Friday Findings – April 6th, 2018
SEE LAST PAGE OF THIS REPORT FOR IMPORTANT DISCLOSURES
Graham Copley / Nick Lipinski
April 6, 2018
- Chart of the Week
- The Volatility of the Best Stewards of Capital
- Weekly Winners & Losers
US consumer sentiment is at a ten year high – whatever measure you use – chart of the week. This data does not capture the trade wranglings of the last couple of weeks, but it is unclear whether the trade rhetoric would impact local confidence, as its implications are hard to measure at the street level and it is being presented as something undertaken to help the US, even if the likely outcome is quite the opposite. Note that in prior trade battles there generally has not been a national success, with gains in one industry 9generally the beneficiary of the tariff) more than offset by losses elsewhere (generally buyers of the higher priced material). But first let’s look at consumer optimism – it is at a 10-year high, but not at a peak – chart below. Indices were higher in 2000.
However, it is concerning to see that the US maybe confident and growing in isolation all of a sudden. The surprise indicator for economic data that we showed a couple of weeks ago has turned sharply negative for Europe, while remaining positive for the US – chart. This is an historic measure as opposed to confidence, which is more of a forward expectation, but it does show that European expectations had got ahead of themselves relative to what in fact happened – could the US be next and could trade be the problem.
China and the US are in a war of words with respect to trade that will either escalate into a change in trade patterns, changes in relative pricing and industry beneficiaries and losers in both countries, or it will result in some give and take that are less problematic and ultimately give the US an incremental gain. Chemicals, not surprisingly, were targeted by China – machinery and chemicals are two big buckets for US exports and consequently were always going to be the biggest targets. The reality is that China is around 8% of US chemical exports today (chart), but in select areas this could be as much as 4% of production or growing towards that number as new US investments come on line this year.
Chinese chemical producers may make more money if local prices rise because of the tariffs, but Chinese exporters will be hurt and we will likely see a balance of trade shift with US exports either moving to other Asian countries, whose exports of finished goods will rise, or we will see investment in the US to consume more chemicals here. While there could be some pricing noise – and this expectation has clearly been reflected in some of the stock movements we have seen over the last few weeks – US chemical producers could actually benefit from Chinese import tariffs if the right investments are made in other countries or in the US itself.
We would focus on the most beaten down US Chemicals and Materials names YTD: AA, HUN, DWDP, possibly OLN, in addition to our other favorites, PX, WLK and EMN in Chemicals and FCX, IP and OI in the rest of Materials.
In our Industrials and Materials monthly – earlier this week – we continued a theme that we wrote focused on chemicals looking for the best allocators of capital – the timing driven by what is currently an all-time peak for free cash flow in Chemicals, Capital Goods and Conglomerates (Ex-GE). Who do you trust with that cash flow? The most interesting conclusion when you look outside chemicals is that many of the volatile materials names make up the “better overall return” group – but they come with volatility – chart below. To be fair, the top right outliers for chemicals were CF and MOS. The odd one out here for us is OSK – very good – in fact the best average allocator of capital outside the Materials group (BGC is its own special case) but much more volatile than its capital equipment peers – averages and volatility are summarized in the second and third chart.
In the fourth chart we attempt to look for some value: Risk/reward best for FCX, OSK and CLF, more concerning for GE, TRN, DOV.
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