How Will Monetary Policy Impact Markets Going Forward?

How Will Monetary Policy Impact The Stock Markets September 2020?With gold hitting $2,000 an ounce in recent days, coupled with the Federal Reserve’s monetary policy creating a lot of liquidity, how will markets perform for the rest of 2020 and beyond?

Based on a reading from the Federal Reserve’s minutes from its July 28 to July 29 meeting, the Fed remarked that the ongoing pandemic would continue to put a strain on the economy, slowing expansion and causing additional damage to the country’s monetary framework.

The Fed highlighted the nation’s GDP drop by 32.9 percent in the second quarter. While Q3 growth is expected to be positive, that was not quantified. Additionally, the Federal government’s debt has grown by $3 trillion since the onset of COVID-19, reaching $26.6 trillion. The release of these minutes sent stock prices downward and helped the U.S. dollar gain.

Forward guidance or communication to the general public and business owners of the Fed’s goals for inflation and unemployment target figures could be upgraded, but no time frame was given. More details on how the target range for the federal funds rate’s path would be appropriate at some point, per the Federal Open Market Committee’s (FOMC) minutes. How the target range of the federal funds rate evolves is outcome-based or based upon meeting certain economic goals before rates see further movement. For now, The Fed’s mandate is to ensure full employment and price stability.

The FOMC is expected to keep the current overnight borrowing rate between 0 percent and 0.25 percent until the U.S. economy has emerged from its current situation and on course to achieve the Committee’s maximum employment and price stability goals.

The July meeting kept short-term interest rates at near-zero because the economy is still not at its pre-pandemic economic activity levels. Given that COVID-19 has already impacted the jobs picture, the value of the U.S. dollar, and how well the economy is functioning already in the near term, the FOMC see the pandemic continuing to impact economic growth in the medium term.    

The Fed remarked that the U.S. Congress needs to pass another economic stimulus plan, especially when it comes to renewing unemployment insurance that recently expired. The FOMC meeting also noted that the Fed is not expected to purchase bonds to control yields on government bonds. However, it did speak to how it has played a role in buying bonds on the open market to support liquidity during the COVID-19 pandemic. 

The meeting also determined that bond purchases by the Fed grew by more than $2.5 trillion, increasing to $7 trillion – up from $4.4 trillion over the course of the coronavirus pandemic. While skepticism by the Fed’s FOMC members regarding the use of purchasing bonds to manipulate the government bond yield curve wasn’t given much consideration, it’s still noteworthy to explain this versus what many refer to as quantitative easing or QE.

If the Fed’s efforts to bring down short-term interest rates, the rate that banks earn on overnight deposits, to zero with no positive economic effects, another tool the Fed has is Yield Curve Control (YCC). Whatever longer-term rate the Fed has in mind, YCC would involve an ongoing campaign of buying long-term bonds to maintain rates below its target rate by increasing the bond’s price and lowering the bond’s longer-term rates.

This is in contrast to QE, where the Fed purchases a fixed amount of bonds from the open market. It’s done by central banks to increase the money supply in hopes of spurring spending and investing by Main Street. It’s an important tool that central banks rely on when rates are at or near zero. This helps banks with their reserve requirements, giving them more liquidity to provide more loans to consumers and commercial borrowers.

Quantitative Easing Considerations

As central banks increase the money supply, it can create inflation. If it does create inflation, but there’s no measurable economic growth, this can lead to stagflation.

It is noteworthy that QE and the resulting lending attempt to stimulate the economy is effective only if individuals and commercial operations take loans and use them to spend and invest in the economy.

QE also can devalue the currency. It can help domestic manufacturers export goods (because the currency is cheaper), and anything that’s imported is more expensive. Consumers are hit with higher prices for imported goods, along with domestic producers using higher-priced imported raw materials for their final products.

With the economy still facing the headwinds of the COVID-19 pandemic, the Fed has played a major role in stabilizing the economy. While the increase of liquidity has certainly provided a lifeline for the markets, the price of gold can be seen as a hedge against this liquidity – with inflation as one potential outcome. For the rest of 2020, The Fed will be ready and able to assist the markets but will leave lingering questions about the value of the U.S. and other global currencies. 

How Will the Market Price in Q2 Earnings?

The New York Fed Staff Nowcast predicts a negative 14.3 percent (-14.3 percent) growth of real GDP for Q2 of 2020 and a positive 13.2 percent growth of real GDP for Q3 of 2020. Clearly, the Fed is expecting a rebound in the second half of 2020.

This forecast, presented in the July 17, 2020: New York Fed Staff Nowcast, attributes better than expected results for industrial production, capacity utilization and retail sales data categories, resulting in the upward revision.

