Why Trump's trade moves taste like chicken
Unlike Australia’s largest companies – the big banks, Telstra and BHP Billiton – the biggest US stocks are not run by rent-seeking technocrats, or at least not yet. When Commonwealth Bank chief executive Ian Narev was being pursued around the verdant grounds of Auckland Grammar by future All Black Grant Fox*, Alphabet (nee Google), Amazon and Facebook didn’t exist and Microsoft and Apple were in their infancy.
That might be a matter of some regret for the likes of Tim Cook, Satya Nadella and Sheryl Sandberg, who face an awkward choice: how to lunch on the Trump carrot of corporate tax cuts without getting beaten around the head by a stick made of trade disputes and immigration orders.
And it all started off so well. A few weeks before Christmas, Trump met with the scions of Silicon Valley and made nice. Unity came from that old favourite, mutual self-interest. “Yes, Mr President, corporate tax cuts would be great and we would happily repatriate $US200 billion in cash if there was an incentive to do so. Oh, you’d like us to make a few iPhones in the rust belt? Sure, no problem.” Or something like that.
The bargain made by investors has been equally self-serving: infrastructure spending will be good for GDP growth and corporate tax cuts will be even better. Let’s buy stocks, enjoy Trump’s bump (that’s a ‘b’ folks, not an ‘r’, Trump steaks were a dreadful failure) and worry about all that sabre-rattling later.
It might still play out that way but the initial optimism around Trump’s victory is dissipating a tad. In hindsight, the 'I can’t believe I’m here' expression on the face of Tim Cook – right, in picture (left in politics) – at the tech pow wow was perhaps a pointer to where this might go.
Where that might be is anyone’s guess. But we do know politicians say all sorts of stuff to get elected and backtrack once they win. That doesn’t appear to be the case with Trump, who – and I never thought I’d write this – is showing worrying signs of being a man of his word.
For decades, our investment decisions have been implicitly predicated on the assumption that the post war consensus, enshrined through a network of open border agreements and organisations like the WTO and IMF, was a good thing. Despite the spoils flowing unequally to the top, globalisation has lifted many more people out of poverty than it has pushed into it (although that’s of no consolation to them). That consensus is now being challenged, and too few investors are considering its implications.
America was made great through the rebuilding of Europe and Japan and a four decades-long expansion in global trade. Personally, I find it a stretch to think promoting a break-up of the European Union and implementing policies that trigger trade wars will make it even greater.
Global trade was slowing well before everyone started wearing red hats. A decade ago it was growing at twice the rate of global GDP growth but those times are over, as this Economist chart shows. Weak growth, especially in Europe, doesn’t help but a US tariff of 45 per cent on all Chinese imports and 25 per cent on Mexican imports would be a disaster.
The story of how frozen chicken parts helped US car manufacturers dominate the market for small trucks – unlike the gratuitous Grant Fox reference, I did not make that up – illustrates how easily the consensus might be lost.
In late 1950s Europe, chicken was scarce. Meanwhile, across the Atlantic, cashed up Americans were returning from the supermarket in VW Beetles loaded up with delicious flightless birds. Enterprising producers sniffed the opportunity, bagging and freezing chicken parts for export.
The Germans especially went mad for it. In 1961, imports of US chicken rose 23 per cent (Planet Money has the full story). With VW sales booming in the US and frozen chicken going crazy in Germany, it was a model of how free trade was supposed to work. Everyone was happy, except European farmers, who even now yearn for a place on the list of protected species. After lobbying the European Economic Community, a 50 per cent import tax was slapped on US chicken.
In response, the US instituted a 25 per cent tariff on small commercial vehicles like the Volkswagen Kombi. This remains in place to this day, which is why Americans in the market for a pick-up truck pay far more for a Japanese, German or Korean vehicle than a US one. Without frozen chicken thighs, the Ford 150 might still be a sparkle in the eye of a gun-toting redneck from Montana.
If a 50 per cent tax on chicken can distort an entire segment of the US automotive market, imagine the effect of country-wide tariffs imposed on China and Mexico. No wonder Tim Cook looked pensive at that meeting. The iPhone contains components from all over the world but is technically made in China. US citizens would face price hike for their gadgets, cars and basic items like food and vegetables, 44 per cent of which come from Mexico.
