Canada and U.S Trade Dispute:
A Concern but No Cause for Alarm
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Jeffrey Sindall, Financial Advisor - July 11, 2018
I have had several phone calls from clients concerned about the new U.S tariffs and
how the “trade war” will affect their investments. There always has been, and always will be,
uncertainty regarding owning equity investments which have a market value that can fluctuate.
The U.S. tariffs and retaliatory measures by Canada have notched the uncertainty higher. However, here are my four main observations to help explain why I believe from an investing perspective the Canada-U.S. trade dispute is no cause for alarm, followed by my suggestions for investment choices you have if you want to reduce the risk in your portfolio.
1. Tariffs on steel imports into the U.S. have been attempted before and failed. As reported in The New York Times, the prior Republican president, George W. Bush, on March 6, 2002, “imposed tariffs of up to 30% on most types of steel imported into the United States from Europe, Asia and South America, intending for the tariffs to last three years to give American steel producers time to consolidate operations and stem layoffs.” Then according to this article on March 1, 2018, by TIME, the “European Union ended up hitting Bush where it hurt, by planning tariffs on a wide range of products including many produced in key swing states where job losses could hurt Bush’s chances of re-election. In late 2003, Bush reversed the sanctions.” The same retaliatory strategy is being followed today by Europe, China, and now Canada.
One difference now is that the Trump Administration is proclaiming the tariff’s are necessary for national security, which according to the TIME article is a “provision of trade policy that the World Trade Organization typically does not try to probe” and according to an article in Forbes, “Unlike other trade laws, it doesn’t require [Trump] to get congressional approval or a review by the independent U.S. International Trade Commission.” Trump included tariffs on Canadian steel as well to help support his national security position and also as leverage for negotiations to renew NAFTA.
It appears everyone knows that the national security claim for steel tariffs in the context of national defense is a façade. According to the Forbes article, “Not even Defense Secretary James Mattis bought it. He read the Commerce Department report before it went to Trump, and this is what he said about it in a memorandum to U.S. Commerce Secretary Wilbur Ross: The U.S. military requirements for steel and aluminum each represent only about 3% of U.S. production. Therefore, DoD does not believe that the findings in the reports impact the ability of DoD programs to acquire the steel or aluminum necessary to meet national defense requirements.”
However, the Trump Administration is attempting to broaden the definition of national security to include protecting American jobs and, especially with respect to China, protecting American intellectual property.
Yet, with respect to Canada, the Globe and Mail reported that on June 20, 2018, in Washington at a U.S. Senate committee “U.S. Commerce Secretary Wilbur Ross [said] Canada is not a national security threat to the United States and that a revitalized NAFTA could make the Trump administration’s tariffs on steel and aluminum go away. Mr. Ross also acknowledged Wednesday that the United States doesn’t have a trade deficit on steel with Canada. In fact, he said it has a surplus with its northern neighbour in terms of dollar value.” It appears then that tariffs against Canada are indeed just a negotiating tactic and that many in the Trump administration have a desire to see Canada-U.S. trade resume normally.
2. A renewed NAFTA is very close. The Toronto Star reported on May 31, 2018, that Prime Minister Trudeau had the opportunity to finalize an updated NAFTA however rejected the Trump Administration’s condition for a five year sunset clause, which is an automatic five-year expiry date unless all three countries agree to renew. If this is all that stood in the way of a renewed NAFTA then, in my opinion, the rejection of the five-year sunset clause may have been a mistake by our Prime Minister.
Trade negotiations are constantly occurring, including over the past many years while the NAFTA agreement has been in effect. Disputes usually go unnoticed by the general public, and have been regularly resolved under NAFTA and at the World Trade Organization. Even with the current U.S. tariffs initiated in June nothing is definite because the U.S. has allowed for American companies to apply for exclusions from the tariffs on imports of goods that are not otherwise already available in the U.S. The current NAFTA has a provision for either party to withdraw after providing six months notice anyway, so a five-year sunset clause is really not any different apart from setting a timeline for ongoing negotiations.
In my opinion, Prime Minister Trudeau could have accepted the five-year sunset clause, signed a renewed NAFTA so that an agreement would be in place, and then after a short break continue to negotiate for the renewal of NAFTA to occur in five years. It’s very likely, as U.S. Commerce Secretary Wilbur Ross implied, that this would have exempted Canada from the current U.S. tariffs. Presumably all other NAFTA details that have been agreed upon so far are still in effect and the agreement can be signed soon.
