The Days Ahead:

  • Short week and light on data; home sales and Fed minutes.

This Week:

  • The U.S. trade deficit is back in the news.
  • But the U.S.’s huge surplus in services trade is overlooked.
  • The threat of higher tariffs on European trade is big…
  • But unlikely to happen.
  • Some data turns out to be a damp squib.
  • MSCI dumps more Chinese stocks.

Programming Note:

  • There will be no Friday commentary next week. You can find regular updates from Cerity Partners Investment Office here.

Trade With the European Union (EU)

The U.S. runs a total trade deficit of around $773 billion, down from $950 billion in 2022. We tend to hear more about the goods deficit, which was $1,061 billion in 2023. The service side runs a surplus of around $288 billion. The big services are financial services (mostly insurance and banking) at $116 billion, other businesses services (like consulting and investment management) at $110 billion and intellectual property (IP) at $82 billion. The total services trade is worth around $1,716 billion a year and the total goods trade $5,162 billion. Combined they’re worth nearly $6,900 billion.

U.S. trade with the EU is worth around $1,400 billion, around 20% of the U.S.’s total exports and imports. Broken down by goods and services, the U.S. imports around $174 billion of EU services and exports $252 billion. It thus runs a healthy services surplus of around $80 billion.

The goods side is different. The U.S. imports $576 billion of goods from the EU and exports $368 billion for a goods deficit of $208 billion and a goods and services deficit of $120 billion.

Here’s a chart showing recent growth in trade with EU exports to the U.S. rising around 3% from pre-Covid-19 days and U.S. exports to the EU rising by 4%. The big surge in the blue line from the 2020 lows is due largely to U.S. exports of natural gas and the strength of the dollar.

In the EU-US pattern of trade, the U.S. sells natural gas (up 170% in two years) chemicals, machinery, services, IP, travel and banking services. In turn, it buys pharmaceutical goods and cars. Although EU wine tariffs received a lot of attention a few years ago, the industry is a minnow in the $1,400 billion of trade flows, at around $1 billion.

All of which got us thinking. What if the next, not-Biden, administration levies a 10% tariff on European imports?

On one level, if we take it unfiltered, it means a 10% tariff on all European imports. If we include goods and services that means a $72 billion tariff. If we only include goods, it means $55 billion. Most of the talk is about goods, so we’ll go with the lower number. That would equate to around 0.2% of GDP. That doesn’t sound great, but it’s manageable. We’re not sure that’s how it will play out, for several reasons.

First…It’s complicated. The closest we have to a trade policy is the “Mandate for Leadership” from the Heritage Foundation. One of the points is that the trade deficit has “soared” from $654 billion to $845 billion. But, as we’ve seen, that’s not quite right. It’s $773 billion for goods and with a big surplus in services. One of the policies (page 772) would match all EU tariffs with similar U.S. tariffs. This is where the 10% number comes from because it’s the average tariff on all goods coming into the US from the EU. This would reduce the deficit by about $25 billion. ­­

But there’s a lot in that document and it may take considerable time to consider all the ramifications. Ireland, for example, sells around $16 billion of goods and $85 billion of services. Most of that is vaccines, patents and IP, which often originated in the U.S. That’s likely to get a lot of push back from U.S. tech and pharma companies.

Second…Europe is Getting a Head Start. Several EU states have started traveling to the U.S. and visiting tariff supporters. Germany’s Foreign Minister, Annalena Baerbock, recently visited several states where German companies employ over 1 million workers, ranging from Daimler Group in Atlanta, (25,000 employees) to every Trader Joes (yes, it’s a German company). Presumably, the talk was to reinforce existing ties and perhaps quiet the idea of tariffs.

Third…Retaliations. The EU responded quickly last time tariffs were imposed in 2018 to 2020. No one wants to go down the road of tit-for-tat moves, which may keep any U.S. actions from being too immediate and damaging.

So far, we’ve seen few signs of nerves from financial markets.  European public companies have around 25% of their sales in the U.S. There are 40 companies with U.S. sales of over 50%, for example: Stellantis, Hochtief, Fresenius, or Dassault. We’d expect stocks to sell off if there was real concern. There’s no sign.

These are early days to worry about elections and the gap between policies stated said and full implementation is wide. We  expect the tariff issue to come up many times between now and November. But it’s probably a paper tiger.

Some Data Just Isn’t Important (Part 1)

These days markets watch every twitch from the Federal Reserve, inflation and the jobs reports. The story over the last two years has centered on how much the Fed will raise rates, when and for how long it will stop, and when it will cut.

We know most of those by now. They started from zero in March 2022, raised 11 times, stopped in July 2023 at 5.25% and since then forecasts of when it cuts keep moving out. Back in June last year, investors thought there was a 40% chance of a cut in December 2023. The meeting came and went. In January, the chances of a March cut rose to 74% but have now slipped to 16%. Even that looks high. The chance of a cut in May rose from 17% to 52% and the chance of a cut in June from 4% to 40%.

You can play around with the numbers here and they’re kind of fun to do.

