Last weekend, the Trump administration said it would give Chinese telecom company, Huawei more time to work with U.S. customers. It also suggested the White House is laying the groundwork for a new round of trade talks with Chinese trade officials.
Now, we’ve seen all this before, so we’re not wildly enthusiastic that an agreement is right around the corner.
That said, we’ll take some positive news when we can get it. This trade war has cast a long shadow over the financial markets for months, and recent data is suggesting its impact is beginning to have negative ramifications in our economy. So, we’re pleased to see even small advances. Plus, we believe that a deal will eventually be reached. After all, Trump has an election coming up and the lack of a meaningful trade deal would likely weigh against him.
So, as we look ahead, one of the questions becomes “what stocks will benefit the most when a trade deal is finally reached?”
In a Digest last week, we interviewed John Jagerson of Strategic Trader. In discussing what historical data tell us about future market gains, John made an interesting comment:
I would not be surprised to see more definitive progress in the trade dispute serve as the catalyst for a bounce higher in late September. Investors should build a list of stocks with exposure to tariffs — retail, industrials, tech — that could be added to a portfolio if an agreement between President Trump and President Xi can be reached.
Following that interview, I asked John if he’d be willing to share with us some analysis and specific stocks he believes are good candidates for such a “Trade Deal Watchlist.” He graciously agreed, and wrote a short piece on the topic, which I get to feature below. The analysis is a great starting point for your own watchlist.
So, at this point, I’ll hand it over to John. When he’s finished, I’ll take back over for a few follow-up questions.
5 Companies That Could Skyrocket on a Trade Deal Agreement
The trade war is heating up between the U.S. and China. On August 1st the Trump administration announced an additional 10% tariff on Chinese consumer goods being exported to the United States and is set to take effect on September 1.
China then retaliated with a suspension on its purchases of U.S. agricultural goods purchased after August 3rd and allowed the Chinese yuan to fall below 7 to the dollar, prompting the Treasury Department to label China a currency manipulator. This designation opens up the possibility of additional penalties.
However, on August 13th, President Trump seemed to signal some interest in easing tensions and maybe moving towards a resolution by postponing many tariffs until December 15th. The market rallied nearly 1.5% on the news before whipsawing again over the last few days on additional trade news.
I won’t be surprised if this back and forth pattern repeats itself a few more times before a deal is reached but who stands to benefit the most if an agreement is reached? Here’s a look at the 5 companies that could skyrocket if a trade agreement is finally reached and the tariffs on U.S. and Chinese goods are lifted.
Dollar Tree Inc (DLTR)
Companies like DLTR have limited price flexibility because their margins are so small. Discount retailers, like DLTR, source 70% of their products from China, and according to UBS, the financial impact of the new tariffs would have been a 4% reduction to 2019 earnings. Investors are already pricing this into the stock’s price, which means a big discount could turn into a huge rally if an agreement looks likely.
Caterpillar Inc (CAT)
Caterpillar posted a large negative earnings surprise for its second quarter report. Their earnings report pointed to significant slowing in China as a result of the trade war. Consolidated sales and revenue declined 7% year-over-year for the Asia Pacific region on $70 million additional expenses due to tariffs.
While the global economic slowdown is a contributor to CAT’s woes, a trade deal would allow the pricing of their equipment to become more competitive and provide better profit margins on the sale of equipment. A move back to the top of CAT’s long-term trading range could return 20% or more depending on the timing of a deal.
Archer Daniels Midland (ADM)
Agriculture companies were one of the first to feel the impact of the retaliatory tariffs instituted by China. As one of the largest growers in the world, ADM is a major exporter of soybeans, ethanol and other agricultural products. A little over a year ago, China instituted a 25% tariff on U.S. agricultural products. Initially, it was thought that they couldn’t diversify away from U.S. producers, but reduced demand and shifting purchases to South America allowed China to meet their needs.
In their most recent quarterly report, ADM saw a 58% decline in non-GAAP EPS from the same quarter a year ago. Like DLTR and CAT, the bad news for ADM is already priced into its shares. If a deal is reached early, this would be one of our favorite candidates for a quick rally.
3M Company (MMM)
From an earnings perspective, tariffs have had the biggest impact on industrials, energy and agriculture stocks. 3M’s products are supplied to manufacturers in the industrial and energy sectors, with over 60% of their total sales originating outside the U.S. and significant exposure to the Asian-Pacific region.