It may not happen, of course. On Thursday I asked research director James Carlisle if he was worried about a trade war. “Hadn’t really thought about it. But even if it does happen, we have four tough years, Trump is then replaced and someone sensible comes in and cleans it all up. It’s not perfect but it’s hardly a disaster.” Then there’s the view expressed by Lin Brehmer on Twitter: ‘Mess with the price of tequila and guacamole just before the Super Bowl and you've gone too far.”
History offers an equally compelling lesson. Passed in 1930, the Smoot-Hawley Tariff Act (there’s one to impress your friends) raised tariffs on more than 900 imported goods, prompting global retaliation. The 1929 crash was bad enough but this act helped turn it into a depression. Within four years global trade had collapsed by 66 per cent.
That’s the worst case scenario, one which prices on US markets at least appear to be ignoring altogether. In other words, not much is cheap. But the rhetoric – not just in US but in France, the UK and elsewhere – is a worrying break from a past where open trade and globalisation have had cross-party, global support. In the words of a famous singer, much liked by another financial commentator, ‘you don’t know what you’ve got ‘till it’s gone.’
That policy has been at the heart of the prosperity we’ve enjoyed over the last few decades and it’s a worry to see it at risk. Moreover, from a portfolio point of view there’s not much we can do to guard against it, other than to stick with high quality companies purchased at attractive prices.
They say it’s a blessing to live in interesting times but, for me, it all feels just a little too interesting. Have a lovely tariff-free weekend.
*Grant Fox was at Auckland Grammar but he may not have chased Ian Narev around the playground.
Readings and Viewings
Global share markets were into volatility overdrive again this week, and it's not that difficult to figure out why. Donald Trump, in characteristic form, continued to upset the status quo as he made more new hirings, executed some firings, and managed to set the US on a collision course with Australia.
That's not all, of course. Iran is back in the firing line, for good reason.
And the border traffic queues between Tijuana and the United States are already getting longer, and now talk around renegotiating the North America Free Trade Agreement (NAFTA) between the US, Mexico and Canada is being centred on the "rules of origin".
And now Uber has got caught up in the world's trade whirlwinds as its CEO exits Donald Trump's business advisory council.
Billionaires were all over the news this week.
Things continue to get more ‘complicated’ in Hong Kong, with a billionaire financier apparently spirited across to the mainland.
These young tech-heads, both aged under 30, are set to become billionaires when their company lists on Wall Street.
Talking of billionaires, which Australian rich-lister is still all the talk in the Israeli media? James Packer, of course, over his ties to Prime Minister Netanyahu. Packer is set to be called as a witness in a major bribery probe.
He’s not the only one hitting turbulence. So is drone maker GoPro.
And so is another avid drone user, online retailer Amazon, which was pummelled on Wall Street after it announced lower sales.
Also in the online space, Sydney has become a mecca. But there are consequences. The harbour city is in AirBnB’s top 10 cities globally, and it’s affecting rents.
Maybe the Reserve Bank will do something about it, but we doubt it. This article outlines the for and against cases for the existence of central banks.
Lastly, when is funny not funny? Just ask Robert de Niro.
Shane Oliver, AMP Capital
Investment markets and key developments over the past week
- Trump jitters dominated markets over the last week with his 90 day travel ban and reports of belligerent phone conversations with various country leaders (including Australia’s) and attacks on allies like Germany adding to concerns about inexperience and political and trade risk. So despite pretty good global economic and profit news, this saw most share markets dip and bond yields fall. Trump jitters along with a still gradual Fed also weighed on the $US which combined with news of a record trade surplus saw the $A rise.
- Worries about Trump could be with us for a while yet as his belligerent approach, his team’s inexperience and fears about trade wars and US isolationism could dominate the pro-growth positives for a while as it will take time to push through deregulation, tax cuts and increased infrastructure spending.
- While most of the global political focus has been on Donald Trump, Eurozone political risks will also feature this year. High on the list is France which has presidential elections in April and May. Polling continues to show that populist Eurosceptic Marine Le Pen will make it into the second round polling more than any other candidate at around 27 per cent, but that the independent former economy minister Emmanuel Macron (polling at 23 per cent) or the Republican party’s Francois Fillon (polling 20 per cent) will defeat her in the second round (at 65 per cent to 35 per cent and 59 per cent to 41 per cent respectively). Both Macron and Fillon are pro Europe and reform oriented but Fillon has been hit by a scandal involving the employment of his wife and children as parliamentary assistants (which is legal but the issue is whether they actually worked). Whether its Macron or Fillon who makes the second round against Le Pen, it looks unlikely Le Pen will win the final round. But then again there is still several months to go and of course last year’s Brexit and Trump “upsets” can’t be ignored. As a result investors will worry about it and so French bond yields have been rising against German yields.
