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What's Up With the Phase One Deal?

By Mac Greer - Jan 17, 2020 at 8:00PM

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The market has gotten pretty used to ignoring trade war news, but this update is markedly tangible.

In this episode of Market Foolery, Mac Greer chats with Fool analyst Emily Flippen about some business news. After years of trade antagonism, the U.S. and China reached phase one of a trade deal. What does this deal really entail, and how excited should investors and consumers really be about it? Emily explains.

Also in business news: Morgan Stanley's (MS 2.48%) stock popped on much better than expected results this quarter. And a new law that's making its way through the House could have big ramifications for the cannabis industry, assuming it doesn't die along the way. Tune in to hear more.

To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. To get started investing, check out our quick-start guide to investing in stocks. A full transcript follows the video.

This video was recorded on Jan. 16, 2020.

Mac Greer: It's Thursday, Jan. 16. Welcome to MarketFoolery! I'm Mac Greer, and I am joined in studio by Motley Fool analyst Emily Flippen. Emily, it is just you and me. How are you doing?

Emily Flippen: It is. Thanks for having me on again! Doing all right.

Greer: Well, always great to have you on. We're going to talk some big earnings from a big bank. And we're going to talk about a potential game-changer for cannabis stocks. I'm actually going to find out from you, is it a game-changer? Or is it much ado about nothing? Or somewhere in between?

But we begin with big trade news: the U.S.-China trade deal now under the phase one agreement that was signed on Wednesday. China will purchase an additional $200 billion of U.S. goods and services over the next two years. In exchange, the U.S. will reduce tariffs on $120 billion in Chinese products. Now, Emily, this is an 86-page agreement. There's a lot of moving parts. There's a lot more going on here. But I think investors have gotten pretty good over the last couple of years of just shrugging off all the China-U.S. trade war news. So what does this deal, what does this phase one agreement, mean for investors?

Flippen: It's more of a sign of good faith on the part of China and the U.S. than really doing much for investors and for relieving tariffs. For the average American consumer -- you mentioned the stock market's been on fire -- they're probably not even aware of the lengths that the trade war has come to, and what this deal means for them. The New York Times put out an interesting article that broke down the cost of the trade war for the average American household. And while you hear big numbers like $200 billion of consumer goods, ultimately what that trickles down to is, depending on your income level, this trade war over the past year has cost the average American family between $340 to $970. Despite the fact that the market's been on fire, the average American is spending a little bit more for a lot of those basic consumer goods this year than they were last year as a result of the trade deal.

But for investors, we mentioned the fact that the market's been great. There's still lots of strong impacts on these consumer goods companies as a result of the trade war that we're still seeing. But in large part, the market's been on fire because of tech companies that really don't see the day-to-day impacts of the trade war. I do think that looking forward, this might be a good thing for investors who are looking to get into Chinese companies. It could be a cyclical movement back into these Chinese companies that have largely been abandoned over the past two years.

Greer: Emily, you are our resident expert in China. You lived in China; you studied in China; you are a student of China. When you've seen this trade story play out over the last couple years, what do you think we're missing?

Flippen: I think people miss the motivations behind China. We, for a large part, understand the U.S.'s motivation. We don't like counterfeit goods. We don't like intellectual property theft. We feel threatened by China's currency manipulation, what have you, during the market today. There are concerns from U.S. consumers about China. But you have to understand where China's position is when they come in and they negotiate things like trade deals. In my opinion, the single most important thing to remember about China is that they want to look good on an international stage. Trade wars do not make China look good. Also, things like the Hong Kong protests, or reports of Uyghurs being forced into essentially concentration camps in western China -- these are all things that China does not want to talk about, does not want them on the front page of the paper, and does not want international organizations reprimanding them for. So they are motivated to reach a trade deal with the U.S. in large part because, not just that it's hurting their economy, although it is, it's hurting the U.S.'s too, like we said, but because it makes them look bad.

Greer: Back to what this might mean for investors. We know over the last couple years, as I mentioned, and as you mentioned, the stock market hitting new highs. So, investors seem to have gotten pretty good at just shrugging off all this trade war news. At the same time, as you mentioned, we know it has a real impact on consumers. We certainly know it has an impact on businesses. Agriculture, or if you have a business and your cost of doing business is going up. And yet, we seem to be able to reconcile, or live in two different cities, with the stock market going up and this ongoing impact of the trade war. I guess my question is, given that we've shrugged it off, how much shrugging should we do with this news? Or, is this truly something different?

Flippen: It does feel a little bit lackluster. For an 86-page agreement, not much has been accomplished here. That's not to say that future agreements, future phases won't accomplish something. Hopefully they will. But it is a long way to go. Investors, yeah, it's almost like we're accepting trade wars as the new normal, because it's not just with China; we're also having trade disagreements with the entire European Union, which has forced the price of wine thus far, but likely other products, such as cheese, to go up as well. And it's not being reflected in the markets right now -- for good reason, because like I said, the stocks that are propping up the market have not really had exposure to these trade war issues. But I do think it's going to start impacting the consumers' pocket, which could trickle down.

Greer: As we wrap up this story, what are you watching going forward?

Flippen: I'm going to be watching to see when consumers start getting slightly more upset about the costs that are being pushed onto them. Like I said, that $372 to about $970, it's not something that the average consumer is really aware that they're paying. If trade [war] does become the new normal, if we're not able to fix these trade wars, and consumers are paying more and more for products that they've become accustomed to paying lower prices for, I think it'll be interesting to watch when the American consumer starts to have these issues, and what they do.