In 3M’s 2Q earnings report, they beat estimates, but saw a decline of 15% in EPS and 2.6% in revenues. According to the company’s CFO, organic growth in China will cause sales to contract somewhere in the low to mid-single digits versus expectations of a flat growth trend. Given the company’s significant margins, any return to a normal rate of revenue growth will cause earnings to increase dramatically.
Since the tariffs began to take effect, MMM is down nearly $100 as it fell from $260 to $160. The stock currently pays a 3.5% dividend yield, which could help boost its returns if a trade deal starts to look more likely. A recovery back to its 2019 high near $220 is a potential gain of over 30% in its share price.
Bed Bath & Beyond Inc (BBBY)
BBBY currently derives 65% of its imports from China and UBS estimates the negative impact of the new round of tariffs at 13%. This puts Bed Bath & Beyond in a similar situation as DLTR if the tariff situation remains unresolved.
Since it’s April earnings announcement, shares of BBBY are down by more than 50% as the price fell from a closing price of $19.41 on April 10th to the $8 range. We don’t like BBBY as a long-term value play because the company is plagued with other management issues in addition to the tariffs. However, if a deal starts to look more likely, we see this as a potential “short-squeeze” that could briefly send the stock skyrocketing if investors start to price in the potential for an end to the trade war.
If for no other reason that political expediency, we expect some cooling in the trade war and the news of a tariff postponement on August 13th and President Trump’s delay of sanctions on Huawei on August 19th seems to confirm our view. We see the most upside in the retail sector, which is why Dollar Tree (DLTR) looks so interesting. Even short-term plays on more troubled companies in the sector, like Bed Bath and Beyond (BBBY) could be very profitable for risk-tolerant investors in the short-term.
We also like the major industrial firms as an interesting play on a trade-truce. The gains in that sector may be a little more muted than retail, but should outpace commodity and energy stocks if the outlook for a deal between Trump and Xi starts to look more likely.
How long the watchlist is effective, LEAPs, and potential shorting opportunities …
Jeff here again. After reading the analysis above from John, I asked a few follow-up questions in order to help any Digest readers looking to begin their own Watch List.
Jeff: How does this watchlist hold up if it turns out Trump’s tweet is just more posturing, and we’re still far from a meaningful trade deal?
John: I think this is the best list if there is good news in September or October. However, if there is no progress by then I will re-evaluate and maybe adjust the list for changing conditions.
My goal is to always have a plan ready to deploy since market events, and political events, are impossible to predict. That means I have to make adjustments over time, but I am also never caught flat-footed when an opportunity arises unexpectedly.
Jeff: Given that the timing of all this is uncertain, could buying LEAP options be a good way to play this?
(NOTE: A LEAP — “Long-term Equity Anticipation” — option is a long-dated option. If you believe the price of a stock will make a big move in one direction or the other, but that move will require a period of many months or years, a LEAP would be a way to play your hunch.)
John: I think LEAPS are a great way to take advantage of some of the big moves we could see from a resolution in the trade dispute. However, because options are a wasting asset, I think investors should wait until we have more definitive progress in the trade talks beyond a mere postponement of tariffs by President Trump before using a strategy like that.
Jeff: If the list of stocks you gave us should do well when a deal happens, is the converse also true? Specifically, are they toxic — possibly even candidates for a short-trade — here in the meantime?
John: The question we have to ask ourselves about these stocks is what factors are being priced in by the market right now?
I assume that ongoing damage from the trade war is the primary factor driving these shares lower, which means much of the downside is already priced in to a large extent. Additionally, with the exception of BBBY, these companies all have strong underlying fundamentals. I never think shorting stocks with strong fundamentals is a good idea.
If I were to build a bearish list of stocks that would suffer from further delays in the trade war, I would build a different list comprised of companies with bad management and weak fundamental trends like UA, FOSL, JWN, KHC, etc.. Those bad stocks are also currently dropping, but I think assuming there is additional room to the downside is still reasonable.
Jeff: Thanks, John
We’ll let you know if John decides to edit his Watchlist. In the meantime, feel free to use it as the basis for your own list of stocks that will benefit from a trade agreement. Finally, to learn more from John about how he uses options within his Strategic Trader service, click here.
