Negative Evening Trade News Ruins Thursday Rally
The stock market increased slightly on Thursday, but that doesn’t matter much because President Trump tweeted he will add a tariffs to Mexican imports. Trump’s tweets are getting more erratic by the day, making it so no investor is safe from the carnage. I thought the main issue was with China as America, Mexico, and Canada seemed to have worked out a trade deal. Alas, a trade war seems to be on the table with every country. Maybe I should take the potential for a global auto tariff more seriously. I will discuss that again in a few months when the 180 day extension comes closer to its end.
On Thursday, there was a slight relief rally from the selling pressure in May as the S&P 500 increased 0.21%, the Nasdaq increased 0.27%, and the Russell 2000 fell 0.3%. That rally is minuscule compared to the potential reaction to Trump’s latest 5% tariff on Mexico which is set to be imposed on June 10th. President Trump wrote, “Tariff on all goods coming into our Country from Mexico, until such time as illegal migrants coming through Mexico, and into our Country, STOP. The Tariff will gradually increase until the Illegal Immigration problem is remedied.”
Potential 25% Tariff On Mexico
I thought President Trump might cede ground in his battle with China because the stock market has been declining and the economy is on pace for below 2% GDP growth in Q2. However, he appears to be on the offensive with another potential trade war in the works. It’s debatable if this new tariff is legal because it’s not being done for economic reasons. However, traders are going to sell first and ask questions second. There is the potential for a 5% increase each month until it reaches 25% in October. This new trade war will increase uncertainty which will hurt capex. It will also hurt consumer sentiment.
As you can see from the chart below, the trade war with China has caused America’s imports to come from other emerging markets. In Q1, imports from China were down $17.14 billion. That’s a 14% decline from last year. The imports from other emerging markets picked up the slack, causing the net decline to be only $0.79 billion. As you can see, Mexico was the largest beneficiary of this shift. With Mexico now out of the picture, other countries will see increased demand. At this rate, America is going to run out of trade partners.
Incredible Rally In Treasuries
The rally in treasuries as a result of the trade war and weak economic reports is shocking. The 2 year yield is now at 2.01% which is 41 basis points below the Fed funds rate. It was at 2.41% in mid-April. It has been a great 6 weeks for treasuries as investors have digested the weak Markit PMI, durable goods orders, and Dallas Fed manufacturing index. The 10 year yield is now at 2.17% which is down from 2.59% in mid-April. It is now 25 basis points below the Fed funds rate as the near term part of the yield curve has inverted because investors see rate cuts coming soon. Most of the curve isn’t inverted as the 2 year yield is 16 basis points below the 10 year yield. The 30 year yield is at 2.62%. This shows us investors still think future economic growth will be positive.
It’s clear we are at a moment where sentiment is taking a severe turn. Sometimes these types of extreme moments don’t last. It depends on how trade negotiations go and what the next few economic reports say. As of now, there is a 16.7% chance of a rate cut at the June meeting. It’s very rare for rate odds to move quickly right before the next meeting occurs. It would be a big shock to see those odds increase above 50%. That will only happen if the stock market correction gets worse than 10%.
Even if the market shows there is an over 50% chance of a rate cut, I struggle to see the Fed going through with it because the Fed has never said anything about rate cuts this year, let alone one in June. Markets are anticipating a cut because of the weak data. If the Fed doesn’t guide for any cuts this year, stocks will fall like they did in mid-December. I doubt that will happen because investors are so confident a rate cut will occur soon. The chance of at least one rate cut by September is 67.5% and the chance of at least one cut by the end of the year is 89.8%.
Uber Reports Big Losses
Uber stock rose 1.76% after its first earnings report. The company reported a net loss of $1.01 billion which met estimates. Revenues were $3.1 billion which beat estimates for $3.04 billion. As you can see from the chart below, yearly revenue growth fell to 19.9%. Uber Eats increased to 21% of gross bookings. Its bookings were up 108% year over year. Operating margins increased from -35.4% to -33.4%.
The CEO of Uber, Dara Khosrowshahi, stated he likes “what we see on the competitor front in the U.S.” The competition with Lyft has been fierce and has made this a money losing business. Personally, I don’t see this report as a green shoot because if competition wanes in the next few quarters, another competitor with spring up. Also, it’s not like Uber is suddenly making money. Sales and marketing expenses were 33.6% of sales which is the highest percentage in 8 quarters. I need to see more improvement in operating margins before I declare this company investible.
Conclusion
The stock market is in trouble because President Trump is re-starting the trade war with Mexico. He plans to potentially raise tariffs to 25%. Mexico had been gaining business at the expense of China. Which country will pick up the slack for Mexico? Uber reported an okay quarter. The company is still struggling to make a profit, but the results weren’t a disaster.