Trade War? No Worries!

  • The place to seek refuge from trade war fallout
  • Stocks soar, gold stumbles, housing stagnates
  • An economic civil war? Washington declares on N. Dakota
  • Too big to jail — in London and Washington
  • “Fall of Rome”? Check out another record art auction
  • An update on the nail producer caught in trade war crossfire.

With no “bad” trade war headlines the last couple of days, the stock market is staging a decent little rally.

At last check the Dow is up nearly 1% on the day. At 25,885 the Big Board is the highest it’s been since… well, last Friday, before China announced retaliation tariffs over the weekend.

Two of the 30 Dow stocks delivered good earnings reports — Walmart and Cisco.

Walmart’s conference call with analysts was interesting. The CFO said consumers are bound to feel the effects of tariffs: “Increased tariffs will lead to increased prices,” he said. WMT is up more than 3% as we write.

Yesterday, Macy’s also delivered a good earnings report and also fretted a bit about tariffs… but M shares sold off a bit.

Point being, the specter of the trade war still hangs over U.S. stocks…

… unless you look for U.S. stocks that are insulated from the trade war. Which is why our Zach Scheidt has his eye on small-cap stocks these days.

“Smaller companies based in the U.S. have fewer international customers,” he reminds us. “In particular, small-cap companies in the retail, energy and financial industries are largely immune to the trade challenges that investors are worried about.

“Niche retail companies tend to focus on building their brand here at home before expanding into international markets. And with the U.S. economy still very strong, energy companies like oil producers can sell to refiners here in the U.S.”

Another plus for small caps right now is the relatively strong dollar.

At the moment, interest rates are steady in the United States and falling overseas. That means hot money overseas will flood into the United States in search of a better yield. That drives the value of the dollar higher — which is bad news for U.S.-based multinationals.

“The strong dollar makes it more expensive for international customers to buy our products and services,” Zach explains. “And when profits are earned overseas in ‘weak’ international currencies, those profits translate to smaller gains when reported in dollar terms.

“Add it all up and smaller companies that create products and services here in the United States — and sell those products and services to Americans — have a competitive advantage over big blue chip companies.

“One final reason I expect small-cap stocks to do quite well this summer is that the stocks themselves still have lots of room to run,” Zach ventures.

He directs your attention to this chart the Russell 2000 small-cap index…

Room to Run chart

“As you can see,” says Zach, “there’s still a lot of room left for small-cap stocks to run before getting close to the highs from last year.

“This is important because stocks often take a bit of a pause when trading close to previous highs. (That’s exactly what we’re seeing in the broad market for blue chip stocks right now.) Investors can be more likely to sell when markets initially hit new highs because they’re worried about a pullback.”

All told, Zach says small caps are the place to be right now. An easy way to play it is IWM, the big Russell 2000 ETF. “And from there,” Zach says, “I’d recommend looking at American retail, American energy and smaller American banks with strong earnings and loyal customers.”

Now… If you’re looking for a way to play smaller stocks for far bigger gains, Zach has a strategy he’s eager to tell you about. It could mean at shot at $1,000 in your pocket each week. And it doesn’t require putting up a lot of money to start with.

Zach lays out the strategy — and why it’s best if you act before the market closes tomorrow — when you follow this link.

The other major U.S. stock indexes are following the Dow higher this morning.

In fact at last check the Dow is the laggard — up 1%, while the S&P 500 is up 1.25% and the Nasdaq is up one and a third percent.

Gold’s latest run at $1,300 got squelched in overnight electronic trading. The bid is back to $1,285. Crude has pushed up $1.40, to $63.42 — a two-week high — despite a dearth of dire headlines from the Middle East today. Go figure…

The big economic number of the day is housing starts — which rang in better than expected, up 5.7% in April. But the year-over-year comparison still looks weak, down 2.5%. Permits, meanwhile, are down 5% year over year… and permits are a better indicator of future activity.

