We’ve long said markets love free trade, and we’ll say it again: We’re über pro-trade. But genuine free trade and trade pacts aren’t equivalent. Over time, much of the public has bought into the notion that trade pacts are inherently bullish. They aren’t. They aren’t even essential for free trade. Why anyone believes you need the government to negotiate trade at all is something of a mystery and anachronism to me. International trade isn’t a bulk transaction between nation-states. It is the aggregation of billions of transactions, big and small, from you buying something from a foreign website to manufacturers and retailers sourcing merchandise from abroad. Genuine “free” trade would imply liberation from the machinations of governments, yet it seems headlines and pundits can only muster talk of governments negotiating (read: bickering).
Think back to classical economics, before the days when people fetishized abstract math equations as reality. One of the central issues of the time was Mercantilism: “the economic theory that trade generates wealth and is stimulated by the accumulation of profitable balances, which a government should encourage by means of protectionism.”
That last bit is what matters most for this discussion: “which a government should encourage by means of protectionism.” Ask yourself: what exactly is a trade pact, even if its intention is to promote trade? Why, it’s mercantilism! All a trade pact does is create special relationships between one country and another (or sometimes several). By definition, that favors some nations over others. Many trade pacts have loopholes for “national champions” and sensitive local industries like agriculture and auto manufacturing. Basic mercantilism. Real free trade would be an environment where all countries have a shot to do business with each other, free from government meddling and favoritism.
This isn’t to say greasing the rails for more trade is an evil thing if it reduces barriers between nations. The massive jump in trade with Mexico—exports and imports—and the jobs created as a result are a testament to this. But as investors, trade pacts tell you virtually nothing about future profitability, nothing about the relative equity performance of countries, and generally little about future prosperity that is actionable for a portfolio.
Research is often a game of trial and error; vision and revision. A few years ago, Korea’s veritable free trade spree looked like a wonderful opportunity. Korea signed agreements with countries representing roughly 40% of their trade in about 3 years. However, Korean stocks underperformed, and trade deals had no discernable impact on stocks or actual trade data. It simply takes too long for the deals to phase in. Trade pacts, particularly among big nations, take forever to hash out (let alone implement), and there are so many other forces at work in the global economy that they tend not to be the force people think they will be. Even with the world’s marked increase in free trade agreements, global goods trade still sagged the last couple years. Trade barriers were lower, but other forces won out.
What investors should really look for, and fear, are government actions that curtail trade in big ways—like sweeping tariffs. Smoot-Hawley back in the Depression era created a wallop by massively choking off trade in rapid fashion. Said differently, the real risk is a big, negative change to trade in a short time. Wallop! The mere absence of a trade pact isn’t nearly the thing people fear it to be. The death of the Trans-Pacific Partnership (TPP), for example, merely extends the status quo—which stocks have already proven they’re fine with—instead of gradually reducing some tariffs and barriers over several years. Distant, gradual, well-telegraphed changes lack market-moving surprise power, good or bad. Keep that in mind not only for the US, but also as headlines persist for Brexit and the EU.
It’s the old saw: Governments can’t create wealth, they can only distribute it. That’s true for trade as it is anything. Trade pacts create winners and losers, but they don’t necessarily increase prosperity. That’s why they’re mercantilist.
As this year progresses, trade will be in the news. Remember—it isn’t really about NAFTA, TPP, TTIP, Doha, MERCOSUR or any of the others. It’s about whether global trade is more or less free to happen and having as many participants as possible in the game. Everything else is bluster and noise for investors.