For June 2020, the forecast for the Industrial Production Index was 2.48, but the actual figure was 5.41. As the Board of Governors of the Federal Reserve System defines it, this index gauges the real output in the U.S. economy’s industrial sector on a month-over-month basis as a percentage change.

For June 2020, its Capacity Utilization measure was 3.54, versus the original forecast of 1.84. Coming from the Board of Governors of the Federal Reserve System, this measures the percentage of resources consumed by businesses to create goods for all domestic production.

Also for June 2020, the U.S. Census Bureau reported a figure of 7.50, compared to the forecast of 2.17, for the month’s retail sales data, on a month-over-month basis as a percentage change. It looks at the sales from more than 12,000 retailers with paid workers, including food.

While there’s no definitive way to determine how each community, state or region will be affected, the Brookings Institution did an analysis that provided interesting insight into how and why certain areas may be more impacted economically than others. It looked at sectors more prone to interruption by COVID-19, resulting in less business, more closures and layoffs. It found that areas reliant on energy and in the southern part of the country were more likely to be negatively impacted.

Brookings found that by looking at 2019 employment figures for these industries, there are approximately 24.2 million jobs that are ripe to be disrupted. Looking to Moody’s, Mark Zandi found that the following five industries are most vulnerable: mining/oil and gas, transportation, employment services, travel arrangements, and leisure and hospitality.

Conversely, Brookings found that more mature manufacturing locales, agricultural centers and already economically challenged areas are less prone to negative impacts. However, it’s noteworthy that because of the proliferation of technology, which has seen in an uptick in computer sales and IT/cybersecurity due to increased remote working and learning, the potential for a rebound will be easier.

While the COVID-19 pandemic has the world in its grip, it’s noteworthy to discuss how past pandemics and infectious disease outbreaks have impacted markets. Over the past 40 years of global epidemics, according to FactSet and Charles Schwab, there have been mixed results when it comes to the impact of disease outbreaks on market performance, using the MSCI World Index as a reference.

In June of 1981 during the HIV/AIDS outbreak, the index fell 0.46 percent during the first month; falling 4.64 percent over the three months after the start of the outbreak; and down 3.25 percent six months after the initial outbreak.

As for the 2006 avian flu outbreak, the index dropped 0.18 percent one month after the start; then the index was up 2.77 percent three months after the outbreak; and up 10.05 percent six months after the outbreak. 

Looking at these figures, it shows that more often than not, these types of events are short to medium term pullbacks, presenting investors with buying opportunities.  

According to Zacks & Nasdaq, Q2 earnings’ projections for the S&P 500 is a negative 43.7 percent, with a drop of 11 percent in revenue. While Q2 is expected to be the worse, Q3 and Q4 are expected to experience smaller, but still noticeable drops in earnings due to the coronavirus. The transportation sector is expected to decline by 152.4 percent; autos is expected to decline by 224.2 percent; and energy is projected to drop by 138.4 percent, on a year-over-year basis.

While these were some serious declines for Q2, the one bright spot was technology. The technology sector declined by only 13.2 percent year-over-year, with a drop of 1.2 percent in revenues. However, it’s noteworthy that, much like technology has seen shallow losses along with the medical sector, it’s projected that in 2021 the technology sector will earn 8.8 percent more while the medical sector is expected to grow its earnings by 12.8 percent in 2021.

The coronavirus is unique in that there’s been mass stay-at-home orders and closures. However, based on past disease outbreaks, the economy and markets generally seem to find a way to balance themselves out.

How Likely Would a Second Coronavirus Wave Negatively Impact the Stock Market?

As Johns Hopkins University of Medicine’s Coronavirus Resource Center revealed a recent increase of coronavirus cases in the Southern and Southwestern United States, the VIX ticked up. With fears of the outbreak curve not flattening, how will this impact markets?

The Volatility Index (VIX) was established by the Chicago Board Options Exchange in 1993 to gauge volatility in the financial markets. Referred to colloquially as the “fear index”, it measures the next 30 days of anticipated volatility for the U.S. Stock Market via S&P 500 options. For reference, during the peak of the 2008 financial crisis, it topped out at 89.53. During periods of relative calm, it’s not unheard of to trade below 10. On March 16 of this year, the VIX reached 82, thus demonstrating how volatile investors expected markets to be due to the uncertainty of the coronavirus.

On February 12, 2020, the Dow reached 29,551.42 and the S&P 500 rose to 3,379.45. But by the end of February, these major indices experienced their greatest fall since 2008, ushering in a market correction.

