Friday 22 February 2019

Paul Sommerville: Trump's governance shows why he's a serial bankrupt

Outgoing economic adviser Gary Cohn listens as US President Donald Trump speaks during a cabinet meeting at the White House last week Photo: Reuters
Outgoing economic adviser Gary Cohn listens as US President Donald Trump speaks during a cabinet meeting at the White House last week Photo: Reuters

Paul Sommerville

Donald Trump has had a bad week, global markets or Gary Cohn not so much. One month ago world markets suffered a disquieting volatility event, with the main world stock indices falling between 10 and 15pc in a four-day period.

Two weeks ago, although not as intense, we saw a renewal of this volatility with more wild swings.

Ultimately, however, the USA bourses have recouped at least half of the losses. European and Asian indices have recovered also, but in a somewhat more muted fashion. This week, despite the news flow seeming more dramatic, the price movements have been more subdued in comparison.

Trump, after being rebuked by the Swedish Prime Minister during a joint press conference for his new trade tariff policy, learnt the news that he is likely to be sued by Stormy Daniels, the "adult entertainment" star.

If the US President admits being a party to an agreement that paid Daniels to stay quiet (the "hush agreement") the Federal Election Commission may view it as a violation of campaign finance law.

Later the same day he was forced to accept the resignation of Gary Cohn, the director of the National Economic Council and his chief economic advisor.

Cohn joins a very long line of team members that have either quit or been removed. His departure has been coming for some time. His jump from Goldman Sachs Group to Donald Trump's administration helped him unlock more than $284m in pent-up bonuses, stock holdings and other investments through the Wall Street bank.

He will now be able to access this cash, possibly tax free, through the special break available to rich people picked to join the government, which lets them cash out and defer their capital gains taxes indefinitely.

His final straw came with the Trump announcement that he plans to impose 25pc tariffs on steel and 10pc tariffs on aluminium imports, setting off fears of a trade war.

However, this is not about steel, per se, and it is not about a global trade war but is more likely an attack against China's predatory trade behaviour.

This is why Canada and Mexico are exempt indefinitely. Nearly 17pc of steel imported into the US comes from Canada.

In 2017, China was responsible for more than half of the world's steel production, some 800m tonnes, and has an excess capacity of more than 300m tonnes per year.

Aluminium is similar. China has increased its production from 10pc in 2000 to more than 55pc of the global total. China subsidises its inefficient and grotesquely indebted state enterprises to dump abroad at any price, even at a loss.

If the US President was only looking to boost domestic metals capacity then allowing the number one (Canada) and number four (Mexico) exporters to the US to continue does not make much sense.

Some 88pc of Canadian steel exports went to the US in 2016. The same is true for 75pc of Mexican steel.

His aim is an attack on Chinese trade policy. Tariffs are an extremely poor way to apply policy but Trump is a simple man and is not particularly bothered by details. He believes these policies will be very popular among his core supporters. Above all he believes that by acting tough he may eventually receive a fairer deal on trade policy for the USA in all future negotiations.

The USA steel and aluminium industries are tiny in employment terms and any jobs created will easily be offset by a multiple loss of jobs if manufactures are forced to pay higher prices for their components. The American Institute for International Steel, a pro-trade advocacy group, says about 142,000 Americans work in the steel industry. But the institute says about 6.5 million Americans are employed by steel-consuming companies. Some of those jobs would be at risk, for example in the auto industry.

Also he must expect retaliation. The EU has already announced a list of potential products and seems to be focused on Bruce Springsteen fans for their inspiration. They are targeting Harley Davidson, Levi and bourbon whiskey.

However, Trump and his team are missing one vital point. Alongside its current account deficit (it imports more than it exports), that Trump is so irked about, the USA is also running a large fiscal deficit or government budget deficit.

This occurs when a nation's expense exceeds its revenues. It needs to be financed by issuing bonds. While currently the biggest buyer of these bonds is their own US treasury department through quantitative easing, this programme is coming to an end.

The Chinese are one of the biggest external buyers and their role will become even more vital. The 2018 deficit total could exceed $1trn for the first time ever.

Trump believes he is in a strong position as the US is the biggest consumers for the world's exports but he fails to appreciate his position is weak.

Any indication of a reluctance to continue to buy US treasury bonds by the Chinese will send bond yields higher and the US economy into a tailspin. It is very easy to see how Trump is a serial bankrupt.

His wish to promote more fair and reciprocal trade for the USA has some validity and if he sticks to this he may win some success but picking a major fight with the Chinese would be a huge mistake.

The markets this week, despite the headlines, have taken this "trade war" news very calmly as they are betting that even Trump cannot be that stupid.

Exxon Mobil - A valuable lesson for investors

Stock and pension investors would be wise to disregard the "Trade War" headlines and concentrate on the drivers of price action.

All movement and volatility in the last month came from the rise in bond yields and the prospects for higher inflation. The market did not fall this week, despite prospects of a trade war.

Eighteen months ago we advocated selling out of Exxon Mobil shares, to our subscribers, when the stock was trading at $94.50. The share price is currently down 22pc from this level while the oil price is up 50pc. The general market is also substantially higher.

Everything that could go right for this stock seemingly has. There has been huge rise in the oil price, a reported acceleration in the global economy, a massive rise in the stock market. Yet the shares are down 22pc.

This should be taken as a valuable lesson. Many stocks in this market place are so highly valued that they can move substantially lower regardless of the news on the overall economy.

High dividend, low-growth companies are trading at very expensive price-to-earnings ratios. It does not take much for them to trade lower.

Stocks of this nature can and will be re-rated lower if bond yields continue to climb. Any long term portfolio holder should be aware of this and any stocks of this nature should be rooted out or at least evaluated more closely. There are plenty of better places to invest.

I expect the US economy to slow towards recession late next year, but even if you have a more optimistic view, higher bond yields mean the composition of your portfolio should alter before any re-rating of similar stocks may occur.

Paul Sommerville is CEO and head of advisory of SAM.

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