Tariffs Kick Caterpillar Where It Hurts

In this episode of Market Foolery, host Chris Hill and Motley Fool contributors Aaron Bush and Matt Argersinger take a look at the market today. 3M (MMM 0.41%) and Caterpillar (CAT 1.58%), mostly Caterpillar, triggered a bit of a marketwide sell-off.

It turns out construction companies are more than a little affected by steel tariffs. How much big-picture impact will these tariffs end up having? Does spiking volatility in the markets, especially in China, present a buying opportunity for international stocks? What should investors watch when they're combing through non-U.S. companies?

And a dip into the Fool mailbag brings us the question: What happens to Tencent shareholders when Tencent Music Entertainment goes public? Tune in to find out more.

A full transcript follows the video.

This video was recorded on Oct. 23, 2018.

Chris Hill: It's Tuesday, October 23rd. Welcome to Market Foolery! I'm Chris Hill. As you can probably tell from the ambient noise, we're not in the studio. We're in Denver, Colorado. We're here for our member event. And fortunately, I'm not alone. Producer Dan Boyd -- not behind the glass, just sitting right next to me, and I'm here with Aaron Bush and Matt Argersinger. Thanks for being here, guys!

Matt Argersinger: Hello!

Aaron Bush: Hello!

Hill: A couple of things. We're going to dip into the Fool mailbag. Let's start with the market, though. We get off the plane this morning, I don't know about your email, but my email starts blowing up with news flashes. "Market Tanking, 2 Dow Components, 3M and Caterpillar." Caterpillar is the one that's really getting attention because that stock is down more than 7% because Caterpillar came out and warned basically everyone, "Hey, the cost of what we make is going up because the cost of steel is going up. This all plays into tariffs." Aaron, I'll just start with you. Tariffs are an issue that, I think increasingly, investors both at The Motley Fool and around the world are starting to grapple with. How do you think about tariffs? This is starting to affect a lot of different companies.

Bush: Tariffs are starting to be in the headlines more. If you think about what type of companies that it tends to affect, though, it tends to be the companies selling big, physical goods that pass through borders. A lot of focus gets put on those companies, but most other companies are fine, especially as we turn into a more digital economy, more services. Those types of things don't have the same level of tariffs. Plus, if you look bigger picture and look across history, back in the 1800s, early 1900s, tariffs were way higher than they are today, and that's when the U.S. became a superpower. So, even though they've fallen since the Great Depression or so, I don't think a big hike in tariffs changes the entire narrative of the economy. I'm not too worried about that.

Hill: Matty, to play off of what Aaron said, yeah, there are certainly a lot of companies out there that aren't directly affected by tariffs. But there is the headline risk. Particularly with the volatility we've seen in the last couple of weeks, it does play into this narrative of, "Hey, selling is going on, so I'm going to sell shares of my restaurant stock, even though it's not affected by steel tariffs in the same way that Caterpillar is."

Argersinger: That's right. It's easy to dismiss what's going on as short-term noise, that we've had tariffs in the past and we're going to get through this. But there is something to say that we are in a situation where input costs for certain companies are going up. We've had this period of time when corporate earnings and margins have been at record highs. And we've looked for plenty of excuses to see when those will finally go down -- whether it's wages going higher, inflation, as we're seeing with input costs, if tariffs become an issue. Standing back from things, you have to say, maybe we are at a period where, because of what's going on, even though, at the margin, it does affect profitability at the edge. Depending on whether or not these tariffs, whatever they evolve into, whether we go into a full-blown trade war, I don't know. But I don't think they're as easily dismissible as we'd like to think they might be.

Bush: I'll just add that most of this narrative is around China. China is an important trade partner, but the world is a lot bigger than just China. Picking and choosing your spots, if you're really worried about tariffs, can save you a headache.

Hill: Let's stick with that. As I mentioned, we're here for a member event. At the moment, we're in the lobby of the Four Seasons Hotel here in downtown Denver. One of the things we're going to be talking about at the event on Thursday with the two of you and with Bill Mann is, we're going to be having a cozy little fireside chat. By fireside, I mean, on main stage, in front of hundreds of people. We'll be talking about global investing. Matty, I'll start with you. At this moment in time, how are you thinking about non-U.S. investing?

Argersinger: First of all, you think we've had volatility here in the U.S. stock market, the international markets, especially emerging markets and China, have experienced significant volatility for several years now. We've talked on the show, the Chinese stock market entered a bear market over the summer. The Shanghai index, the Shenzhen index both are down at least 25% last I checked. As a Foolish, long-term investor, that excites me, and I'm glad we're going to be talking about it with Bill Mann here in Denver. I think there are a lot of opportunities. Aaron, Bill, and I recommended a lot of stocks about a month ago. Our timing looks absolutely awful right now. Especially some of the Chinese companies we recommended are down. I'll give one example of that. iQiyi, a company we've talked about on the show, the "Netflix of China," IPO-ed at $18 earlier this year, shot all the way up to almost $47, and now it's back around $20. It's close to its IPO.

Hill: Is it really?

Argersinger: Total round trip.

Hill: I've got to put that on my watchlist. Well, it was already on my watchlist, I've got to move it a little bit higher on my watchlist.

Argersinger: That's just one example the kind of volatility we've seen in the market. I'm sure Aaron will agree with me, I'm starting to see a lot of opportunities to potentially take advantage of.

Hill: What do you think, Aaron?