Greer: Let's move on to investment banks and some big profits from Morgan Stanley. Emily, shares up around 7% at the time of our taping after Morgan Stanley reported better than expected earnings across the board. Their three main businesses -- investment management, wealth management, and trading -- all doing better than expected.

Flippen: It was a great quarter for Morgan Stanley. Their earnings per share was actually 30% higher than what was expected for the quarter, and expectations for the quarter were already pretty high. They saw a 27% increase in revenue. And like you said, all their divisions have been doing relatively well. It came from their investment management division. And they associated it with what they called a large IPO in Asia. They didn't provide much more color than that. However, if I had to guess, I think that would be Alibaba's secondary listing on the Hong Kong Stock Exchange, for which Morgan Stanley was an underwriter for. So, they saw a near $700 million pop as associated with this investment management that they did on behalf of their clients. So, a large earnings increase in part because of this one-off event. But otherwise, still a good quarter for Morgan Stanley. They continue to thrive despite the fact that it's a low interest rate environment. We see lots of stuff moving the markets in the financial industry, which has been largely supportive of their business.

Greer: But that's a pretty good pay-off, $700 million. I mean, it's not quite what it used to be. To me, that feels like a lot of money.

Flippen: [laughs] It is. It is definitely a lot of money. But I will say, other divisions, in particular their wealth management division, despite still growing, they've been really squeezed because of the low-fee environment that we're entering. I think people are becoming increasingly skeptical of paying somebody to manage their assets for the. The landscape now is so much more competitive for the price that you can charge to manage assets. Internationally, it's fine. But here in the U.S., we're seeing that get squeezed.

Greer: Emily, let's close with some cannabis news. Now, a bipartisan group of lawmakers introduced a bill and the U.S. House of Representatives on Monday that would give the FDA flexibility to allow hemp-derived CBD oil to be sold as a dietary supplement. Now, the news lifted cannabis stocks like Charlotte's Web and other cannabis stocks. As someone who has studied the cannabis industry, explain what this means and the implications for investors.

Flippen: It does have very strong implications for the CBD space in the U.S. That's largely because any company that is selling CBD products right now can really only do it legally by selling it as topicals. If you sell something that's hemp-based CBD as a dietary supplement, you're technically violating the FDA's guidelines there. And that goes back to the federal Food and Drug and Cosmetic Act, the FDCA, which simply states that any substance that has been studied for pharmaceutical uses can't be sold as a dietary supplement. This really tied the hands of CBD companies, because GW Pharmaceuticals not too long ago was approved for the first CBD derived drug, Epidiolex. Now, this helps people with rare forms of seizures; however, because there was a pharmaceutical use for CBD, the idea that other companies can come along and then sell CBD as a dietary supplement, when it was already approved as a drug, was a big issue that was preventing the FDA from making a decision about what we do with so many companies, Charlotte's Web being one of them, that are essentially illegally selling dietary supplements right now. So, it's important to remember that this bill is a big step. It does have bipartisan support, but it's only just been introduced in the House. If it is approved by the House, it will then move on to the Senate. We've seen lots of bills die in the Senate. Priorities right now are not so much on passing smaller legislations such as this one. However, Majority Leader Senate Mitch McConnell, he does have a background. His state is largely a producer of hemp. So, he has some interest there in potentially getting this through the Senate. So, I think it does stand a decent chance of passing. I just don't know at what speed it will do so. If it does pass, then the FDA then has to come in and say, "OK, we've studied this product, we think it's OK for consumers to consume it," and then you can sell it as a dietary supplement. To keep a very long story, which is already kind of long, short, essentially, it's a good first step, but it's only a first step, and it will take a long time to get there if it does pass.

Greer: OK, so, my summary -- tell me if this is right. I'm going to give you a three-sentence summary here, OK? Opens up new market. Good for business. Good for investors.

Flippen: I'll add, not yet.

Greer: Not yet.

Flippen: It's not there yet.

Greer: I was so close. OK, time for our desert island question. This one's going to be a little tricky because of the U.S.-China trade deal. So, I'm first going to ask you, given the partial trade agreement, is there a particular stock, a Chinese stock, that you think stands to benefit disproportionately relative to other stocks?

Flippen: I actually think the entire industry in China has been largely moved out of. E-commerce companies, for instance. One of my favorite companies, Baozun, the Shopify of China, has a decent amount of trade war exposure, and that's largely hurt the company. But even pure-play Chinese companies, so, Chinese companies that don't have exposure to the trade war, companies focused on live streaming, for instance, that have no exposure to the U.S. market, have still been hit. I think the entire industry there in China, or division there in China, has been ignored by investors.

Greer: OK, I'm going to go with Baozun. Is that correct?

Flippen: Sounds good.

Greer: So, you're on a desert island for the next five years, and you can only own one of these three stocks. We've got Baozun, Morgan Stanley, or, let's say, Charlotte's Web.

Flippen: I would definitely pick Baozun. That might be surprising for people, because I do follow the cannabis industry, but I think the huge pop we've seen today, while it's great and I like the legislation that's being moved on behalf of the House for cannabis, I think it does take a longer time to get there. I think there's a lot of details that need to be worked out. And the devil's always in the details. Versus Chinese companies, these are businesses that have been around for a while. They're profitable, for the most part. And it's largely just the fact that investors have been too scared to invest in it, unlike cannabis, for whatever reason.

Greer: Well, as always, people on the show 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. Emily Flippen, thanks for joining me!

Flippen: Thanks for having me!

Greer: That's it for this edition of MarketFoolery. This show is mixed by Dan Boyd. I'm Mac Greer.. Now, the stock market is closed on Monday, so we will see you on Tuesday. Thanks for listening!

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