Coronavirus and its Impact on the Markets

Starting in early March, the COVID-19 pandemic began taking a negative toll on stock markets worldwide, the worst since 2008. On March 9, the Dow fell 2,158 points, or 8.2 percent, during the day’s lows. Other major U.S. markets were not spared – the S&P 500 fell 7.6 percent and the Nasdaq dropped 7.3 percent.

On March 12, the U.S. stock indices dropped more. The S&P 500 fell another 9.5 percent, along with the Dow falling 2,353 points, almost 10 percent lower. For the Dow, it was the worse one-day performance since Oct. 19, 1987’s drop, bringing it back to 2017 levels. While there was hope of a sustained rally beginning on March 13, it was dashed when the Dow Jones fell nearly 13 percent or 2,997.10 points, and the S&P 500 dropped nearly 12 percent on March 16.

Factors Contributing to the Crash

While the stock market crash in 2020 was directly attributable to the coronavirus outbreak worldwide, many experts, including the International Monetary Fund (IMF), view the coronavirus as speeding up a global slowdown that was already in the works.

Despite the St. Louis Fed’s data that showed the United States had an unemployment rate of 3.6 percent in late 2019, the nation’s industrial output peaked in 2017, and experts noticed a declining trend at the start of 2018. The IMF also believed the United States-China trade war made global growth more challenging going forward.

There were other concerning factors about economic growth domestically and internationally, causing fear a worldwide recession was beginning. March 2019 saw the U.S. yield curve inverting – which means longer-term debts yield less than shorter-term debts. The ISM Manufacturing Index fell below 50 percent in August 2019, dropping to 48.3 percent in October 2019, and remaining below 50 percent through 2019.

When it comes to rising COVID-19 cases, the state of California saw 4,515 new cases over 24 hours, as reported on June 21. Florida’s reports on June 20 and 21 saw the number of cases increase by 4,049 and 3,494, respectively. Other Southern and Western states, such as Nevada, Missouri, and Utah, reported one-day records in increases of coronavirus cases as well.

With Georgia, Alabama, Florida, and California, among others, showing concerning trends for increased coronavirus infection rates, analysts at Deutsche Bank expressed concern about how the virus may keep spreading. According to the same research, there’s some trepidation on how it may negatively impact economic growth. Depending on the overall hospital capacity to handle a resurgence in severe COVID-19 cases, how well the medical infrastructure responds will influence how the economy functions going forward.

With the number of increasing cases shifting from the Northeast to Southern and Western states, it’s feared that there will be another panic on Wall Street as reopening the economy is postponed, further stunting economic activity.

Research from Jefferies Financial Group found that even though coronavirus cases are increasing, it’s not the only or the biggest worry. Jefferies’ research found that for investors, the biggest concern is how well and how fast the economy bounces back.

Analysts believe that there needs to be more than just action by The Federal Reserve to inspire market confidence. The research found four main concerns, which included the effects of COVID-19:

  • 6.6 percent of respondents said the upcoming election is the most important factor
  • 12.1 percent of respondents said a second wave of COVID-19 is the most important factor
  • 31.1 percent of respondents said The Federal Reserve’s decision is the most important factor
  • 50.2 percent of respondents said the shape of the recovery is the most important factor

As the economy reopens and medical experts become more knowledgeable and better prepared to deal with COVID-19 through therapies and equipment for hospitalizations, it seems that investors will be taking a more holistic investing approach.

Are Dividends Becoming a Luxury During the Coronavirus Pandemic?

According to the futures market, Chicago Mercantile Exchange contracts are forecasting a drop of 27 percent in dividends over 24 months for the S&P 500 index. Dividends are projected to fall to $42.05 in 2021, a drop from 2020’s dividend of $47.55 and 2019’s high of $58.24. Looking forward to 2026, according to CME’s futures contract, the dividend is expected to recover to $56.65. While the latter years are not as likely as what’s up next, it’s worth taking note.

Although these dividend levels have already been announced, the future doesn’t look much brighter. According to Goldman Sachs, Q2 economic growth is expected to drop by 34 percent. Even though the COVID-19 economic crisis is expected to be worse, we can get an idea of how bad by comparing it to the financial crisis of 2008. From 2007 to 2009, the S&P 500 dividend dropped by 25 percent; it took 48 months to recover from this drop. Based on this historical look-back, chances are it’ll take longer to get back to par this time around.

It’s noteworthy to highlight companies that suspended their dividends in April 2020, and when they last suspended their dividends, historically speaking. Dine Brands Global (DIN) initially paused its stock-buyback program. This was followed up with a suspension of its quarterly dividend of 76 cents. Royal Dutch Shell lowered its dividend by two-thirds to 16 cents per share, the first time since 1945. These examples illustrate just how dire the economic situation is for companies around the world.    

