Reasons For Concern: Interest Rates, Tariffs, Valuation

The market was cruising along until a weak 20 year treasury auction in the middle of the day Wednesday sent interest rates soaring and stocks stumbling. Early Friday President Trump spooked markets once again by calling for a 50% tariff on the European Union and a 25% tariff on Apple (AAPL) iPhones not manufactured in the US causing another stock market selloff.

Interest rates are rising with the yield on the 30 year Treasury once again exceeding 5%. This is a big cause for concern because higher debt servicing costs for the government and private sector soak up money that would otherwise be spent in the economy for consumption or investment.

The WSJ’s Greg Ip wrote an excellent column in Saturday’s paper about what’s going on (“Bond Market Is Making Washington Pay” [SUBSCRIPTION REQUIRED]). Essentially, the market is showing discomfort with $2 trillion to $3 trillion deficits for the rest of the decade on top of all the Federal debt and unfunded liabilities (Social Security and Medicare) already outstanding. A sort of inflection point in sentiment seems to have occurred and investors are demanding higher rates to own Treasuries.

Tariffs are another concern. While the market has been rallying on de-escalation of the trade war, Trump reminded everyone Friday morning that it’s not over. While there is enormous uncertainty about the endgame, tariffs are going up which are going to make imported goods more expensive for American consumers.

The WSJ’s Dan Gallagher wrote a column in Saturday’s WSJ saying that AAPL will likely pay the 25% tariff on iPhones and pass on some of the increase in costs to consumers because moving its massive supply chain to the US is unfeasible. However, that will squeeze AAPL’s profit margins and could put continuing pressure on the stock (“Apple’s Stock Still Not Pricing In Trump’s Demands” [SUBSCRIPTION REQUIRED]).

Last, the market – especially some beloved mega cap names – is quite expensive. Consider two stocks reporting earnings this week: Autozone (AZO) and Costco (COST). These are two of the greatest stocks of all time that I owned for years before selling last year. The problem is that valuation has simply become untenable. Both stocks are up well in excess of 100% over the last three years. AZO’s multiple is approaching 30x forward earnings while COST’s exceeds 50x. No matter how great these companies are, the present value of their future earnings simply cannot support these valuations.


More By This Author:

Why You Should Have A Bullish Bias
Why I Suspect This Is A Bear Market Rally
Reflections On Buffett And The Future Of Berkshire

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