Inflation and jobs numbers have thus become the focal point for investors. That makes sense. After all the Fed’s famous dual mandate states that policy should always strive for “maximum employment [and] stable prices.” This year markets have looked at every nuance of employment and inflation to try and gauge what’s next.

Recently, highly anticipated changes in jobs and inflation numbers turned out to be damp squibs.

First, we saw an employment report where the household working population fell by 31,000 in January and 683,000 in December. But in the same report we saw establishment, or employer, data increase by 686,000 in the same two months. That’s a 1,370,000 discrepancy. What’s going on?

Regular readers may recall the employment report is made up of two surveys.

First, the household survey is a 10-minute phone call to 60,000 households which has a 70% response rate, down from 80% pre-Covid-19. A growing number of people either refuse to provide answers. Many that do make mistakes. These are all perfectly robust statistical methods but the result is that the reports are volatile and subject to revision. The household survey gives us the number of people working, and the unemployment and labor participation rates.

Second, is the employer survey which uses more sophisticated collection methods for 119,000 businesses in 651,000 locations. It has an initial 45% response rate but the Bureau of Labor Statistics (BLS) keeps calling back for up to two months, hence the revisions.  The employer survey gives us the number of new jobs created and in what industries.

We expect both surveys to be volatile, but especially the household survey. It’s becoming harder to get people to respond and the survey includes self-employed, who don’t show up in the employer survey. The 8.2 million people who hold more than one job will also show up as one person in the household survey but twice in the employer survey. It’s tricky to reconcile the two.

Still the discrepancy in January got us thinking. Does one going up and the other down happen often? Is it something that matters?

The green line is the household survey, showing 161.1 million at work, and the blue line is the employer survey, showing 157.7 million at work. The black line shows the difference between the two, at 3.4 million.

Turns out that one survey going up and the other down happens often …around 23% of the time. In a rapidly expanding or declining jobs market, like 2021 or 2008, it may be only 8% of the time but otherwise the 23% number holds pretty steady. The overall picture is that if the two surveys are off, the household survey tends to be revised to the employer survey. Employer survey trumps household survey, for two reasons.

One, the employer survey excludes farm workers and the household survey does not. The number of farm workers fell from around 10 million in 1960 to around 2 million today, although it rises to 6 million during hiring season. This reduces the household survey and increases the employer numbers (assuming workers went into non-farm employment).

Two, the number of people with multiple jobs has risen from 6.7 million to 8.2 million in the last 10 years. This trend both decreases the household numbers, because someone just says “Yes” if they’re employed even if they have two jobs, and increases the employer number, because two separate employers have the same person on the payroll. Hence the smaller gap. In a recession, the numbers may widen out as workers leave employers and move to self-employment.

Last year also saw some big swings in the household survey, ranging from a fall of 683,000 to a rise of 852,000. The employer survey was much calmer, ranging from 146,000 to 482,000.

The bottom line is that neither survey is perfect but the employer survey probably reflects the real state of the labor market and we’d expect the household numbers to be revised so that they match the health of the employment market shown in the employer data.

There were plenty of comments about the discrepancy in the last jobs report, most along the lines of “labor market shakier than it looks.” But it’s not the case. Revisions will take care of it.

Some Data Just Isn’t Important (Part 2)

This is quicker! Last week we saw the annual revision to the Consumer Price Index (CPI) data. There was some concern that we’d see a repeat of last February when the revisions changed the Q4 2022 inflation numbers from 3.2% to 4.1%. Markets don’t normally worry about revisions too much but in this case Federal Reserve Governor Christopher Waller aired his concerns about the updates.

In the end the revisions were small and sent the December inflation rate down from 0.30% to 0.23% on an adjusted basis. For the five years to 2023 the nonadjusted changes look like this:

There’s little difference. The revisions restated when, not how much, the inflation changed. For Q4 2023, inflation rose at an annualized rate of 3.4%, unchanged from the prior report.

There were some changes to the underlying indexes. For example, prices of used cars fell 4.5% in the last quarter, not the -6.7% originally reported. But the Fed is more interested in the total change not the subcomponents.

In the end, the market shrugged and moved on.

The Bottom Line

We’ve written about Chinese stocks a fair bit lately. Between an over leveraged property market, regional bank problems, deflation and heavy handed intervention in corporate governance, the stock market continues to slide. It’s down 7% this year after a 24% fall in 2023. Since 1997, the once thriving Hong Kong market is up a grand total of 1.8%. This week saw MSCI, a leading index provider, deleted 74 out of 761 companies from the MSCI China index. They no longer made the cut in terms of size or profit. Someday China stocks will be a buy. But not yet.

The big news this week was the inflation report which came in at 0.3% compared to December’s 0.2%. The annual rate fell from 3.4% to 3.1% but investors would have liked to have seen 2.9%.

The 10-year Treasury rate jumped from 4.15% to 4.33% but was back down to 4.20% by Thursday. Slower retail sales, lower industrial production and numbers from the small business survey all came in below expectations.

Stocks marched on up around 0.5% while small caps were up nearly 4%. They’ve lagged for months and have been especially volatile of late.

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Art of the Week: Phyllis Shafer (b. 1958)

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