story.

A recent rebound in oil prices came to an end as the benchmark contract for U.S. crude fell $2.32, or 5 percent, to $50.66. Crude prices rallied 19 percent over the previous four days as producers canceled exploration projects and cut the number of rigs drilling.

When will oil stocks recover? Look for when the number of drilling rigs increases again and look for better economic numbers from Japan, China and Europe. And look for an end to Russian adventurism in Ukraine!

When Will Oil Stocks Recover? DOC

When Will Oil Stocks Recover? PDF

When Will Oil Stocks Recover? PPT

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