Scary story we don’t care about: “China has cut its holdings of U.S. debt to the lowest level in two years amid trade tensions,” says CNBC.

That’s true, as far as it goes.

But look closer: China’s holdings of U.S. Treasuries now total $1.12 trillion — down from a peak in 2017 of $1.2 trillion. That’s a not-so-whopping drop of 6.7%.

We keep saying it — most recently on Monday — but we’ll say it again: China’s “nuclear option” in the trade war of dumping Treasury paper is a dud.

Call it the Economic War Between the States.

From The Associated Press: “North Dakota is preparing to sue Washington state over a new Washington law requiring oil shipped by rail through that state to have more of its volatile gases removed, which supporters say would reduce the risk of explosive and potentially deadly derailments.”

You don’t hear much about North Dakota’s Bakken oil shale the way you did a few years ago… but the Peace Garden State is still the nation’s No. 2 oil producer, behind Texas. And about 10% of North Dakota’s crude production is shipped to Washington state. But the new law in Washington amounts to a ban on North Dakota oil being hauled by rail to refineries in the Pacific Northwest.

“We know these trains pose a serious risk as we watch them pass through downtown Spokane in sight of Lewis and Clark High School, hospitals, medical buildings and senior living facilities,” says the bill’s sponsor, Senate Majority Leader Andy Billig (D-Spokane). “This bill is about safety.”

Or is it really about “climate change”?

The bill was readily signed into law by Gov. Jay Inslee. He’s one of the gazillion Democrats running for president, and he’s staking out climate as his niche issue.

It’s true there’s risk to shipping oil by rail; there was a horrific derailment and explosion in Quebec six years ago that killed 47 people. But that was more of a rail safety issue than an oil safety issue.

Clamping down on the vapor pressure limit for oil shipped by rail doesn’t address the real safety issue. But it might well destroy the economics of hauling North Dakota crude out west… and from where we sit, it’s hard not to wonder if that’s the real objective and safety is a canard.

In any event, North Dakota won’t go down without a fight; the suit might resort to a constitutional argument that Washington’s law interferes with interstate commerce.

Too big to jail, U.K. edition: “The Bank of England warned prosecutors that a criminal charge against Barclays could present an existential threat to the lender,” says the Financial Times.

During the global financial panic of 2008, Barclays cut an emergency deal with the government of Qatar so it could stay afloat — a deal prosecutors said ran afoul of British law.

The investigation dragged on for years. In 2017 the Bank of England’s top banking supervisor Sam Woods tried to warn off the prosecutors.

As the salmon-colored rag explains, “Mr. Woods questioned whether a corporate criminal charge would be in the public interest as officials believed it would present a small, but not insignificant, threat to Barclays’ safety and soundness.”

In the end, the prosecutors went ahead with a single charge against a Barclays subsidiary… that ultimately was thrown out of court. Barclays is still a going concern.

Of course, “too big to jail” is long-standing U.S. policy too — a sorry history we feel compelled to revisit today.

During a hearing of the House Financial Services Committee in 2013, Attorney General Eric Holder was asked why no criminal cases had been brought against large banks after everything that happened in the run-up to 2008.

“I am concerned,” he replied, “that the size of some of these institutions becomes so large that it does become difficult for us to prosecute them when we are hit with indications that if you do prosecute, if you do bring a criminal charge, it will have a negative impact on the national economy, perhaps even the world economy.”

Dontcha love the logic? We can’t pursue the banks for criminal wrongdoing because then people would be out of work, or if they did have work it wouldn’t be enough to make ends meet for a middle-class lifestyle…

Oh, wait — that’s been the reality for vast numbers of Americans the last decade anyway.

For Holder, that wasn’t a “new” position that came out from the “harsh realities” of 2008. When he was deputy attorney general during the Clinton administration, he wrote a memo arguing officials should bear in mind the “collateral consequences” of prosecuting corporate crimes.