Cash Dividends Explained

A cash dividend is money distributed to stockholders according to a corporation’s present earnings or amassed profits. Dividends are declared and issued by a board of directors that determines whether they’ll remain the same, increase or decrease. 

Understanding the Need to Reduce or Cut Dividends

A dividend cut often results in a drop in a company’s stock price since it indicates a weakened financial position. Oftentimes, dividends are cut because earnings are dropping or there’s less money available to pay the dividend, which can be due to increasing debt levels.

The point here is that dividend cuts are a poor sign for a company that is facing financial difficulties due to reduced revenue, with the same overhead still needed to be paid (rent, wages, insurance, debt servicing). While dividends can be cut for short- or long-term reasons, such as buying their own stock back or buying out another company, with the ongoing coronavirus situation the majority of businesses aren’t doing it for positive reasons.

While reducing or removing a dividend from a company’s stock can divert cash for ongoing operations or debt servicing, it also can tell the markets things aren’t going well financially. This is illustrated by looking at AT&T. In December 2000, the company reduced its dividends by 83 percent, lowering it to 3.75 cents, versus the expected 22 cents by shareholders.

One of the first signals that a company can’t pay dividends, or won’t be able to in the near future, is to look at the company’s earnings trend and its payout ratio.

Looking at a Historical Example

During the second half of the 1990s, AT&T’s stock faced more and more competitors as deregulation went into effect. According to the company’s income statements from 1998 to 2000, annual earnings per share dropped by 50 percent.  

This data is according to AT&T’s 10-K, which shows that its yearly earnings dropped from $1.96 in 1998; to $1.74 in 1999; and finally to $0.88 in 2000. With this precipitous decline in earnings and the financial pressure it put on AT&T, a reduction in dividends came next. Based on this data and some analysis, we can explain how the Dividend Payout Ratio works.

Understanding the Dividend Payout Ratio

Using this ratio can help investors gauge how likely a company’s dividend will be cut or removed altogether.

Dividend Payout Ratio = Dividend Payment per Share / Earnings per Share

Looking at AT&T’s 10-Q report for Q3 of 2000, AT&T earned 35 cents per share and gave shareholders a dividend of 22 cents a share. Based on the dividend payout ratio formula, the resulting ratio was 0.63. This ratio means that 63 percent of AT&T’s earnings were given to shareholders via dividends. When companies have challenging earnings seasons, the payout ratio gets closer to 1 because whatever the company earns is eaten up by the dividend. Therefore, the closer the ratio gets to 1, the more likely the dividend will be lowered or suspended.

While there’s no predicting what the economy will do in the future, looking at past trends can give investors insight into what companies will do with their dividends when the economy faces new headwinds.

How Will U.S. Employment Figures, Coronavirus Impact Job Markets?

How Will U.S. Employment Figures, Coronavirus Impact Job Markets?With the CARES Act (Coronavirus Aid, Relief and Economic Security) signed into law by President Trump on March 27, this set into motion major initiatives by the U.S. government in response to the coronavirus’ economic impact. This Act provides $2 trillion in financial aid to the nation, in big part to soften the impact of the coronavirus’ hit to the country’s unemployment numbers.

For the week ending April 11, seasonally adjusted jobless claims came in at 5,245,000, a drop of 1,370,000 from the April 9 revised level of 6,615,000, according to an April 16 news release from the U.S. Department of Labor.

For the week ending April 18, seasonally adjusted initial claims were reported at 4,427,000, or 810,000 fewer than the prior week’s revised level, according to an April 23 news release from the U.S. Department of Labor. April 11’s adjusted level was lowered by 8,000 to 5,237,000, down from the original 5,245,000 figure.

Taking into account the cumulative unemployment claims over the past five weeks, there have been approximately 26 million workers in the United States put out of work due to the coronavirus and the resulting economic downturn. With the employment picture facing a grim reality, the CARES Act provides many relief programs.

One part of the law provides financial relief for individuals, families, and businesses. Highlights include direct payments of $1,200 for individuals making up to $75,000, $112,000 for heads of households, and $150,000 for joint filers. Enhanced unemployment benefits also are included in the law to help those who are laid off, including contract workers.

Another way the CARES Act helps stimulate the economy is through the Paycheck Protection Program. Funded at $349 billion, this SBA-backed loan is designed to offer financial help to struggling businesses impacted by the coronavirus. A key aspect of this program is to give businesses enough money to pay at least eight weeks of payroll and related expenses to increase their chances of staying in business.

