Americans did vote for tariffs when we elected Donald Trump. Many perhaps thought they’d be implemented with a clearer strategic purpose. I had hoped we’d use them to open up foreign markets such as the EU, reducing our trade deficit by exporting more not by importing less. And most voters probably weren’t voting for a recession, odds on which Goldman Sachs revised up to 35% for next year.

Among the improbable targets of tariffs on steel and aluminum imports are screws, along with bolts, nuts, coach screws, screw hooks, rivets, cotters, cotter-pins, washers (including spring washers) and similar articles, of iron or steel. These are all members of the Harmonized Tariff Schedule (HTS) code 7318.

When a blunt instrument is applied with force, it will inevitably hit more than the intended target. Last year we imported $7.05BN of HTS code 7318 products and exported $5.63BN, for a trade deficit of $1.43BN.

There’s no particular trend in the series. The net balance in HTS 7318 was worse in 2022 than last year. Exports have been growing at 12% annually, faster than imports at 9%. We bought almost two thirds of our HTS 7318 imports from just three countries: Taiwan, China and Japan. The two biggest buyers of our exports were Canada and Mexico under the USMCA and no doubt including the auto sector’s integrated cross-border assembly processes.

China’s the world’s biggest exporter in this category and the US is the biggest importer. But that’s true for many traded items.

The trade deficit in 7318 doesn’t seem especially problematic. Manufacturing screws isn’t obviously in the national interest. If other countries can make them better and cheaper, go for it. The net deficit in 7318 is only 25% of our exports. There’s a lot of two-way flow in the category, as what economists call comparative advantage drives production to where it’s done relatively better.

Somebody is getting screwed with 7318 tariffs, and the market fears it might be the American worker.

Adding manufacturing jobs is always good, but US manufacturing employment is in fine shape. A decades-long decline ended when the shale revolution began to lower domestic gas prices.

During tariff turmoil, midstream energy has been showing its value as defensive sector, beating the S&P500 by 17% since the election. A Fox News poll found that 69% of Americans believe tariffs will lead to higher prices. White House trade counselor Peter Navarro claimed they’d act as a tax cut, a fringe view that’s simply wrong.

It’s not only that US energy has limited exposure to tariffs. Many pipelines are regulated by FERC which links price increases to PPI. The FOMC’s most recent Summary of Economic Projections showed policymakers had shifted their growth expectation down and inflation up, hence the stagflation headlines that accompanied its release.

Pipeline investors have little to fear from inflation given that around half the industry’s EBITDA is linked to PPI. In 2022 when inflation reached 9%, midstream returned +21% while the S&P500 was down 18%.

The market is pricing in at least two rate cuts by the end of the year, suggesting investors expect the Fed to regard tariff-linked inflation as temporary. In this scenario, midstream earnings will get a boost from the PPI linkage while maintaining relatively attractive yields.

Energy consumption is very stable (see Midstream Is About Volumes). Power generation is rising because of AI demand after two decades of being flat. Liquids (about half of which is gasoline) have been between 20 and 21 Million Barrels per Day for many years. Natural gas consumption continues to grow strongly. For fifteen years this was driven by the coal to gas switch in US power generation. Now increasing LNG exports and the growth in data centers are the drivers.

There’s little reason to expect any of these trends to change.

Morgan Stanley noted that Oklahoma’s natural gas rig count has risen from 44 to 54 this year in response to higher prices. They expect the beneficiaries to include Energy Transfer, Oneok and Targa Resources as E&P firm Anadarko pushes increased volumes through their infrastructure.

Shipping giant AP Møller-Maersk expects the EU’s proposed maritime emissions trading scheme to encourage the use of gas-powered engines, saying it was, “highly likely that fossil LNG remains the cheapest option.”

LNG stocks have sagged recently on fears that a cease-fire in Ukraine could see increased Russian gas exports to the EU. A senior coalition member in Germany’s new government recently said the sanctions regime was hurting the EU more than Russia. We continue to think the White House would not look kindly on a resumption of gas shipments through Nordstream.