Holder stepped down as Obama’s AG in 2014 to return to the white-shoe law firm of Covington & Burling from whence he came. The firm literally kept a corner office empty for him while he was away. Covington’s clients have included most of the large banks Holder refused to prosecute.

From the “Because why not?” department — we can report a record art auction for the second day running…

Silver Bunny Art Tweet

Yesterday, you’ll recall it was a record-setting $110.7 million for an Impressionist painting. (“Show me the Monet!” Sorry, couldn’t resist…)

Today it’s a record-setting $91.1 million for a work by a living artist — 1986’s Rabbit by the pop artist Jeff Koons.

The buyer? Art dealer Robert Mnuchin. And if the name sounds familiar, yes, there’s a relation. He’s the father of Treasury Secretary Steve Mnuchin.

Both of them had long careers at Goldman Sachs. How fitting that beneficiaries of central banks’ money-printing largesse have the means to throw down such a sum for what the author Steve Silberman calls “this dumb, trashy, self-parodic piece of kitsch… File under ‘Fall of Rome.’”

“OK, I’m getting it a little,” writes the reader who inquired yesterday about what can make tariffs problematic — prompting your editor to summon his inner Bastiat.

“So say I have domestic widgets/steel that I sell for 10–15% above the made-in-China, hauled-across-the-ocean steel. I have customers who like made-in-USA, two–three-days-delivery steel over Chinese imports.

“Now with higher import costs they (and others) buy my ‘stuff,’ and lots of it. I become the low-price leader and hire thousands!

“I don’t buy the loss of other jobs, because the steel for these other projects has to be purchased! They’re not going to not build a Trump Tower because they can’t find cheap steel.

“Help me, Obi-Wan. You are my only hope. You guys and ladies are great!”

The 5: You overestimate our wisdom. We pale in comparison to the late Henry Hazlitt, who took on tariffs and other follies in his highly readable book Economics in One Lesson. It’s easy to find a free PDF of the original 1946 edition.

All we’ll say today is that there’s no guarantee “the steel for these other projects has to be purchased.” The projects might become too costly to be worth pursuing at all. Or the managers of the projects will find other means to get the job done.

Last year we wrote about Mid Continent Nail Corp. of Poplar Bluff, Missouri — producer of about half of country’s nail supply. When steel tariffs took effect on June 1, the company lost half its business in a week.

Some of Mid Continent’s customers turned to — drumroll, please — imported nails. The 500-strong workforce was cut to less than 300.

About six weeks ago, the Commerce Department granted Mid Continent a waiver.

“All along,” reports David Nicklaus for the St. Louis Post-Dispatch, “Mid Continent has argued that it should be excluded from the tariffs because domestic steelmakers can’t supply all the steel wire it buys from Mexico.” (From its parent firm in Mexico, we’ll add for context.)

Why it took 10 months for the waiver to come through no one is saying. We know this much: “For three months after Trump announced the tariffs,” Nicklaus writes, “any objection from a steelmaker was enough to deny an exclusion request. Two steelmakers, Nucor and Mid South Wire, objected to Mid Continent’s requests.”

Anyway, Mid Continent has its waiver now. But some of the business the company lost is lost forever. “Some of those orders will never come back,” says operations manager Chris Pratt.

“Meanwhile,” Nicklaus writes, “its tariff exemption is only good for a year, so it will soon have to start the harrowing process all over again.”

Best regards,

David Gonigam

Dave Gonigam
The 5 Min. Forecast

P.S. By the way, Cato Institute scholar Daniel Ikenson suspects Commerce Secretary Wilbur Ross personally intervened to prolong the agony for Mid Continent.

Wouldn’t surprise us a bit. As we mentioned last year, Ross is both a trade hawk — and a longtime investor in the steel sector. So much for draining the swamp…</p

Dave Gonigam

Dave Gonigam

Dave Gonigam has been managing editor of The 5 Min. Forecast since September 2010. Before joining the research and writing team at Agora Financial in 2007, he worked for 20 years as an Emmy award-winning television news producer.

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