Factors for eligibility to apply for PPP loans include companies that are able to demonstrate their business has been reduced by Covid-19 and have less than 500 workers on their PPP application. Examples of eligible businesses/individuals include independently-owned franchises, contractors/self-employed individuals, tribal businesses, hotels, and restaurants. Eligible companies are able to have their loans forgiven, up to $10 million if they are borrowed from an SBA-approved 7(a) lender.  

According to the U.S. Department of the Treasury, loans may be forgivable if the following criteria are met. No less than 75 percent of the loan is to be used for payroll costs, at which payroll costs on a 12-month basis are maxed out at $100k. Other allowable loan funds, up to 25 percent of the loan proceeds, can be used to pay for rent, utilities or mortgage interest. However, if full-time staffing is reduced or if the salary is reduced by more than 25 percent for full-time employees making less than $100k per 2019’s salary, PPP borrowers may owe money back. However, if any disqualifying changes that occurred between Feb. 15 and April 16 are made whole by June 30, the loans can become re-eligible to be forgiven.

Economic Injury Disaster Loan

Another significant relief program the CARES Act provides in the way of economic relief is through the Economic Injury Disaster Loans program (EIDL). The EIDL program is generally for businesses with 500 or fewer employees, whereby the company can apply to borrow as much as $200k. Loans up to $25,000 require no collateral, and requests above $25,000 require only business assets to serve as collateral.

One significant provision of the EIDL is what’s referred to as the Economic Injury Disaster Loan Emergency Advance. This enables applicants of the EIDL to receive as much as $10,000 in relief that’s not required to be paid back, creating a de facto grant, per the U.S. Small Business Administration. Businesses can receive as much as $1,000 per employee, up to $10,000, based on the number of workers a business employs. Depending on how extensive a business has suffered economically, a maximum of $2 million can be borrowed by a business through EIDLs and/or physical disaster loans, according to the U.S. Small Business Administration.

With these and other domestic government stimulus programs, coupled with other countries implementing their own stimulus programs, it’s worth noting different potential outcomes depending on the pandemic’s severity and health mitigation factors. According to the Organization for Economic Cooperation and Development, the following are some forecasts on how Covid-19 is likely to impact the global economy:

  • While the coronavirus data from China has been questioned, the OECD says that assuming the infections from the coronavirus peak during Q1 in China, the world’s economy is expected to grow less than projected for 2020, dropping to 2.4 percent from 2.9 percent. And while China’s economy is expected to drop below 5 percent in 2020, the country is expected to exceed 6 percent growth in 2021.
  • The OECD also noted that with a pandemic lingering longer and with greater intensity throughout the Asia-Pacific region, North America and Europe, it projects worldwide growth to drop to 1.5 percent in 2020.

Only time will determine how much of an impact the coronavirus will have on global markets. Governments around the world will continue to do their part to mitigate negative impacts.

How Will Oil Prices Fare in 2020 With Global Events?

When it comes to 2020 and energy prices, the world’s energy market will face many known and unknown variables. How and what types of events that will ultimately play out are unknown but, according to industry and government experts, there are some variables that are projected to lead to lower global prices overall.

Based on a Dec. 10 short-term energy outlook publication from the U.S. Energy Information Administration (EIA), there will be a mix of pushes and pulls on the price of crude oil and associated refining products. Market prices in 2020 for Brent crude oil is expected to average around $61, compared to 2019’s $64 average price per barrel. Looking at West Texas Intermediate (WTI) quotes, the EIA sees this type of crude settling, on average, at about $5.50 per barrel lower than Brent crude oil in 2020. The EIA bases its lowered price forecast on greater supplies of oil globally, especially in the first half of 2020. 

The agency’s data shows that in September 2019, America exported more than 90,000 net barrels per day of products from and crude oil itself. This is coupled with domestic export projections of 570,000 net barrels per day in 2020, in contrast to average net imports of 490,000 barrels per day in 2019.

According to EIA’s projections, U.S. crude oil production will grow by 900,000 barrels per day in 2020, compared to 2019’s production, resulting in 13.2 million barrels of daily production in 2020. This growth is compared to 2019’s production gains of 1.3 million barrels per day, and 2018’s 1.6 million barrel per day growth. The decrease in production, attributed by the EIA, is due to increased rig efficiency and well level productivity, despite the number of rigs dropping.

The EIA believes that OPEC and its “+” oil producing states will go beyond announced oil production cuts on Dec. 6, further cutting production through March 2020. The original cuts of 1.2 million barrels per day, announced in December 2018, have been modified to reducing production to 1.7 million barrels per day. The EIA expects the major global producers to keep production curtailed through all of 2020, due to increasing global oil inventories.

