Spindly Transport Stocks Dealt Another Blow In New Tariff Threats

Markets are off broadly, but not deeply. The Dow Jones Industrial Average has been off a little more than 1 percent for most of the session, with the Dow Jones Transportation Average Index seeing similar declines. The S&P 500 Index is down less than 1 percent. While the degradation was seen across most sectors, the transports are seeing outsized declines.

On May 30, 2019, President Trump threatened to implement increasing rounds of tariffs on all Mexican imports beginning with a 5 percent tariff on June 10 unless Mexico (and U.S. lawmakers) take immediate steps to stop the flow of illegal immigration into the United States. The tariffs will be raised to 15 percent on August 1, 20 percent on September 1 and 25 percent on October 1.

Similar remarks came from the White House in April, but with a one-year time frame to take measures to stem illegal immigration into the U.S.

Transport stocks, already dealing with lower volumes and corresponding pricing weakness, may have another hurdle to navigate. Eroding freight fundamentals have been attributed to general economic malaise, the other trade war (China) and tough year-over-year comparisons from a record 2018 freight demand environment. The potential for a new trade war with Mexico, which is a large domestic freight generator for U.S.-based transportation companies, will likely provide another obstacle for the stocks to contend with, whether it comes to pass or not.

The automakers, which have a large physical manufacturing presence in Mexico, were hit particularly hard. General Motors Company GM is down more than 4 percent; Fiat Chrysler Automobiles FCAU is down 4 percent; and Ford Motor Company F is down 3 percent. Additionally, Japanese auto manufacturers are off anywhere from 2 to more than 6 percent.

Cross-border Class I railroads are trading lower as well. Kansas City Southern KSU is down more than 6 percent and Union Pacific Corporation UNP is off around 2 percent. KSU has been the primary beneficiary of manufacturing near-sourcing in Mexico as the company benefits from headhaul and backhaul freight as it moves input goods into the region for assembly and finished product back to the U.S for sale. Roughly half of its revenue derives from Mexico.

Amit Mehrotra, an analyst with Deutsche Bank wrote about the Mexico tariff announcement. "From a stock standpoint this has clear negative implications for KSU, which derives about 50 percent of its revenue from Mexico (with significant exposure to cross-border trade). Other companies impacted include UNP [with] $2 billion plus of revenue to and from Mexico and Werner Enterprises WERN [with] a sizeable portion of its over-the-road business [related to] cross-border Mexico [freight]."

The truckload stocks are off a little more than the broader market, with U.S. Xpress Enterprises USX outpacing the group, down more than 4 percent. WERN is down approximately 2 percent.

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American Trucking Associations' estimates said that 32,000 U.S. truck drivers participate in cross-border freight moves, representing roughly $1.1 billion of cargo per day.

The broader stock markets have cooled over the last month, with the S&P 500 down approximately 6 percent for the month of May. Economic softness and China trade tensions have been some of the culprits. Further, the yield curve is seeing inversion with the U.S. 10-year treasury at 2.175 percent and the U.S. 3-month treasury trading higher at 2.357 percent. Yield curve inversion occurs when long-term debt instruments have a lower yield than short-term debt. This is often viewed as a predictor of a future recession. The 30-year is still higher at 2.601 percent.

On May 31, 2019, CNBC reported that JP Morgan expects the Federal Reserve to lower interest rates in September and December and that if the 25 percent tariff warning were implemented, rates could be lowered by much more than 50 basis points.

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