May 6, 2019

Axios Markets

By Dion Rabouin
Dion Rabouin

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Situational awareness:

  • Tens of thousands of shareholders descended on Omaha, Nebraska, for the annual meeting of Warren Buffett's Berkshire Hathaway. Buffett turned some questions during the all-important Q&A session to his lieutenants, Ajit Jain and Greg Abel, in a sign of their growing influence. (WSJ)
  • Stan Collender, a longtime economist and adjunct professor at Georgetown University, died on Friday, according to MSNBC journalist Ali Velshi. Collender was a "leading experts on the federal budget, federal spending and revenues, the deficit, the national debt and the congressional budget process." (The Budget Guy)
1 big thing: Tariff Man Returns

President Trump holds up a signed presidential memorandum aimed at what he calls Chinese economic aggression. Photo: Mark Wilson/Getty Images

The plot has thickened and the characters have developed as President Trump announced plans to re-engage 2018's tariff battle with China.

Chinese stocks fell more than 6% at one point, Dow futures dropped more than 500 points and the Chinese yuan weakened significantly after Trump sent 2 tweets yesterday threatening more U.S. tariffs on imported Chinese goods.

Behind the scenes: A source familiar with the situation tells Axios' Jonathan Swan the Chinese have been backing off of agreements the U.S. negotiating team believed they had already made. Trump's view, the source said, is that he's negotiating from a position of economic strength, especially with April's strong U.S. jobs numbers.

Flashback: We've seen this movie before. In late March 2018 the Dow fell more than 1100 points in just 2 days, after Trump ramped up trade war rhetoric and announced another round of tariffs on China.

Why it matters: The stock market has had one of its best starts to a year in almost a decade, but the run has been based on traders pricing in a resolution to the trade war and no further tariffs. It's one of the many positive assumptions the market has been making all year.

Reality check: China is in a much more advantageous position this time around. Its government added stimulus that has seemingly stabilized the economy, its stock market is the world's top performer so far this year and its central bank has ample room to cut rates.

  • The editor-in-chief of China's state-owned Global Times tweeted: "President Trump threatens China while he seemingly doesn't understand how tariffs work. ... China has long ago prepared for the worst. We won't buy this trick. Moreover, he didn't even scare North Korea."

Trump also is facing pressure from U.S. businesses who aren't eager to relive the uncertainty of last year's tit-for-tat drama.

  • "Tariffs are taxes paid by American businesses and consumers, not by China," National Retail Federation senior vice president for government relations David French said in a statement.
  • "A sudden tariff increase with less than a week's notice would severely disrupt U.S. businesses, especially small companies that have limited resources to mitigate the impact. If the administration follows through on this threat, American consumers will face higher prices and U.S. jobs will be lost."
Bonus: How tariffs work

There's been lots of commentary about Trump's claim that China pays tariffs to the U.S. Treasury, strengthening the country's financial position. That's untrue and Trump clearly knows that, evidenced by his change of verbiage when discussing tariffs during his most recent State of the Union address.

While China is not paying all of the tariffs, tariffs are a bit more complex than people realize. Reuters' Rajesh Kumar Singh points out that the onus to pay the tariffs is on U.S. companies, but some Chinese companies can also take a hit.

"An importing company paying tariffs can manage the cost in several ways:
"1. Pay the full cost and live with a lower profit margin.
"2. Cut costs to offset higher tariffs.
"3. Ask suppliers in China for a discount to help offset the higher tariffs.
"4. Seek to source supplies from outside China. So some Chinese companies are losing business.
"5. Pass the tariff costs on to customers by increasing retail prices."
2. Emerging markets may not recover this year
Expand chart
Data: Institute of International Finance; Chart: Axios Visuals

Despite strong performances from both U.S. and Chinese stocks this year, emerging markets have not seen significant inflows in debt or equity. EM currencies, bonds and equity markets have also broadly lagged their U.S. counterparts.

Investors have been talking themselves horse about attractive EM valuations since late 2018 but haven't been buying. Typically, investors flock to EM in times of risk seeking, as they tend to rise more than mature markets like the U.S. or Europe.

What's happening: The cause appears to be the sell-off in August and September as Argentina and Turkey looked to be in danger of massive implosions, leading to broad selling of most EM assets.

  • Losses amounted to nearly $40 billion for investors who held Argentine assets and "most real money inflows were captive and unable to leave," says Elina Ribakova, deputy chief economist at the Institute of International Finance.
  • That's left investors largely unable to put fresh capital to work buying up EM assets this year.
  • Worse, Argentina and Turkey again are looking vulnerable.

Why it matters: "The positioning overhang means no smooth sailing for emerging markets, even with a dovish Fed shift," Ribakova tells Axios. "Asset managers already own lot of 'problematic' emerging market assets ... In this environment it is hard for EM to rally."

3. There's hope for Europe

Data out of Europe has gotten worse and worse as the year has gone on, but a pick-up in Chinese trade numbers and first quarter GDP appear to have steadied the euro zone as well.

  • Consumer prices in the euro area rose 1.7% last month, the strongest since November, Bloomberg reports, with core inflation, rising to 1.2%. Both readings beat economists estimates, and put an exclamation point on the economic bloc's stronger-than-expected 0.4% increase in GDP during the first quarter. It was twice the pace of Q4's growth and also beat economists' expectations.
  • Bundesbank president Jens Weidmann said in a speech ahead of Friday's consumer price numbers that "much suggests that the economy is only experiencing a temporary weak phase and will pick up speed again after its soft patch."
4. The dollar rally is starting to look unstoppable

Dollar bears have been beaten into submission, as the dollar index rose to its highest level in nearly 2 years in late April. Speculators had raised long dollar positions to $37.2 billion, the highest level since December 2015, according to Commodity Futures Trading Commission data released on Friday.

Having risen by 4% in 2018, the dollar is up about 2% so far this year and a Reuters poll of economists expects that strength to continue for the next 3-6 months. Though, they expect it will fall within a year.

  • Analysts have been predicting the dollar would weaken for the past 2 years, but have consistently been proven wrong, as central banks outside the U.S. have mimicked the Fed's dovish tone.
5. A big problem at Milken 2019: There's too much cash

One big takeaway from this year's Milken conference: attendees were obsessing about the outsized cash environment, Axios' Courtenay Brown writes.

Why it matters: Too much cash is never a bad thing, but it's disrupting norms.

What they're saying:

  • Startups are putting off IPOs, thanks to big capital raises on the private side. "The amount of funding in the private markets has been greater each year. These companies in effect are getting all the capital they need privately. Whereas before they would go public," Dan Levitan, co-founder of venture capital firm Maveron, told Axios' Dan Primack on stage.
  • Companies are flush with cash, but unloading their cash pile via buybacks has become more controversial. Booking Holdings CEO Glenn Fogel told me: "There are some people who believe that companies should be restricted from using their capital to buy back their shares. I don't understand the logic on that at all."

The intrigue: Often these conversations were happening as attendees debated the whether or not capitalism was working.

  • One example: At the final session of the conference, Ray Dalio questioned whether capitalism was "producing the outcome" of shared prosperity and cited stagnant income per capita.

Meantime, Carter Lyons of investment firm Two Sigma said on a panel that his biggest worry was the impact that growing populism and proposals like "financial transaction taxes" could have on liquidity in public or private markets. That could cause a lot of disruption in the short or long term, Lyons said.

Dion Rabouin