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The New NAFTA: "USMCA"

As usual, the politics and drama surrounding the deal was more interesting than the final agreement, which must be passed by Congress in the months ahead. If the Dems win the House, parts of it may be challenged so Trump cannot gloat about his success. The changes to NAFTA are not as significant as the new acronym.

The deal will have an inflationary impact.

Autos:

My main observation is that the rules of origin, which will be phased-in over time, call for 75% North American content, compared to 67%, and minimum salary of $16.00/hr. This will definitely increase the cost of autos as the terms take effect.

Dairy:

US milk producers get moderately improved access to the Canadian market over time, and the Canadian producers’ loss will be covered by a subsidy from the Federal Government. The US feeds growth hormones and antibiotics to their Dairy herds, which is illegal in Canada. I hope Canada has not abandoned this policy. Both countries overproduce milk by very large quantities. A better free market solution would be to shoot 9 million cows and reduce prices.

Steel & Aluminum Tariffs Remain:

The Trump tariffs on steel and aluminum for National Security reasons is insulting, and disappointing that they remain in place.

Interest Rates:The Fed just raised the Fed Funds interest rate for the eighth time to 2.25% from 2.00%. The Fed Funds rate is the interest rate negotiated by deposit taking institutions between each other. The Prime rate is the rate charged  for highest rated credits, and is now 5.25% after this increase.

The Bank of Canada is expected to raise interest rates now that the NAFTA negotiations have been settled.

The yield on the 10 year US Treasury bond is 3.05%, and on 10 year Canada bonds is 2.46%. The S&P 500 Index yields 1.85%, so equities are becoming less attractive on a yield basis. The Fed is promising one more increase in December and at least 2 more in 2019. This means the Fed funds rate is expected to be around 3.25% and the US prime rate at 6.25% by mid-2019.

The withdrawal of monetary stimulus and higher interest rates is bound to take its toll on equity values, as higher rates cause the P/E ratio to decline, and economic growth to slow. Investors typically start moving towards the exit under these conditions.

The role of cash in a portfolio:

Cash is a dynamic asset in a portfolio. It reduces volatility, and increases in value during a falling stock market. Being fully invested in a collapsing stock market is a terrorizing storm, while cash is like a full candy jar. The markets are optimistic about the bump to earnings from the recent tax cuts. But this is a non-recurring event, which has an expiry date, perhaps sooner than expected. The US fiscal deficit is unsustainable, unless increasing the National debt to $40 Trillion is deemed acceptable.

 

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WealthNotes

The Federal Open Market Committee (FOMC) reduced the central bank rate by 0.25% yesterday. The Dow closed down 334.75 points (1.22%) which reflects the disappointment that the cut wasn’t 0.50%, with promises of more stimuli to follow.

The market fully recovered that loss early today but Trump’s announcement of additional tariffs of 10% on over $300 Billion of Chinese exports caused that gain to evaporate to a loss of another 280 points (1.04%).

The FOMC is walking a delicate tightrope. If they had made a bigger cut and promised more stimuli, investors would have interpreted that as confirmation that the economy is in worse shape than is understood.

The question period after the announcement was an amazing display of circumlocution. I found it quite understandable because the US economy has some pockets of weakness that are concerning but the indicators are not universally bad.

I will give them the benefit of the doubt for the time being but I suspect that the 20% market decline in late 2018 increased pressure from Mr. Trump to cut rates. Trump does not want a strong US currency or falling markets.

He has been trying to talk down the US currency.

The European and Asian economies are clearly in a slowdown, which will impact the US in due course. This cut in rates could be the FOMC’s response to the risk from external weakness. The European Central Bank is promising to join in with more stimuli. Their rates are already negative, which is killing the European banks.

The FOMC denies that more cuts will be automatic unless the economy needs more help. I don’t believe that statement, because there has never been just one cut and done through history.

They seem to be trying to get out of the way of the financial markets, rather than promise to come to the rescue of investors if markets decline. This is probably the most important message because investors have been rescued from falling markets since 2009 and have been expecting this to continue.

Currently, short-term bond yields, have fallen below the Fed’s new rate. Clearly, the bond market is anticipating more rate cuts.

All-in-all, the rate reduction is not meaningful. In the meantime, we are implementing a significant adjustment to our portfolios with the expectation the change may provide a solid gain over the next few months.  There is no guarantee of course but it is a strong likelihood.

Sincerely

Bruce Sansom

 

 

 

 

 

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Investment Wisdom

WealthNotes

WealthNotes

The Federal Open Market Committee (FOMC) reduced the central bank rate by 0.25% yesterday. The Dow closed down 334.75 points (1.22%) which reflects the disappointment that the cut wasn’t 0.50%, with promises of more stimuli to follow.

The market fully recovered that loss early today but Trump’s announcement of additional tariffs of 10% on over $300 Billion of Chinese exports caused that gain to evaporate to a loss of another 280 points (1.04%).

The FOMC is walking a delicate tightrope. If they had made a bigger cut and promised more stimuli, investors would have interpreted that as confirmation that the economy is in worse shape than is understood.

The question period after the announcement was an amazing display of circumlocution. I found it quite understandable because the US economy has some pockets of weakness that are concerning but the indicators are not universally bad.

I will give them the benefit of the doubt for the time being but I suspect that the 20% market decline in late 2018 increased pressure from Mr. Trump to cut rates. Trump does not want a strong US currency or falling markets.

He has been trying to talk down the US currency.

The European and Asian economies are clearly in a slowdown, which will impact the US in due course. This cut in rates could be the FOMC’s response to the risk from external weakness. The European Central Bank is promising to join in with more stimuli. Their rates are already negative, which is killing the European banks.

The FOMC denies that more cuts will be automatic unless the economy needs more help. I don’t believe that statement, because there has never been just one cut and done through history.

They seem to be trying to get out of the way of the financial markets, rather than promise to come to the rescue of investors if markets decline. This is probably the most important message because investors have been rescued from falling markets since 2009 and have been expecting this to continue.

Currently, short-term bond yields, have fallen below the Fed’s new rate. Clearly, the bond market is anticipating more rate cuts.

All-in-all, the rate reduction is not meaningful. In the meantime, we are implementing a significant adjustment to our portfolios with the expectation the change may provide a solid gain over the next few months.  There is no guarantee of course but it is a strong likelihood.

Sincerely

Bruce Sansom

 

 

 

 

 

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