In January, we said the bull-or-bear outlook for 2019 could hinge on China. In that piece, we pointed out the importance of achieving a U.S.-China trade deal — something the stock market badly wants to see.
The outcome here is sharply binary:
- If we get a trade deal, that would be seen as bullish for the Chinese economy, and also for U.S. multinationals and U.S. exporters who could sell more product — a LOT more product — to China.
- If the U.S. and China fail to achieve a deal, the results could be very painful. China’s economy, already in a slowdown, could drag the global economy into recession if hit by more tariffs. That would be bad for markets everywhere, and U.S. markets would not escape the vortex.
March 1 is the official deadline for getting a trade deal completed, though that deadline can be pushed back if need be. Fortunately, the odds of a trade deal versus no deal (and the placing of sharp tariffs on China) are not 50-50. They are more like 70-30 in favor of the bullish deal scenario.
That is because the powers that be, in both the U.S. and China, have strong political incentive to create a positive outcome. Nobody wins if a bad outcome tanks the markets and ushers in a global recession.
If a U.S.-China trade deal does go through, shipping stocks could produce huge profits for investors. They could go on a run for the ages.
This is partly because shipping stock valuations have been beaten into the dirt, and partly because a multi-year U.S.-China trade deal would have massively bullish implications for shipping companies.
To get an idea of how badly shipping stocks have fared, take a look at the Baltic Dry Index, a popular shipping measure that has fallen more than 50% in the past few months.
“Free-Falling Freight Rates Spell Trouble for Shipping,” said a Feb. 7 headline in The Wall Street Journal. As the world’s biggest importer of raw materials, economic slowdown in China is a negative for commodity shipments. Shippers were also hit by a tragic mining accident in Brazil, in which a dam collapsed, and a flood killed 150 people.
Vale SA, the global mining giant held responsible for the Brazilian mine disaster, had to suspend operations at a number of sites, removing an estimated 40 million tons of annual output from production. That was 40 million tons of lost business for the shippers.
Beaten-down shipping stocks have mostly priced in the China slowdown and the Vale disaster by now. They have also priced in the wild collapse in crude oil prices that took place in the final months of 2018. (Falling crude oil prices hurt tanker rates.)
But here is the thing about a U.S.-China trade deal: In order to satisfy demands on the U.S. side, China would likely have to agree to big, gaudy, dollar figure — think a trillion dollars or more — in terms of trade multi-year purchase commitments to American exports such as soybeans, crude oil, liquid natural gas — the whole works.
And America has a lot it can export. The United States has long been an agricultural superpower, and in the past decade, America became the Saudi Arabia of shale oil.
For instance, the Houston Chronicle reports that American oil exports are expected to more than double by 2020, to 4 million barrels per day, and that the Texas Gulf Coast will be ready to handle that stepped-up transport volume. That is a lot of ton-miles for tankers.
Then too, a U.S.-China trade deal would likely cause U.S. agricultural exports to surge — bullish news for dry bulk carriers. And America’s liquid natural gas (LNG) export business is already starting to boom.
All of this means shipping stocks of all stripes — tankers, LNG, dry bulk — could boom if a U.S.-China deal goes through. And because shipping valuations are so compressed, a new bull trend could last a while.
If you look at SEA, the Invesco Shipping ETF, it is still very down in the dumps as of this writing. There are signs of a December V-bottom taking hold, but it is definitely early innings.
If we get a “no deal” U.S.-China trade result, the shippers will likely get hammered again. (But then again, so will everything else.)
But if a deal goes through — and again, this is the more likely scenario by a significant margin — the shippers could be off to the races.
Most of the shipping space is still in red zone SSI (stock state indicator) status. Below, however, you will find a handful of names that are turning the corner (already showing yellow or green status).
If you like the shipping stocks idea, be aware there is still a lot of risk until a trade deal is confirmed.
A simple risk mitigation strategy could be buying a small allocation of the names you like ahead of time, then adding to the positions once a trade deal is confirmed. And, if the less-likely “no deal” scenario occurs, the smaller allocation will be easier to manage, and shipping valuations are already insanely cheap.
Shipping stocks will almost certainly see a surge if a U.S.-China trade deal goes through. But that surge would be a buying opportunity or a holding opportunity, not a “quick pop” profit opportunity, because the follow-on result could easily turn into a multi-month or multi-quarter bull trend.
It’s not often you see a sector this beaten down with such a positive catalyst waiting in the wings.
Richard Smith, Ph.D.
CEO & Founder, TradeSmith