Thursday, December 13, 2018
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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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