Trade Talks to Spur More Volatility in Stocks

 Ellen Chang
  30th-Aug-2018

The renewed trade talks among U.S. and Mexico officials to change the North American Free Trade Agreement could increase volatility in stocks for the near term.

Officials from Mexico have started new discussions on negotiating the terms of NAFTA again with Washington officials, according to a statement from Mexico's government reported by Reuters.

Tensions rose in June when President Donald Trump repudiated support of the statement given by the Group of Seven meeting in Quebec and criticized Canadian Prime Minister Justin Trudeau on his position against the U.S. imposing tariffs.

Both officials from Mexico and the U.S. are seeking to reach a deal before Dec. 1, which is when Mexico's President Enrique Peña Nieto's six-year term ends. This would require that negotiations proceed quickly in the next couple of weeks. The three countries need to reach a consensus for a preliminary agreement by Aug. 25. The current administration is required by law to give a 90-day notice to Congress prior to signing a deal.

Resolutions from the NAFTA talks could also help offset negative news about the stock markets in Asia and Europe, especially the emerging markets, which have dipped as the Turkish lira has dipped drastically.

"Any resolution with NAFTA would be seen as a step toward a broader resolution on other global trade deals as it would likely take compromise from all parties involved to reach a resolution," says Shawn Cruz, a manager of trader strategy at Omaha, Nebraska-based TD Ameritrade. "It would follow that the willingness to compromise would be expected to extend to other trade discussions."

The impact on stocks may not be immediate, but it could encourage a "rise in optimism that should benefit risk assets, particularly cyclical equities and cause outflows from defensive equities," he says.

As the talks progress, additional volatility in stocks is likely to occur as officials from each of the three countries will propose various bargaining chips to reach a compromise which is favorable for each country's primary industries.

"Any compromise could benefit some companies and hurt others, depending on their individual supply chains and end markets," Cruz says.

The dips in the market are an opportunity for retail investors to add to their current positions.

"On the pullback, investors can use this as an opportunity to rebalance, but should be cautious in overweighting any particular sector or asset class," he says.

The trade war discussions could last indefinitely and another hiccup is that fiscal policy from this administration is being communicated through "unprecedented social media via tweets, irrespective of whether or not it has an intention to follow through with said threats," says Edison Byzyka, chief investment officer of Credent Wealth Management in Auburn, Indiana. "Such a method of communication releases undue stress."

Investors who are attempting to decipher the sentiment of the market are facing many challenges, including a large percentage of uncertainty.

Despite the continued unpredictability of new tariffs being added, investors should not confuse it with risk.

"Risk is a diversifiable aspect of investment management, especially over the long-term, whereas uncertainty is a wild card," he says.

The White House continues to take the position that tariffs are good for the U.S. economy despite the fact that almost 40 percent of revenues from the S&P 500 index come from abroad.

Allocating some income toward international markets could be a good strategy, especially if the administration continues to gravitate to this stance.

"It may make sense for most retail investors to consider the notion of home country bias in the very near-term," Byzyka says. "International markets appear attractive at this time and they're cheaper relative to domestic markets when observing them from traditional market metrics."

One glaring issue remains the sentiment which is produced from the White House may only encourage more tariffs from other countries.

Trimming some international positions in the in the near-term could be a good strategy, he says.

"Should trade war talks be resolved, however, international markets could rally," Byzyka says. "This is why investors should not entirely exit their positions but could consider trimming them."

Another risk factor arises from the strength of the U.S. dollar and how continued tariffs impacts the currency.

"Even in a scenario where international markets are doing well, yet the domestic protectionism agenda goes on, the translation of foreign currency to U.S. dollars may likely result in a loss to domestic investors," he says. "Understanding such risk, and allocating long-term horizon assets within the international landscape may bode well for the next 10 or more years. Volatility may be likely short-term."

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