Fuel Standard’s Impact on Oil Prices

Through implementation of the International Maritime Organization (IMO), Jan. 1, 2020, is ushering in new standards for allowable levels of sulfur in bunker fuel. This fuel will be required to contain no more than 0.5 percent sulfur content, compared to current allowable levels of 3.5 percent of the bunker oil’s weight. In reaction to the new standards, the EIA expects American refineries to increase operations by 3 percent in 2020 versus 2019’s production. It’s expected to increase wholesale margins in 2020 to 57 cents per gallon, on average, with it spiking to 61 cents per gallon. This is compared to 45 cents a gallon in 2019.

The Federal Reserve and Oil Prices

According to the Dec. 11, 2019, FOMC statement from The Federal Reserve, there was no modification to the federal funds rate. They based their decision on a yearly measure for inflation, excluding food and energy, along with signs of continued economic expansion, including healthy job creation and continued high rates of employment. However, the Fed indicated that if its goals of fostering a growing economy, maintaining a healthy job market and a 2 percent inflation target fall short, it will take appropriate action to keep supporting economic expansion. Depending on the Fed’s action to lower, increase or maintain its rates, the price of oil would feel the impacts.

While there’s no telling how fiscal policy and geopolitical events will play out in 2020, it looks like the price of oil will head south.

What Would a Phase One Deal with China Encompass?

The so-called phase one of a trade deal with China is expected to contain a provision for $40 billion to $50 billion in purchases of American agricultural products by China, according to an October news release from U.S. Sen. John Hoeven (D-ND) With ongoing discussions surrounding the US-Sino trade talks, there are rumors for such a partial trade deal. But how has the recent past impacted both countries’ economies and a mutual desire for better trade deals?

While not directly related but announced during a similar time frame, a November press release from the United States Trade Representative (USTR) announced Chinese acknowledgment and acceptance of American poultry exports. This stated that China will now accept $1 billion in American poultry and related poultry products, effectively reversing China’s ban.

After a December 2014 avian influenza outbreak, China banned US poultry in January 2015. America exported more than half a billion dollars of poultry to China in 2013, and there has been much interest in restarting exports to China since August 2017. With the USTR citing U.S. poultry exports of $4.3 billion in 2018, this will undoubtedly ensure America maintains its position as the globe’s second biggest poultry exporter.

According to a late October press release from the USTR, there will be a 30-day comment period in November to garner public opinion on continuing tariff exemptions on certain Chinese goods, worth approximately $34 billion. The items currently exempt are set to reverse exclusion on Dec. 28. Additionally, as part of phase one discussions, the United States is expected to not implement tariffs scheduled to take effect on Dec. 15, along with rolling back existing tariffs in stages.

Trade War’s Impact

According to BNP Paribas Wealth Management, the trade impasse between the United States and China has had a measurable negative impact on the world’s economy. BNP cited a 1.2 percent point reduction in growth over the past 1.5 years.

However, the phase one deal is expected to include many provisions, such as $40 billion to $50 billion of US farm product exports to China, along with $16 billion to $20 billion of Boeing aircraft for commercial use to China.

Financial institutions outside of China will be able to establish insurance companies in mainland China, financed by ex-China investments, along with being able to hold shares in the newly created entities. Ex-China lending institutions will be able to create wholly owned banks and conduct business in the Yuan or Renminbi (RMB) currency throughout mainland China without explicit approval from Chinese officials.

These developments, according to the Chinese State Council and China Banking and Regulatory Commission and CNBC, are part of the ongoing discussions to determine how China will increase IP protection and the aforementioned agricultural purchases. Announced on Oct. 11, 2019, the China Securities Regulatory Commission will work on lifting limits on ownership ceilings for ex-China entities, specifically in mutual funds, securities and futures operating in China.

BNP also mentions expectations of Dec. 15, 2019, tariffs to not be implemented, along with expectations for existing tariffs to be relaxed or reduced. In addition to giving American farmers increased sales, this will provide China with more soybeans for domestic consumption, including an ability to help increase the number of the country’s pork livestock population through feedstock. If phase one is agreed to, it’s also expected to help the RMB appreciate. Based on recent data, the RMB has appreciated by three percent since September 2019.   

One noteworthy item that depends on a phase one deal being certified is the expectation that it will positively impact the global economy. The International Monetary Fund dropped its World Economic Outlook gross domestic product projection from 3.2 percent in July 2019, down to 3.0 percent, based on the current trade tensions.

Since there’s great hope for a phase one deal that will encourage mutual and global economic development, there’s confidence that both countries facing economic hardships will find a short-term resolution.

How Will Ongoing China Trade Tensions Tensions Impact Consumer Spending?