Bush: Part of what's interesting about international investing is, maybe 30, 40 years ago, there were way more companies in the U.S. that traded publicly than internationally. Today, it's completely flipped. The number of companies trading in the U.S. has shrunk and there are far more companies trading around the world. As other countries mature, their demographics move along, we're starting to see some pretty impressive innovation in a lot of different places -- really all over the world. When I look out, looking through the volatility, there are so many awesome companies out there that are still able to be invested in.

Hill: As a general rule of thumb, this is a question for both of you, when you start looking outside the U.S., how does your process begin? Does it begin geographically? Or does it begin by industry?

Bush: I tend to be more bottoms up. I'm just looking for greatness, wherever it is. But there definitely is a component of where it is located. Geopolitical risk is very much a factor. But sometimes the best businesses come out of tough environments. Being able to find businesses that excel in tough spots is often a really good sign.

Argersinger: I'll say, industry is an interesting way to put it. One of the things we focused on a month ago when we were recommending stocks for our new global partner service, is we steered away from the 3Ms and Caterpillars of the world, to use the two examples we talked about at the beginning of the show. Companies that are heavily capital-intensive, are very exposed to commodity prices and things like that. Instead, we're looking at companies -- I mentioned iQiyi -- that are really on the cutting edge of their industries. Technology companies, enterprise software, cloud-based companies. Companies that we love and treasure here in the U.S., there's a lot of companies doing the same thing overseas. Atlassian, the Australian company, is another one we've talked about, as well. There's a lot of great dynamics. Companies that we would call Rule Breakers don't only exist here in the U.S. or out in Silicon Valley. They're all over the world. I love uncovering them with Aaron. I think the volatility that we've seen recently is popping up a lot more interesting opportunities.

Hill: Our email address is [email protected]. Speaking of international investing, I've got a question from Kiran Anand. I hope I'm pronouncing your name correctly, Kiran. From Dubai. The email begins, "I started investing in U.S. stocks in 2013 after listening to a few of your podcasts. It's been very satisfying to either see investments play out or learn something important." I like that. [laughs] I like that it starts with our podcast. I like that it's also, "Eh, some of them work out, and when they don't work out, I try and take a little learning from it." That's a great thing to do as an investor. "It's also been very educational as a small business owner to understand how businesses could be analyzed, valued, and CEO performance scrutinized. One of my recent investments was Tencent Holdings. My question is more about the announced spinoff IPO of Tencent Music Entertainment. As an existing shareholder of Tencent Holdings, do I miss out on this part of the business? Or do I automatically receive Tencent Music Entertainment shares? Is this similar to what happened to eBay (EBAY 0.61%) and PayPal (PYPL 1.96%)? Are there any differences in how it's handled because it's a Chinese stock? I know that's technically three questions, but hopefully you'll let that slip by. Thanks again."

Great question! Aaron, if you're a shareholder of Tencent Holdings, eventually, when Tencent Music Entertainment spins off, do you automatically get those shares?

Bush: You don't have to do anything. This isn't a complete spin-out. This is a partial spinoff, where they're raising money in public markets. Right now, Tencent owns majority stake in Tencent Music. After the IPO, they will continue to own the majority stake. Just by owning Tencent itself, you will own a piece of Tencent Music. Of course, you could go in and buy more, but it'll just be automatic. It's still there.

Hill: That's beautiful! I love not having to do anything. He mentioned eBay and PayPal. I was an eBay shareholder. As a result of that, I'm a PayPal shareholder. I think this is the first time I've been involved in a spinoff like that. It's worked out pretty OK for eBay; it's worked out quite well for PayPal. I'm curious, Matty, if you've been involved in spinoffs before, where the spin off happens, and you automatically make a decision about one of those two companies. I was always going to sit back. Even though at the time, I thought, "I think PayPal is going to do better," I still felt confident enough in eBay that I was going to hold on to those shares. But I'm curious if you've been in situations where you're like, "Oh, this good thing is being spun off? I'm dumping the other one."

Argersinger: I can't recall, thinking back, a situation that I've had. I was also an eBay shareholder when that happened. Even though I kept my eBay shares, I remember at the time, I was like, "I'm glad I'm getting PayPal shares, and I should probably add to my position in this one." I was kind of cut in half a little bit. I should have had more exposure to PayPal. Looking back, of course, that would have been smarter to do. But, no, I can't think of a situation. Generally, spinoffs tend to be undervalued in the market, at least initially. Oftentimes, they're good places to actually add more capital. Don't get diluted out of the good thing, because the good thing is generally being spun off.

Hill: By the way, I know that there aren't absolutes in investing when it comes to "buy signals" or "sell signals," but as close to perfect as I can think of is, a company splits, and the CEO decides to go with one of the two companies. I'm thinking of Meg Whitman when Hewlett-Packard split, and she said, "I'm going to go with this one." I remember thinking at the time, "She's a smart woman. I'm pretty sure that's going to be the better business to invest in. That seems like as big a lock as there could be."

Argersinger: Follow the leader in those situations. Definitely follow the leader.

Hill: I know you guys are going to get out to our Colorado office. I appreciate you hanging with me here in the lobby of the Four Seasons.

Bush: Thanks, Chris!

Argersinger: Thank you, Chris!

Hill: Aaron Bush, Matt Argersinger, thanks for being here! As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. That's going to do it for this edition of Market Foolery. The show is mixed on the road by the one and only Dan Boyd. I'm Chris Hill. Thanks for listening! We'll see you tomorrow!