Q&A: Of tariffs, trade and international equities

05-15-2018

Senior Portfolio Manager Leo Vila offers perspective on possible impacts and considerations for investors.

Q: How has all the speculation about tariffs and trade affected global markets, particularly international equities? The speculation has added extreme volatility to commodity prices. Companies with exposure to those targeted areas have also seen their stock prices decline. One of the largest, most immediate impacts is the rapid depreciation of foreign currencies relative to the U.S. dollar. The dollar had declined 14% since the beginning of 2017 and in the last three weeks strengthened 3.7% to reach a new high this year. Many emerging markets had been faring well with stabile economies of low inflation, low interest rates and stable currencies. All that now has been turned on its head. Central banks are now grappling with the idea of raising rates to defend their currencies without stifling economies that show little inflation.

Q: Do you expect those tariffs to come to pass—and what then if they do? The U.S. negotiation team is tackling trade agreements on two primary fronts: Nafta and China. It is possible that only one gets addressed by year-end and the other in 2019. We’re continuing to monitor negotiations and key agenda items, but there are many unknown variables involved, so it’s too early to speculate. We do know that many of the company managements we’ve met have not altered their course in planning for their businesses. No one has moved manufacturing bases or altered production volumes. Most U.S. farmers haven’t changed planting plans for this season. There simply isn’t enough information for these parties to make informed and very costly decisions.

Q: Would changes to Nafta negatively affect the economies of Canada and Mexico? In 2017, Mexico’s largest export market was the U.S., with goods and services totaling $314 billion. These exports account for nearly 30% of Mexico’s GDP and 75% of the country’s total exports. Unfavorable Nafta terms for Mexico would initially be felt in the depreciation of the peso, a slowdown in investments to include foreign direct investments and slower economic growth. The first industries to be affected would include autos, some real estate and retail. Over time, Mexico can seek to establish trade relations with other countries. In fact, Mexico and the European Union just reached an agreement in principle updating a trade pact from 2000.

The U.S. was Canada’s largest export market of goods and services, totaling $300 billion or 76% of all its exports. These exports account for nearly 20% of Canada’s GDP. Canada’s largest export to the U.S. by far is crude oil followed by vehicles, aluminum, lumber and natural gas. Few realize that excluding energy, Canada actually runs a deficit, not a surplus, with the U.S. If Nafta ends, Canada will negotiate a bilateral trade deal, which may be easier to achieve. One of the U.S.’s objectives is to gain greater access to the Canadian market.

So while Mexico and Canada would certainly undergo some adjustments in their respective economies, America also needs to be aware that while Mexico produces goods at a lower cost, Americans benefit by spending less on those goods. Raise those prices, by tariff or higher labor costs, and Americans will either pay more or spend less. Either way, this can’t be in America’s best interests.

Q: What should investors keep in mind? There has been plenty of discussion—formal and informal—on trade tariffs and Nafta since President Trump took office. So far nothing has been implemented but it is reasonable to expect changes will come relatively soon. Nonetheless, deadlines and targets are constantly being moved. Trade missions for bilateral discussions come back empty-handed as we’ve seen many times with Mexico and, more recently, China. “Soon” may be getting closer, but it’s not clear when.

On the other hand, we do know the areas targeted for renegotiation: autos, steel, aluminum, technology and dairy. There are also other issues or political interests such as drug pricing, intellectual property and countervailing duties and anti-dumping disputes (including the Chapter 19 dispute settlement process between the U.S. and Canada) and a sunset clause. These are sensitive negotiations, but everyone is interested in walking away with a win. While a deal in principle may be cause for celebration, the technical details will still need to be hammered out before one can say it’s done. Then Congress has to approve Nafta 2.0.

Keep in mind that Mexico has a presidential election in July while the U.S. Congress is facing midterm elections in November—which is sure to keep things interesting. We’re closely following developments.

Thanks, Leo.