China Trade Tensions 2019According to the U.S. Department of Commerce and the U.S. Census Bureau, retail sales came in at a negative 0.3 percent for September, even though it’s still 4.1 percent more than September 2018’s report. The same report followed up on August 2019’s numbers, with a revision by the agency to 0.6 percent, up from 0.4 percent. With the ongoing U.S.-China trade war and tariff uncertainty, how will consumer spending be impacted?

Current State of Trade and Tariffs

With phase one agreed to, at least in principle, at the end of the meeting with Chinese Vice Premier Liu on Oct. 11, President Trump agreed to keep tariffs at 25 percent on $250 billion in Chinese imports, instead of increasing the tariffs to 30 percent. Additional tariffs also are threatened to be imposed on Dec. 15 for other goods, depending on future negotiations. However, by then the fourth quarter will be nearly completed, so this will probably lessen the likelihood of reduced U.S. consumer spending during the holiday shopping season.

According to an Oct. 3 press release, the National Retail Federation (NRF) projects that consumer purchases for the 2019 holiday season will come in between $727.9 billion and $730.7 billion. The current holiday spending is projected to grow between 3.8 percent and 4.2 percent compared to 2018. It’s important to note that the NRF’s 2019 projections don’t include restaurants, auto dealerships or gas stations. And the projections are higher despite an average retail sales growth of 3.7 percent over the past five years.

The NRF says that along with interest rate and global economic concerns and a politicizing of the economy, trade is an equally concerning factor for retail sales.   

As the Office of the United States Trade Representative (USTR) announced an additional 10 percent of tariffs on $300 billion in Chinese imports, effective Sept. 1, the NRF explained that consumer confidence was shaken. A September 2019 NRF survey found that 79 percent of retail shoppers were worried that tariffs will increase the prices of goods they would be buying.

With the USTR reporting on Aug. 23 that $112 billion of Chinese imports will face tariffs of 15 percent, up from 10 percent, on Sept. 1, the NRF explains how it impacts consumer items, especially footwear and apparel. The NRF gives a few examples of how consumers, specifically football fans, will be impacted negatively.

Footballs made in China are now subject to 15 percent tariffs, no longer 10 percent. While sweatshirts, T-shirts and jerseys (for football and all professional sports teams made in China), are subject to a 15 percent tariff – this is still a sizeable cost increase. If these were subject to 25 percent tariffs, research by the Trade Partnership done for the NRF found that it would cost U.S. consumers $4.4 billion extra for this type of apparel.

While it hasn’t happened yet, the $160 billion of Chinese imports currently subject to 10 percent tariffs are expected to be increased to a 15 percent tariff on Dec. 15. While it’s still expected to be implemented at the tail end of Q4, any effects will naturally be felt in 2020.

While there’s no way to determine how tariffs will impact retail sales officially calculated, consumers will certainly take a second look at prices whether or not they make a purchase.

Will China’s Recent Soybean Purchase Begin Thawing the Trade War?

China's Recent Soybean PurchaseWith the United States Department of Agriculture’s Foreign Agriculture Service announcing a purchase of 204,000 metric tons of U.S. soybeans by private Chinese importers, there are hopes that the trade war is beginning to dissipate.

Seeing that the last significant purchase of U.S. soybeans by China was in June, professional traders see the September acquisitions as a potential weakening of the U.S.-China trade war. With the USDA’s Foreign Agricultural Service announcing more than 600,000 tons of U.S. soybeans purchased by private Chinese operators on Sept. 13, 16 and 17, there are signs of positive movement between the two nations.

The shipments are expected to leave between October and December from ports in the Pacific Northwest. Looking at the Chicago Mercantile Exchange, soybean futures hit monthly highs on Sept. 16. Coupled with November futures contracts well off their lows, this shows renewed promise. The purchase of soybeans is part of China’s gesture of goodwill to buy other agricultural products, such as pork, during ongoing trade negotiations.

These recent developments are important because China increased tariffs on American soybeans by 25 percent in July 2018 in response to the Trump Administration’s tariffs. On Sept. 1, 2019, U.S. soybeans were subject to another 5 percent in import tariffs by China.

The Context of Soybean Sales

Based on data from the United States International Trade Commission (USITC), there was a drop in soy exports from the U.S. to China to $3.1 billion, or 18 percent of U.S. soybean exports for 2018.

The 2018 U.S. soybean export figure to China represents a drop of 75 percent, compared to 2017’s U.S. sales exports of soybeans worth $12.2 billion to China. The large drop in 2018 is also noteworthy against U.S. exports of soybeans to China in 2016 of $10.5 billion. This drop was directly attributable to trade tensions.

