EXPORTS’ IMPORT

This short Bloomberg article caught my attention:

World Trade Wobbles With Trump Tariffs Impeding Global Momentum

Global trade volumes fell for a second month in March, as President Donald Trump moved forward on threats to slap protective tariffs on imports.

The decline of 1.2 percent followed a downwardly revised 0.7 percent drop in February, the Dutch Bureau for Economic Policy Analysis said Friday. While the number can be volatile, it marks the first back-to-back fall in four years.

As noted when Markit’s flash PMIs were released last week (here), export orders are weak across the world. This is pretty odd when world economic growth is reasonably strong. JPM’s New Export Orders PMI has not been that weak without a similar weakening in total PMI readings.

The CPB World Trade Index is still up 5% YoY but new export orders rapidly falling near the 50 neutral level is worrisome. The latest World Trade Outlook Indicator released on May 17 is at 101.8, only slightly above the baseline value of 100 and below the previous value of 102.3, which

suggests continued solid trade growth in the second quarter of 2018 but probably at a somewhat slower pace than in the first quarter. The recent dip in the WTOI reflects declines in component indices for export orders in particular but also for air freight, which may be linked to rising economic uncertainty due to increased trade tensions. (WTO)

Note that the WTO’s own export orders index dropped sharply last month, falling from an above-trend plateau to a below-trend value (98.1) in the latest month.

(…) automobile sales (97.9) and agricultural raw materials (95.9) are currently weighing down the WTOI. In contrast to the mixed results elsewhere, the index for electronic components trade (104.2) has turned up, climbing above trend.

The WTO’s Export Orders index is down 3.8% YoY in March but it has cratered at a 15.6% annualized rate in the last 3 months! It looks like the “increased trade tensions” are having an immediate impact on exports. Importers and exporters actually cannot be certain of their eventual landing costs, let alone knowing whether they are allowed to import/export certain things from/to certain countries.

This is not a moot point. Trends in new orders are the most vital stat for any business, dictating not only the sales or production profile immediately ahead but also the medium term plans for purchasing, hiring, general spending and capex. Exports account for 12% of the U.S. economy, but nearly 30% of world GDP, 44% of the Euro area GDP and 28% of East Asia & Pacific countries GDP  according to the World Bank. So far, the downtrend in new export orders has been offset by positive trends in domestic orders, particularly in the U.S., as Markit’s flash PMI surveys for May revealed:

• USA: Another strong upturn in new business volumes helped to boost output growth in May. Survey respondents commented on resilient domestic demand and a supportive economic backdrop. (…) May data revealed relatively strong rises in both manufacturing production and incoming new business, which survey respondents attributed to improving economic conditions and a continued recovery in domestic sales.
• Eurozone: Inflows of new business likewise grew at a reduced pace, the rate of increase waning for a fifth successive month to reach the lowest since October 2016. Nineteen-month lows were seen in terms of both manufacturing and service sector new business growth. Reduced new order inflows in the goods-producing sector were linked in part to weaker export growth, which registered the smallest rise since August 2016.
• Germany, Europe’s uber-exporter: Total new business in Germany’s private sector rose at the slowest rate for almost three years in May. The service sector saw inflows of new work increase only modestly, with the pace of growth easing for the fourth time in as many months to the weakest since June 2015. New order growth in the manufacturing sector was solid by comparison, albeit with the rate of increase also easing further from the highs in 2017 as new export sales growth continued to soften.
• Japan: New order growth softens to nine-month low with export orders almost at a standstill.
• China: China’s May PMI will be release June 1. The Financial Times China export index fell to 54 in April, its lowest level since August 2016 (52.5) as respondents reported a gloomier outlook and slower volume growth.

This chart plots industrial production for the U.S., the Eurozone and Japan indexed to 100 in January 2008. The U.S. is 2.0% above its peak of 10 year ago having just recently recovered from the 2015-16 oil drilling slump. The Eurozone IP is still 3% lower than its 2008 peak and recent PMIs are suggesting a rollover. Japan seems to have permanently lost 10% of its industrial markets showing little signs of a breakout from its rather flat trend since 2010. The world is clearly not on a solid growth footing.