We have two have funds that seek to profit from this environment:

Energy Mutual Fund

Energy ETF

 

Which is a more important measure of an investment manager’s skill – the return on the first dollar invested at inception, or the return on the average dollar?

Return since inception is widely used because it covers the longest period. If performance is reasonably consistent, both methods should tell the same story. That this is not the case is surprisingly common.

It was the motivation behind my 2011 book The Hedge Fund Mirage: The Illusion of Big Money and Why It’s Too Good to Be True in which I showed that the average hedge fund investor would have been better off owning treasury bills, even though the industry’s since inception return was good. Although hedge funds generated substantial profits, the 2 and 20 fee structure transferred most of those gains to managers.

The Hedge Fund Mirage received coverage in my favorite magazine, twice (see The Economist Once More Writes About The Hedge Fund Mirage). Since my writing aspires to be as good as theirs while inevitably falling short, I took this as the ultimate endorsement.

Several hedge fund managers told me they fully agreed with the revealed widespread mediocrity, while noting that it didn’t apply to their hedge fund. Hedge fund consultants, who make a living promoting them, were critical (see The Hedge Fund Lobbyists Fight Back). Thus was the gulf in IQ between the two groups confirmed.

The difference between the two measures of performance is explained by the fact that early hedge fund investors did well but weren’t that numerous. As new money flowed in and hedge funds went mainstream, profit opportunities became scarce under the weight of this additional capital. During the 2008 Great Financial Crisis I estimated hedge funds lost $500BN, wiping out all the profits they’d ever made. The promised delivery of absolute returns came up short.

It can be illuminating to apply this analysis elsewhere. Three years ago, I did this for a popular $15BN fund (see ARKK’s Investors Have In Aggregate Lost Money). Equity funds can lose money because of a weak market even if their stock picks are good, so some might say this is an unfair way to look at Cathie Wood’s ARK Innovation ETF (ARKK).

More recently, a team at Morningstar found that Cathie Wood’s firm ARK Invest tops the list of value-destroying fund families at $13.36BN over the past decade. The S&P500 returned 13.1% pa over the same period, a considerable tailwind. It seems Cathie Wood isn’t very good at picking stocks.

At this point a friend of mine who ran government bond trading at JPMorgan decades ago would helpfully say, “Simon, if you had her money, you’d burn yours.” Which is to say that the failure of her investors to avoid poor manager selection hasn’t impeded Ms Woods’ ability to become rich. Her net worth is estimated at over $250 million.

The fortunes of clients and their money manager have rarely diverged so spectacularly.

Inflows to the ARK Innovation ETF (ARKK) peaked in late 2020 following an annual performance of 152.8%. Since then, ARKK has lost over half its value.

Many of those 2020 investors are deeply underwater and are hanging on, waiting for a recovery. Inducing abject hope in your clients can be a powerful asset-retention strategy.

In other news, there are signs that opposition to reliable energy in New England might be softening. A recent conversation took place between NY governor Kathy Hochul and President Trump over the Constitution pipeline.

Intended to deliver natural gas from Pennsylvania to a hub near Albany for further distribution, Williams Companies finally threw in the towel in 2020 after four years of challenging the New York State Department of Environmental Conservation’s 2016 denial of a key water quality permit.

New York and its neighboring New England states have some of the country’s highest energy prices. This is because renewables are expensive, and they sometimes have to import liquefied natural gas. Democrats are worried that working class voters in poor Boston communities won’t prioritize climate change as highly as the college-educated progressives who drive policy.

Much needs to be agreed upon before the construction project can be resurrected. And WMB will worry that the pipeline won’t be fully utilized for its projected 30-40 year useful life if regional policy turns back against hydrocarbons.

But it was surprising that New York’s governor could have a productive conversation with Trump about any topic. Perhaps some pragmatism is intruding.

It also highlights the enduring appeal of natural gas. While US gasoline demand may have peaked in 2019 before the pandemic, natural gas consumption continues to grow along with exports. It’s why we often remind investors that the Natural Gas Transition is the only energy shift of any consequence in the US.

We have two have funds that seek to profit from this environment:

Energy Mutual Fund

Energy ETF