U.S.-China Trade War Escalates

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Includes: AROC, DDM, DIA, DOG, DXD, EEH, EPS, EQL, FEX, HUSV, IVV, IWL, IWM, JHML, JKD, OTPIX, PSQ, QID, QLD, QQEW, QQQ, QQQE, QQXT, RSP, RWM, RYARX, RYRSX, SCAP, SCHX, SDOW, SDS, SFLA, SH, SMLL, SPDN, SPLX, SPUU, SPXE, SPXL, SPXN, SPXS, SPXT, SPXU, SPXV, SPY, SQQQ, SRTY, SSO, SYE, TNA, TQQQ, TWM, TZA, UDOW, UDPIX, UPRO, URTY, UWM, VFINX, VOO, VTWO, VV
by: Darren McCammon
Summary

President Trump is increasing tariffs 10% on $300 billion worth of consumer electronics, sneakers and toys from China.

Oil prices are down 7% to 9% in fear over a global slowdown.

Many energy stocks and stock tied to the business cycle stocks got pummeled.

Be greedy when others are fearful.

Today in a series of tweets President Trump indicated,

Our representatives have just returned from China where they had constructive talks having to do with a future Trade Deal. We thought we had a deal with China three months ago, but sadly, China decided to re-negotiate the deal prior to signing. More recently, China agreed to buy agricultural product from the U.S. in large quantities, but did not do so. Additionally, my friend President Xi said that he would stop the sale of Fentanyl to the United States – this never happened, and many Americans continue to die! Trade talks are continuing, and during the talks the U.S. will start, on September 1st, putting a small additional Tariff of 10% on the remaining 300 Billion Dollars of goods and products coming from China into our Country. This does not include the 250 Billion Dollars already Tariffed at 25% We look forward to continuing our positive dialogue with China on a comprehensive Trade Deal, and feel that the future between our two countries will be a very bright one!

So another 10% tariff on the remaining $300 billion in goods from China which didn't already have tariffs (mainly consumer electronics, sneakers, and toys). Apple (NASDAQ:AAPL) iPhone users will be upset, Oil prices dropped 7% to 9% in response to worries over a global slowdown, and energy sector and cyclical stocks got pummeled. However, some of these firms underlying cash flows have not been negatively affected by past tariffs, and are equally unlikely to be affected by this one.

Archrock (AROC) for example just reported that it is backlogged well into 2020. The biggest problem affecting it's bottom line isn't tariffs, nor even potential counterparty risk, but an inability to get enough compressors to fulfill demand. Indeed, natural gas in the Permian is so backed up prices actually went negative while flaring sets new records. Only by the longest stretch of the imagination can these tariffs be seen as negatively affecting AROC's bottom line cash flows.

In theory, if tariffs lead to recession (unlikely), and E&P firms went under as a result, and the product wasn't just pumped by someone else, maybe one day years in the future demand for compressors will be less than supply. This is possible, but a risk so distant, I wouldn't normally mention it. I only do so here, because if I didn't, someone else would. No, the real reason Archrock fell last week is Mr. Market is scared, and oil prices are down. When oil prices are down and the market is scared, oil service sector ETFs and funds get sold off sharply. Since AROC is a component of those funds and ETFs, its price also suffers regardless of the actual effect (or more properly lack of effect) on its underlying cash flow. In other words this is an opportunity. Listen to Warren Buffett:

Buy when there's blood in the streets... You pay a very high price in the stock market for a cheery consensus.

Let me further remind readers that it was only last week that Fed Chairman Powell made it very clear inflation was below expectations. This indicates the existing tariffs on China aren't having a lot of affect on US consumers. They haven't raised prices a meaningful amount or it would be showing up in the inflation data. Most likely US consumers are simply switching to products made in other countries: South Korea, Japan, Vietnam, etc. We may not "buy American", but we do consistently try to get the biggest bang for our buck. If China's goods don't currently offer that due to tariff's, the market's invisible hand simply picks a good from a different source.

It's also appropriate to point out that tariffs targeted on one specific country have nowhere near the negative effect a more general Hawley-Smoot like tariff would. To the extent that prices from goods made in China raise, US consumers simply switch to goods provided by a different manufacturer who is not subject to the tariff. While China can and I assume will impose retaliatory tariffs in response, their ability to affect the US with them is pretty limited because China imports less than one-quarter of the goods from the US that the US does from China.

Source: US Census Bureau

In fact, the biggest treat from the tariff war is largely in our minds. This can cause people to pull back and become more cautious. Similarly, investors will tend to flee firms those they see as being "the losers" even when the underlying cash flows of those firms are not negatively affected to a meaningful degree.

Thus, I can't tell you a sell off won't get worse going forward. However, I can tell you many of our stocks are better buys now than they were before.

(Side note: I can't help but include some politics in this article. However, the intention is not to be pro or anti any particular person or party, but rather to provide meaningful economic analysis and data that the reader can take advantage of.)

Disclosure: I am/we are long AROC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This article discusses risky investments. I do not know your goals, risk tolerance, or particular situation; therefore, I cannot recommend any specific investment to you. Please do your own additional due diligence.