- The 0.8 per cent fall in Australian shares in January is not so positive in terms of the January barometer, which states that “as goes January so goes the year”. That said negative Januarys are less reliable a guide to the year as a whole than positive Januarys. Just recall last year! Since 1980 a negative January in Australian shares has gone on to a negative year only 31 per cent of the time. Perhaps more importantly – given it impact on the direction of global and Australian shares – the US share market rose in January by 1.8 per cent & since 1980 a positive US January has gone on to a positive year 86 per cent of the time.
Major global economic events and implications
- Looking globally, business conditions PMIs continued to improve in January pointing to stronger global growth. Very different to a year ago when PMIs were heading down.
- US economic data was strong with a further rise in ISM manufacturing conditions index, strong home price gains, solid consumer confidence and growth in personal spending, strong jobs data and a rise in pending home sales. That said wages growth according to the employment cost index remains modest and inflation according the core personal consumption deflator remains stuck around the same levels it’s been at for a year.
- The Federal Reserve upgraded its comments regarding current conditions in the economy but there were no changes to the outlook and it continues to see interest rate hikes as being gradual. There was nothing pointing to a rate hike at its March meeting. We continue to anticipate three Fed rate hikes this year with the first being in May or June.
- Over half of US S&P 500 companies have now reported with 75 per cent beating earnings expectations and 50 per cent beating on revenue. Earnings are now expected to be up 5.6 per cent from a year ago taking them to a new high, highlighting that the earnings recession that began in 2014 is long over.
- Eurozone economic data was also solid with a pick-up in December quarter GDP growth and confidence and manufacturing conditions PMIs at five and a half year highs. While headline inflation rose solidly in December on the back of higher energy prices, core inflation remains stuck at 0.9 per cent year on year suggesting that the ECB won’t be rushing just yet to taper its quantitative easing program.
- Japanese jobs data was good with stronger than expected readings for household spending and industrial production. Meanwhile the BoJ left monetary policy on hold as expected.
- Chinese manufacturing conditions PMIs fell in January but services conditions rose slightly, which points to continued solid growth into early this year.
- Indian GDP rose 7.9 per cent in 2016 and the Indian manufacturing conditions PMI bounced back suggesting the negative impact of demonetisation may be fading.
Australian economic events and implications
- Australian data was a mixed bag. The NAB business survey showed strong business conditions in December adding to confidence that growth bounced back in the December quarter and the surge in iron ore and coal prices drove the trade balance to a record surplus in December. Against this though building approvals slipped further adding to evidence that they have peaked. While the surge in commodity prices and the associated boost to national income won’t provide the same boost to the economy seen last decade (as tax cuts are less likely due to tougher budgetary conditions, the mining investment boom has already happened and its likely to be less durable) its better than falling national income and will provide some offset to the loss of momentum in dwelling construction.
- Meanwhile, a continuing surge in credit growth to property investors in December and a strong start to the year in home price growth adds to concerns that the Sydney and Melbourne property markets remain too hot. If the RBA is to retain the necessary flexibility to cut interest rates again, another round of macro-prudential tightening by APRA is likely to be needed – perhaps lowering the 10 per cent year on year growth threshold for the stock of property investor loans to say 7 per cent.
Shane Oliver is chief economist at AMP Capital.
Savanth Sebastian, CommSec
Reserve Bank hogs the limelight
Another big week of economic events is in prospect in Australia over the coming week including data on retail spending and housing finance. In addition, after essentially two months on the sidelines, the Reserve Bank steps back into the limelight with an interest rate decision and also the release of the Statement of Monetary Policy. In China, the trade data will take precedence. And in the US, trade and consumer sentiment data are also due.