It’s important to note that soybeans are America’s biggest agricultural export (16 percent of all agricultural exports) – $20.9 billion annually on average between 2014 and 2018. With China importing more than 50 percent of U.S. soy over the past 60 months, it illustrates why the trade war has been so impactful. In response to the sharp drop in exports to China, 2018 began the quest for U.S. growers of soybeans to counteract the $9.1 billion drop in soy exports to China by finding new buyers in Mexico, the European Union and Egypt.

Similarly, as the Congressional Research Service points out, trade talks are working toward building upon an existing $12.9 billion of U.S. agricultural exports to Japan, as of 2018. Current talks have expectations for an additional $7 billion in U.S. agricultural exports to Japan. Soybeans, along with dairy, wine, beef and pork, are examples of agricultural imports Japan is willing to buy, based on soon-to-be released details from finalized U.S.-Japanese trade talks.  

However, despite maintaining a competitive or even subpar price against competitor nations such as Brazil, it didn’t sway the Chinese to buy more American soy. Much like American farmers and with China’s state-influenced help, there may be long-term, structural changes for future Chinese soybean purchases even if trade tensions subside. However, China also has established new suppliers of soybeans from Ukraine, Kazakhstan and Russia.

While many do expect a trade deal between the United States and China, there could very well be structural and long-lasting changes on how both countries conduct trade for years to come.

How Will Tariff Developments Impact the Stock Market Going Forward?

According to an Aug. 13 press release from the office of the United States Trade Representative (USTR), there will be a 10 percent tariff levied against $300 billion of Chinese imports effective Sept. 1. The same press release announced a modification, after hearing from the public and business owners, exempting some of the $300 billion in Chinese imports from the 10 percent tariff until Dec. 15.

Items Subject to the 10 Percent Tariff on Sept. 1

Highlights from the USTR’s list include select types of coffee, fruit, vegetables, insects and bees. Along with dairy products, livestock such as sheep, horses and goats are subject to the 10 percent tariff.

Items Subject to the 10 Percent Tariff on Dec. 15

The USTR pointed out that many of the items recently exempted include consumer goods such as computer displays, select shoes and clothes, LED lamps, slide projectors and playing cards. Other items on the list include notebooks, video game systems, toys, snowshoes and parts, fishing rods and reels, paint rollers and microwave ovens.

2019 Forecast

When it comes to industry experts and associations, it looks like there will be limited impacts from the trade spat between the United States and China, coupled with pressure from government shutdown in the beginning of the year. According to the National Retail Federation (NRF), 2019 is expected to see an increase in spending between 3.8 percent and 4.4 percent – or more than $3.8 trillion.

Initial figures per the NRF detail that retail sales for 2018 increased by 4.6 percent, outpacing the organization’s growth expectations of 4.5 percent. 2018’s figures are compared to 2017’s of $3.68 trillion in retail sales. 2018’s estimates factor in a 10 percent to 12 percent increase in online sales, which is also expected for 2019. One caveat for these projections by the NRF is that it doesn’t include dining, gas stations or auto dealers. GDP is expected to grow about 2.5 percent over 2019.

The NRF explained that due to lower energy costs, specifically tame retail gas prices and low interest rates, there should be minimal negative consumer impact. However, the NRF cautions that while the retail industry has been able to cushion the 10 percent tariffs, if tariffs increase to 25 percent, it will have a greater impact on consumers’ costs and retailers’ profitability.

Based upon recent developments, business earnings will face greater challenges. According to the United States Trade Representative’s Aug. 23 press release, tariff rates for $250 billion worth of Chinese imports currently subject to a 25 percent tariff rate will increase to 30 percent effective Oct. 1. For the $300 billion in Chinese imports described above, those going into effect Sept. 1 and Dec. 15, instead of being subjected to a 10 percent tariff, each batch will be subject to a 15 percent tariff rate.

With the Congressional Budget Office (CBO) forecasting a drop in the United States’ gross domestic product (GDP) by 0.3 by 2020, Daniel Fried explains that there’s no doubt the U.S.-China trade tensions have and will take a toll on the economy. Fried explains how they’ll affect consumer spending and business expenditures:

  • The initial impact is that consumers and businesses will have a lowered purchasing power.
  • The next impact is that businesses will either slow or decide to divert investments elsewhere, such as realigning their supply chains to mitigate the tariff impacts.
  • There’s also concern that while businesses may lose international business, that might be offset by domestic consumption.

With Fried and the CBO projecting the mean income for households will be reduced by $580 by 2020, based on 2019 purchasing power, it’ll certainly make consumers think twice about where and how to allocate their spending. This will likely take a toll on companies’ sales figures and likely future earnings reports.