3. Another determinant for how the trade tariffs will progress is the U.S. Mid-Term Elections. The U.S. House of Representatives, which currently has a Republican majority of 236 seats out of 435, appears to be doing nothing meaningful regarding President Trump’s controversial policies. However, CNN has published a House Retirement Tracker which was last updated June 5, 2018. The article headline states “There is a wave of Republicans leaving Congress”. It identifies 44 Republicans who have already left the House or said they will not be running for re-election, including House Speaker Paul Ryan. This is nearly double the average Republican resignation rate as at 17 months into their 24 month term of office. By comparison, only 20 Democrats have left or have said they will not run for re-election, which is about average. The CNN article cites some individual circumstances and also cites the possibility of “strategic retirement” by politicians when they think re-election is less likely. This is an early indication of a possible change in Congress. Democrats need to pick up 24 House seats to retake the majority from Republicans, who’ve had control of the House since January 3, 2011. In the 100 seat Senate where 35 seats are up for election this November, Democrats need only to increase their number of seats from 47 to 51 to become the majority.
The U.S Constitution provides a system of checks and balances designed to avoid the tyranny of any one branch of the federal government. I predict that the Democrats will achieve a majority in both houses of Congress then they will restore a balance of power and somewhat reign in President Trump.
4. The Canadian economic recovery continues. Statistics Canada in its Labour Force Survey has reported positive employment growth for June 2018 by almost 32,000 positions, and overall employment is higher by 215,000 full-time positions since June 2017. Stats Canada also reported on June 29 that the real gross domestic product (GDP) edged up 0.1% in April as 12 of 20 industrial sectors increased. While not impressive for one month, it follows on strong growth since January. For these reasons (and others) the Bank of Canada on July 11 raised its benchmark interest rate by 0.25% to 1.50% even with specific consideration provided to current U.S. and Canadian tariffs. This is the fourth rate hike by 0.25% since last summer. In its press release, the Bank of Canada states “Recent data suggest housing markets are beginning to stabilize following a weak start to 2018. Meanwhile, exports are being buoyed by strong global demand and higher commodity prices. Business investment is growing in response to solid demand growth and capacity pressures, although trade tensions are weighing on investment in some sectors. Overall, the Bank still expects average growth of close to 2 per cent over 2018-2020.”
For the first three reasons: 1) The fact that a trade war with Canada is counter-productive to U.S. interests, 2) the fact that a renewed NAFTA, or at least a Canada-U.S. bilateral agreement, is already very close, 3) the likelihood of a Democrat majority in both houses of Congress after this November’s elections, means that the Canada-U.S. “trade war” may be very short, perhaps ending by early 2019, and won’t get any worse beforehand.
Adding the fourth reason, that the Bank of Canada expects economic growth to continue even including the current trade tariffs, leads me to conclude there is no cause for alarm regarding equity investments.
Furthermore, upon reviewing the asset mix and top holdings of equity funds which my clients own, I find there is negligible exposure to companies which are, or may be, susceptible to U.S. tariffs as exist or have been proposed by President Trump. Canada has a very diversified economy and the Canadian mutual funds I have recommended have very diversified holdings, with financial services being most prominent. Mutual fund managers follow a very thorough investigative process, including many factors such as sources of revenue and geopolitical risk, before investing in a company. If you would like more information about the mutual funds you own, please ask me by reply to this email.
Equities: If suitable for your objective and risk tolerance profile, this asset class is still preferred for long-term investing. Generally, Canadian equity prices have recovered to fair value since the lows of 2009 and subsequently 2015 so please expect only modest growth, though still the best performing asset class, over the next few years with typical volatility. My objective is to identify and recommend equity mutual funds with managers who are excellent stock pickers investing in profitable companies. I still suggest a portfolio with about 50% Canadian equities and about 50% foreign (mostly American) equities. This is most easily done for clients with FundEX nominee or B2B intermediary accounts for greater choice of mutual funds from different mutual fund companies.
Government and Corporate Bonds: These asset classes, while considered lower risk, do poorly during times of economic recovery and rising interest rates, which is what we have experienced during the past 12 months. Longer-term bonds especially have recently declined in value to match higher yields to maturity. However, if and when interest rates level off, government and corporate bond funds will bounce back quickly – though this may take another year to occur. This being said, government and corporate bond mutual funds are an acceptable alternative for clients looking to lower a portion of their portfolio risk away from equities.
If you are drawing income from your accounts, or expect to soon, and if you are very concerned about how tariffs may affect your investments, then an option is to switch a portion of your portfolio (depending on the amount of your expected withdrawal over the next few years) to low risk bond funds. If you have a FundEX nominee or B2B intermediary account, and if you are very concerned about market volatility, then you may also appreciate the safety of a GIC (Guaranteed Investment Certificate) though I would suggest for only a 1 to 2 year term in combination with a bond fund to maintain investment flexibility and an available source of income.