Let’s take a look at some of the recent top stories and their implications on the market.
By Kris Rosemann
Brexit negotiations continue to be a messy ordeal for British Prime Minister Theresa May and her countrymen. The EU (VGK) rejected her most recent proposal without proposing counteroffers, and if there is no agreement, there will be no transition to keep the UK (EWU) and its businesses from being stuck in a sort of trade policy purgatory. May has been quoted as saying, “No deal is better than a bad deal,” as well as, “No one wants a good deal more than me.” A good deal would assure frictionless trade in goods and would not disrupt any intertwined supply chains multinational businesses have in each camp. Disputes over the Irish border have also helped lead to the impasse, and the British pound continues to face pressure as uncertainty persists heading towards the March 2019 deadline.
Across the pond, Walmart (WMT) is commenting on the impact of President Trump’s most recent round of announced tariffs against China, and the company reportedly petitioned the White House not to pursue additional tariffs on select Chinese goods as it would have a negative impact on American consumers. “The immediate impact will be to raise prices on consumers and tax American business and manufacturers,” Walmart said. Rival Target (TGT) added similar commentary, and Walmart went on to say, “Either consumers will pay more, suppliers will receive less, retail margins will be lower, or consumers will buy fewer products or forego purchases altogether.”
The dilemma at Walmart will undoubtedly impact a large number of US consumers as the retail giant has a reputation for low prices and controls 10% of the US retail market with a stronghold in low- to middle-income consumers. It is hard to imagine a scenario in which the company decides to take the hit in place of raising prices for consumers, but it is not out of the realm of possibility, especially in today’s age of heightened political posturing. Meanwhile, JP Morgan (JPM) expects cross-border M&A activity to remain relatively subdued heading into 2019 as a result of the intensifying trade war as the month of July reportedly marked a notable slowdown after global mergers and acquisitions in the first half of 2018 reached levels not seen since 2007.
While retailers like Walmart are in somewhat unfamiliar territory in an environment of rising input costs (outside of labor), Caterpillar (CAT) is all too familiar with uncontrollable factors influencing its business. The company is reportedly using techniques honed in its cyclical past to help it cope with the impact of rising aluminum and steel prices, and it is requiring its leaders to reduce overall manufacturing costs of new products by at least 5% as it estimates that tariffs will add $100-$200 million to its operating expenses in the back half of 2018.
A case study of a Caterpillar front-end loader factory in North Carolina revealed increased production with 30% fewer employees on the factory floor, and it has reportedly redesigned all new machines to require 20% fewer parts, which significantly reduces its consumption of steel as well as improves quality and safety. In addition to the cost consciousness, the company raised prices for the second half of the year, and management expects to report a record profit for the full year 2018. No wonder Caterpillar has been able to successfully serve cyclical end markets for nearly a full century.
The latest round of US tariffs, which will subject $200 billion of Chinese products to a 10% tariff and went into effect September 24, include a host of “less-flashy” tech items such as home modems, routers, and internet gateways but spared notable consumer technology products such as smart watches and speakers (XLK). While consumers may avoid higher prices for the increasingly popular “smart” technology items, a similar situation to that of the retailers is likely as service providers may ultimately pass the higher costs of Internet-providing equipment on to their customers. The group encompassing modems, routers, switching, and networking equipment makes up the largest group included in this most recent round of tariffs from the White House.
While the tech industry sifts through the Trump Administration’s most recent round of tariffs, the President’s recent call for OPEC to boost its output to help reel in crude oil prices (USO, OIL) was rejected as Brent crude touched a four year high September 24. Saudi Energy Minister Khalid al-Falih said his country has spare capacity but such a move is not necessary and may not be needed in 2019 either due to the potential for a significant increase in non-OPEC supply. OPEC recently raised its outlook for US oil output through 2023 and expects to lose further market share over that period, and the cartel projects non-OPEC supply would rise by 2.4 million barrels per day while global demand is expected to grow by 1.5 million barrels per day. Trade uncertainty between the US and China only adds to the murkiness surrounding the global crude oil markets, as do US sanctions on Iran.
Comcast (CMCSA) appears to be suffering from the winner’s curse after winning a one-day auction for UK broadcasting company Sky (SKYAY) over rival Twenty-First Century Fox (FOX, FOXA) with a bid of £17.28 per share, which was substantially higher than Fox’s £15.67 per share bid. Fox still owns a 39% stake in Sky, which will be transferred to Disney (DIS) once the Disney-Fox deal closes (expected in first quarter 2019). Why shares of Comcast dropped on the news of its auction victory is not surprising as its winning bid is significantly higher than the £10.75 per share deal that was initially agreed up on between Sky and Fox in late 2016, and the company will have to significantly expand its financial leverage to complete the deal that is valued at $48.6 billion including debt.
Simulated Dividend Growth Newsletter portfolio idea Digital Realty (DLR) is making a move in Latin America with its agreement to buy Ascenty, a leading data center provider in Brazil, for $1.8 billion. A subsidiary of Brookfield Asset Management (BAM) will contribute ~$613 million, or half of the necessary equity investment for a 49% stake in the JV that will eventually own the business. The move should increase Digital Realty’s exposure to the significant growth potential of the Latin American data center market, which is driven in part by a growing working age population and rapid digitalization.
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Kris Rosemann does not own shares in any of the securities mentioned above. Some of the companies written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.