Only a few months ago, the world seemed in a solid synchronized growth. Suddenly, economic data from G10 countries slumped:

Leading indicators turned down most everywhere as these charts from the OECD demonstrate:

Except in the USA:

Domestic demand in the U.S. is being boosted by tax cuts, rising government spending and increased oil drilling activity, making the USA the only large country with sustained GDP growth rates in 2018. Although positive surprises are also getting fewer there as well:

Obviously, slower exports are negatively impacting world economies with the U.S. being much less affected so far. However, the U.S. government’s soaring indebtedness coupled with Americans’ extraordinarily low savings (i.e. high debt) right when the Fed is firmly on the hiking trail will eventually dampen growth there as well. (LIBOR’S LABOR. Also, read this with Lacy Hunt for more on that from a master).

In the meantime, the U.S. dollar is also heading up as a result of America’s relatively strong economy. This is adding more pressures on Emerging Economies saddled with high sovereign and corporate debt in USD (EMERGING SUBMERGING). Given the strong probability that the U.S. economy keeps outperforming most other economies and that the Fed stays on its well publicized hiking trail, the USD could well be on a sustained upswing. Good for U.S. inflation but very damaging for EM borrowers.

Maybe, the “increased trade tensions” will soon abate. Who knows with this flip-flop administration? They better abate because, even though there have been, so far, a lot more words than real actions, their impact on trade and inflation are nonetheless already significant on supply chains and costs as the recent PMI surveys revealed:

• USA: May data revealed a sharp and accelerated rise in operating expenses across the private sector economy. The latest increase in average input prices was the fastest since July 2013. Anecdotal evidence mainly cited higher prices for metals (especially steel) and increased oil-related costs during the latest survey period. Service providers signalled a robust and accelerated increase in their average cost burdens in May. The rate of input price inflation was the steepest for three months, which firms linked to higher oil-related costs and rising commodity prices. (…) latest data signalled intense pressure on supply chains, with average lead-times lengthening to the greatest extent since the survey began in May 2007. Manufacturers widely commented on stretched supplier capacity and logistics delays during the latest survey period. Robust demand for raw materials and rising commodity prices resulted in another steep increase in input costs across the manufacturing sector.
• Eurozone: The surveys nonetheless continued to provide anecdotal evidence of business being constrained by shortages of both raw materials and labour in some countries. Such constraints were also indicated by a further marked lengthening of supplier delivery times and rising backlogs of work.
• Japan: there was further evidence that supply-side constraints may be impacting output potential, as material shortages contributed to the greatest lengthening of delivery times in seven years. Consequently, input prices soared at the fastest pace in 52 months.

Corporate USA may be blessed to be operating in the best market but costs are nonetheless clearly rising faster in the U.S. (“sharp”, “robust”, “accelerating”, “intense pressures”).

For investors, all this means that dark swans are lining up. Some are already visible but still do not look too mean on the average, such as rising interest rates, oil prices and freight costs. The more dangerous swans are hidden behind currently sharply higher profits:

• Rising operating costs (raw materials, labor, logistics).
• Trade tensions morphing into wars.
• The U.S. consumer rebuilding its savings (i.e. deleveraging) or strangled by higher inflation.
• EMERGING SUBMERGING

Smaller cap stocks have been outperforming lately, investors probably sniffing rising risks among multinational companies and seeing smaller domestic companies as potentially more insulated from trade tensions. But various stats and surveys reveal that smaller companies have their own rising issues:

• Their operating costs are also rising with seemingly fewer offsetting avenues.
• Small cap USA is highly indebted (TOPSY CURVY: SMALL IS NOT THAT BEAUTIFUL)…
• …and very sensitive to the indebted American consumer, the ultimate payer at the end of the supply chains impacted by trade tensions (e.g.: lumber, steel, aluminum, oil).

It is rather interesting to see how small caps margins have trended down since 2013 with the recent bump up due to tax reform still leaving small caps margins much lower than those of mid and large cap companies as this chart from Ed Yardeni illustrates:

Relying on forward estimates for small cap companies has been a highly perilous exercise. The downward trend appears to be resuming: