Trade rhetoric has the equity markets in flux since the latest tariff warning was announced at the beginning of August. Notably, sectors with meaningful trade exposure to China, like the transportation stocks, are feeling the pressure.
Just as some equity analysts were providing commentary about potentially becoming more constructive on the transportation stocks, the next shoe dropped. While investors were purportedly sniffing around the space looking for bargains, likely not interested in a full basket approach to owning the transports, a new round of Chinese tariffs were announced, taking the breath out of the transports.
The “not as bad as feared” earnings season was in the final innings. Some investors appeared poised to take management teams’ lowered guidance (and analysts lowered earnings estimates) for 2019 and 2020 in stride. Then on August 1, 2019, President Trump announced a 10 percent tariff on the remaining $300 billion of Chinese imports set to start on September 1.
This round of tariffs has been a little harder for equity markets to swallow as they are more likely to hit the consumer, the centerpiece of what has been a sustained period of economic growth in the United States. Markets appear spooked as the potential for increased fees on consumer durables like electronics, apparel and household goods have some experts predicting the consumer will be the one to eat at least some of the cost (depending on fluctuations with the yuan). Further, there is greater concern that consumers may meaningfully tighten their belts if trade tensions were to capitulate further and tariffs were to increase to a higher rate.
Recent volatility
Equity markets have been unsettled since the latest tariff threat on Chinese goods, experiencing more than a week’s worth of multi-percentage point swings. The markets saw real degradation on Monday, August 5 after investors had the weekend to formulate a strategy. The Dow Jones Industrial Average (DJI), the S&P 500 and the Dow Jones Transportation Average (DJT) were all 3 percent lower on the day. The markets got a little bit of a dead cat bounce on Tuesday, but opened 2 percent lower on Wednesday as global recession fears spiked when three more central banks joined in with rate cuts (New Zealand by 50 basis points, India by 35 basis points and Thailand by 25 basis points). However, that day’s lower open was reversed with the near-600 point drop being erased. Thursday saw a 2 percent move higher, but that level was wiped out over the next two trading sessions.
Then today, August 13, the Dow and S&P 500 were up 1.5 percent on the Office of the U.S. Trade Representative’s announcement that tariffs on certain items in categories like cellphones, laptops, video game consoles, toys, footwear, agricultural products and chemicals would be delayed until December 15.
Transports were seeing a rally pre-tariff talk
It appears that the truckload (TL) and less-than-truckload (LTL) stocks were fully braced for impact as earnings season began. Management teams and analysts did a good job of warning investors that second quarter freight demand didn’t materialize as hoped and that the back half of 2019 was unlikely to produce a meaningful recovery. Management teams were vocal at investor conferences in May and June, lamenting the lack of a June freight surge and the impacts excess truck capacity was having on rates. Some analysts began trimming estimates ahead of this commentary and investors were well-prepped for what they would hear when J.B. Hunt (NASDAQ: JBHT) kicked off the earnings season on July 15.
The TLs responded positively the first trading session after JBHT reported a $0.12 per share earnings miss. “Not as bad as feared” seemed to be the main takeaway, along with management’s better than expected call on the back-half of 2019 in regard to intermodal volumes. Knight-Swift Transportation (NYSE: KNX) and Covenant Transportation Group (NASDAQ: CVTI) pre-announced less-than-expected earnings expectations the following day which set the TL names back a bit, but then a clean report followed from Heartland Express, Inc. (NASDAQ: HTLD) that got the group reignited.
Even as the TLs continued to report earnings, some better than others, analysts and investors appeared to be a little more constructive. Many management teams indicated that the capacity correction was underway (CVTI and KNX), some said that shippers were indicating higher volumes for peak season (U.S. Xpress NYSE: USX) and one made the call that 2020 could actually provide a year-over-year increase in rates (KNX). With earnings expectations reset for the rest of 2019 and 2020, sentiment appeared stable with some analysts advocating ownership in select names.
Prior to the tariff announcement, TLs and LTLs were up approximately 8 percent since the start of the second quarter earnings season. The railroads, which outperformed the bulk of the year, were under pressure through earnings season as declining carloads for all commodities (except petroleum) weighed on investor sentiment.
The railroads have seen stiff competition on intermodal shipments from the TLs as spot rates remain depressed. Additionally, softer demand in the industrial and manufacturing sectors, prior tariff impacts on steel demand and demand erosion in energy and export coal have resulted in lower revenue. That said, precision scheduled railroading (PSR) benefits have taken hold and provided protection to margins in the face of volume weakness, which has taken some of the pressure of the stocks.
For the most part, the transport stocks (and broader equity markets) appeared on stable footing as the consumer continued to carry the day.
Since the tariff announcement
However, since the latest tariff announcement, transportation stocks across all modes are feeling the squeeze as declines in the transports are outpacing broader markets. The DJT is off more than twice that of the S&P 500 and the DJI. The TLs, airfreight and maritime stocks are off further. While analysts and management teams have indicated the likelihood of a more subdued freight recession, without trade resolution some fear that weakened consumer spending could result in real hits to GDP and drag equity markets lower.
Some have said that new tariffs could provide a near-term lift in demand similar to the freight pull forward experienced in 2018. This problem is two-fold this go-around. Warehouse space is at a premium currently at most major port cities. According to recent data by Cushman & Wakefield, warehouse vacancy rates in the Los Angeles market are down to approximately 2 percent and even tighter in some markets. The firm estimates that the current national average is 4.5 percent, which is roughly 130 basis points lower than historical averages.
Another problem is that the one-month notification of new tariffs doesn’t provide many supply chain managers the time to pull inventory forward. The short notice won’t allow much time to get products on container ships from China, the least expensive mode, and imported in the U.S. before the new tariffs are in place.
Other market concerns
Some market pundits are concerned that the Federal Reserve may run out of bullets. Federal Reserve officials decided on a 25 basis point reduction in the federal funds rate on July 31, the first rate cut since the Great Recession of 2008. The move had been anticipated by investors for months, with several investment firms advising clients that equities markets had already assumed at least two interest rate cuts in 2019.
The rate cut was expected to provide a lift to equities, but a selloff quickly ensued as Fed Chairman Jerome Powell referred to the rate cut as a “mid-cycle adjustment” instead of a prolonged period of rate cutting. This left investors wondering if the future cuts were in play for 2019. Powell later clarified his statements in the same press conference to suggest that multiple rounds of rate cuts were unlikely, but that the Fed would provide an “accommodative stance.”
The yield curve is seeing inversion, with the U.S. 10-year Treasury at 1.695 percent and the U.S. 3-month Treasury trading higher at 2.005 percent. Yield curve inversion occurs when long-term debt instruments have a lower yield than short-term debt. Also concerning, the 2-year Treasury is near inversion when compared to the 10-year Treasury. This was a precursor to the last five recessions. The 30-year is still higher at 2.165 percent.
China’s central bank allowed its currency to exceed the seven yuan-to-one dollar ratio, the lowest level since 2008. This has been viewed by many market watchers as a deliberate attempt to devalue the currency and offset tariffs (a weaker yuan lowers the price of Chinese exports when purchased with other currencies). Although if China is devaluing its currency, making those goods cheaper in foreign currencies, it may be a wash for the U.S. consumer at least initially. The depreciation in China’s currency, along with its halt on U.S. agricultural imports, had many suggesting that China was not backing down.
Then we have today’s developments, which appear to in the least delay tariffs on some Chinese imports and potentially open the door for dialogue between the two countries. In any event, since the tariff announcement new trade war fears have taken root in equity markets and more volatility will likely ensue. The broader equity markets are off modestly since the tariff announcement (the S&P 500 is only 1.8 percent lower since the July 31 close), but the transportation stocks are faring worse. Which is unfortunate because a decent rally in the transports appeared to be in the works. Uncertainty makes equity markets jittery, and they appear to have that in spades now.