The Art of Not Actually Scrapping Trade Deals

Here are some headlines from about a year ago:

• Trump’s Protectionism Threatens to Unravel Decades of Trade Liberalisation
• How a Trump White House Could Devastate Asia’s Trade (and America’s)
• Trump and Trade: A Radical Agenda?
• How a Trump Administration Could Lead to Trade and Capital Controls
• Global Trade Rebound Threatened by Protectionism After Trump Victory

These stories aren’t cherry-picked—in the immediate aftermath of Donald Trump’s surprise US presidential election win, concerns about an approaching wave of protectionism were everywhere. Yet a year later, he hasn’t actually done much on the trade front. To us, this shows the importance of not letting campaign trail talk drive investment decision-making.

When Trump won, investors were largely fearful. Markets generally prefer freer trade, but Trump had talked a big protectionist game during the campaign. He declared other countries are “killing us on trade,” pronounced NAFTA the “worst deal ever” and promised to label China a “currency manipulator” on “day one” of his presidency.^[i] Soon after taking office, President Trump appeared to fulfill the worst fears by withdrawing the US from the Trans-Pacific Partnership (TPP), a pending free-trade agreement between America and 11 other nations. But the TPP torpedoing was mostly symbolic. The agreement was likely dead in the water anyway, with both Trump and Hillary Clinton opposed, insufficient popular or legislative support in the US, and ratification roadblocks in other participating countries.

Other trade moves were similarly symbolic. Yes, he blocked a Chinese venture capital fund from buying a US computer chip manufacturer on national security and intellectual property grounds—a form of veiled protectionism. But this isn’t new. President Obama did the same thing for basically the same reasons in 2016, and George W. Bush similarly blocked Dubai Ports World’s planned acquisition of 22 US ports a decade prior. Yet here we are in 2017, not in a trade war with China or the UAE. Likewise, some presently talk up restrictions on imported Chinese solar panels. While none have emerged yet, it’s worth noting Obama did the same thing more than once. As for that promise to label China a currency manipulator—opening them up to trade restrictions—Trump’s Treasury declined. Logical, considering China never met the Treasury’s criteria.

Canadian trade relations have hit a few small roadblocks, but nothing yuuuuuge or shocking. Commerce Secretary Wilbur Ross announced a 20% tariff on some Canadian lumber in April—but this was way overrated: The tariffs were in the works long before Trump took office, stemmed from a long-running dispute between US and Canadian lumber interests and haven’t been finalized yet. Similar story for the recent tiff between Bombardier and Boeing: Boeing wants tariffs on certain Bombardier planes, arguing the Canadian government subsidizes them. Thus far the Commerce department has been sympathetic—but again, nothing is finalized—and regardless, these aren’t the sort of sweeping barriers that would spark major retaliation or spread worldwide. WTO members usually have several per year.^[ii]

NAFTA is perhaps thornier, at least for now. Trump opened renegotiations as promised, and (reportedly!) they aren’t exactly going smoothly. While pregame comments from Ross and others hinted at broadening the deal—e.g., opening markets for digital services—actual starting positions are tougher. US negotiators have demanded (among other things) a five-year sunset clause, suggested a 50% local-content minimum to qualify for tariff-free auto imports, and proposed restricting Mexican long-haul truckers from operating in the US. Mexico and Canada have objected. Meanwhile, Canada has put forth its own fresh demands, including stronger labor protections and tougher environmental provisions. With so many differences, it’s no surprise negotiations have been heated, with all sides expressing frustration at times. Some wonder: Could the disagreements lead to a narrower deal or its cancellation altogether?

Mexican stocks seem to reflect this uncertainty. Mexican exports to the US were $302.6 billion in 2016, while Mexican imports of American goods totaled $189.1 billion.^[iii] America accounts for 80.9% of total Mexican exports and 46.3% of total imports.^[iv] An estimated 1 million Mexican jobs depend on NAFTA. Thus, while Mexican markets don’t solely take their cues from US trade policy, Exhibit 1 suggests sentiment stemming from it is a big driver recently. Trump’s surprise win seemingly hit Mexican stocks hard, with Mexico lagging Emerging Markets and the MSCI All Country World Index from the election through January 12, 8 days before Trump’s inauguration. But for the first seven-plus months of Trump’s presidency, Mexico outperformed—a stretch coinciding with the administration’s apparent softening. They didn’t resume underperforming until August 21, just days after NAFTA negotiations began.   

Exhibit 1: Mexico’s Performance Relative to Emerging and Global Markets

Source: FactSet, as of 11/10/2017. MSCI Mexico, MSCI Emerging Markets and MSCI All Country World Index, all with net dividends and indexed to 100 on 12/31/2015. Mexico is outperforming when the lines are rising.

While Mexican stocks’ sensitivity to NAFTA talks may seem disconcerting, we see an upside—efficient markets are discounting rumors and negotiation chatter. US and Mexican stocks are digesting all this stuff at the same time. Mexico’s underperformance suggests a weaker or nonexistent NAFTA wouldn’t be a total shock—nor would it be sudden. NAFTA rules stipulate a six-month (nonbinding) notice for any departing country. Yes, Trump probably wouldn’t need Congress to approve, but he does need voters in Texas, New Mexico and other NAFTA-loving states to win in 2020. Re-election is a powerful motivator. If negotiations don’t materially impact NAFTA, we’d expect relief to lift Mexican and American markets.

While losing NAFTA (still hypothetical) would be a setback for trade, that doesn’t mean it would necessarily trigger a bear market or recession. Markets move on probabilities, not possibilities. The only trade war in modern history that wreaked market havoc occurred during the Great Depression, when the blowback to Smoot-Hawley went global. Even then it wasn’t the sole cause of the downturn, as the Fed bears significant blame. Big as NAFTA is, its death isn’t equal to massive trade barriers rising worldwide. It would create winners and losers, but that’s different than a bear market. Another possibility is former NAFTA countries underperforming during a global bull market. Or, maybe markets will have priced in a dead NAFTA by the time it became reality—sell the rumor, buy the news. It’s impossible to say today. This is why basing portfolio moves on NAFTA angst seems premature. Investors will have time to get the facts and consider probabilities. In the meantime, remember heated trade negotiations are the norm. But actions speak louder than words.  

[i] There are issues with all of these arguments, but we won’t go into them here. For more, though, see other MarketMinder articles like this one, this one and this one.

[ii] Never mind that US Export-Import Bank in the corner.

[iii] Source: FactSet, as of 11/13/2017

[iv] Ibid.