In Australia, the week kicks off on Monday when investors will finally get a look at how retailers performed over December. In addition the December quarter inflation-adjusted data will be released. Retail sales lifted by 0.2 per cent in November to be up 3.3 per cent over the year. Interestingly in the prior three months, non-food retailing rose by 2 per cent – the strongest three-month result in 2 years. The Commonwealth Bank Business Sales index indicated that sales recorded healthy growth in December. For the record, we expect retail trade rose by 0.3 per cent in December and by a sizeable 0.9 per cent in real terms over the December quarter.
Also on Monday, data on job advertisements is issued. In the past this was a trusted gauge of labour demand but nowadays more people are going straight to company websites and using social media to scour for available positions.
Job advertisements fell from 4½-year highs in December, down by 1.9 per cent in the month. Job ads are up 3.7 per cent on a year ago.
The Reserve Bank Board meets on Tuesday and much has changed in the past two months. Financial market volatility has eased, oil prices have steadied; and the Aussie dollar has lifted – albeit marginally. And on the global front, economic conditions are certainly healthier.
It is almost certain that policymakers will keep rates on hold and maintain a neutral stance – suggesting rates are likely to remain stable over coming months. Interestingly if the Reserve Bank did indeed surprise and cut rates, it would be able to flesh out its reasoning in Friday’s Statement on Monetary Policy. In the Reserve Bank’s interest rate decision, investors will be particularly interested in the policymaker’s views on the Aussie dollar and also the outlook for inflation.
Also on Tuesday, the Australian Industry Group will release the Performance of Construction index, alongside the ANZ/Roy Morgan weekly consumer sentiment survey results.
On Thursday, the Housing Industry Association will release figures on new home sales for December. New home sales rose by 6 per cent in November, but it was from a 27-month low. It is clear that activity levels have, or are in the process of, topping out. There is greater caution on the part of buyers and builders in response to record building and that suggests slower home price growth over in 2017.
Also on Thursday the Reserve Bank Governor is scheduled to deliver a speech at the A50 Australian Economic Forum (8.00pm AEDT). A title for the speech has not yet been released, but no doubt there are a few ‘hot button’ issues at present such as the governor’s views on the stronger Australian dollar, growth in home prices and the outlook for the US economy under a new President.
On Friday home loans (housing finance) data is released. The home loan data may prove a surprise with data from the Bankers Association suggesting the number of owner-occupier home loans may have lifted by 1.2 per cent in December while investment lending is expected to lift by 2 per cent. While there may be less activity taking place over the summer holiday months, if the results prove correct, it will show that low interest rates are still enticing potential home buyers to upgrade their homes, albeit at a slower pace than witnessed last year.
As mentioned above, the spotlight on the Reserve Bank doesn’t stop with the board meeting – the quarterly Statement on Monetary Policy is slated for release on Friday. Not only does this report assess economic developments over the past quarter, it includes the latest economic growth and inflation forecasts. And once again the focus will be squarely on inflation outcomes.
Overseas: US and China trade data in focus
Turning attention overseas, there are sparse helpings of ‘top shelf’ US economic data in the coming week with the main economic data of interest being trade and consumer credit data. China emerges from the Lunar New Year holidays with the release of key economic data.
The week kicks off on Tuesday with the release of the monthly trade data in the US alongside figures on consumer credit and JOLTS job openings. The trade deficit should hold around $45 billion, while consumer credit is likely to have risen by $20bn in December. Also on Tuesday in China, the Caixin services purchasing managers index is issued.
On Thursday, US wholesale inventories and the usual weekly jobless claims numbers are released.
On Friday in the US, import prices, the monthly budget statement and the University of Michigan consumer sentiment index are released. Forecasts centre on import prices lifting by 0.2 per cent in January after a 0.4 per cent rise in December. The preliminary January reading on consumer sentiment is expected to show a modest fall from 98.5 to 97.9.
In China the National Bureau of Statistics may release trade data on Friday.
Sharemarkets, interest rates, exchange rates and commodities
The Australian profit reporting season cranks up a notch in the coming week as the US earnings season starts to wind down.
On Tuesday earnings announcements are expected from Transurban and SCA Property. On Wednesday, Rio Tinto, carsales.com CIMIC, Genworth, Skycity Entertainment, National Storage and AV Jennings are amongst those listed to issue results.
On Thursday, a few more companies will report earnings including AGL, Suncorp Group, News Corp, Henderson Group and AMP.
On Friday, REA Group is among those listed to issue earnings.
Savanth Sebastian is a senior economist at CommSec.