Trading Places

“Trade War.” Pundits frequently tout the term as of late, claiming one is raging now—perhaps the greatest risk to stocks going. These fears have flown all year, ebbing and flowing with the latest threat and action (or non-action)—like the news Monday that, according to unnamed sources familiar with the matter, the Trump administration is talking up slapping tariffs on the remaining $257 (or so) billion in Chinese goods it hasn’t taxed yet this year. While the tit-for-tat between America and China—along with fears of other actions—gets the most attention, free trade is advancing elsewhere. In our view, this underscores a wide and bullish gap between sentiment and reality over trade. As this reality dawns on investors, we expect stocks to benefit.

In America and around the world, trade scuffles suck folks’ attention despite their trifling overall economic impact. Less noticed: the EU negotiating trade agreements left and right—an underappreciated bullish positive for eurozone and global stocks. Fresh off of signing wide-ranging trade and investment pacts with Vietnam and Singapore earlier this month, the EU is pursuing more deals with Australia, New Zealand and South America’s Mercosur trade bloc.^[i] The Vietnam deal, which the European Parliament and EU members must still ratify, would eliminate 99% of bilateral tariffs over the next decade.^[ii] The deal also reduces regulatory and other non-tariff barriers in the automotive sector and strengthens rules encouraging foreign investment. Moreover, the agreement heralds greater European commerce with Asia, as trade talks are underway with other countries throughout the region. The EU quickly followed up its Vietnamese entrée with a Singapore deal. After eight years of negotiation, it should take effect next year, scrapping nearly all customs duties and overlapping bureaucracy on goods and services trade amounting to around €100 billion annually.^[iii]

These EU deals are just the latest in a series, coming after comprehensive deals with Mexico, Canada and Japan. By some measures, the Japanese deal is the world’s largest trade agreement. In July 2017, the EU and Japan launched the Japan-EU Economic Partnership Agreement. Scheduled to take effect March 2019, it eliminates almost all duties on trade for countries accounting for 28% of world GDP and 40% of world trade by volume.^[iv] The EU and Canada signed the Comprehensive Economic and Trade Agreement in October 2016, and it has been provisionally in force from September 2017, removing 98% of all tariffs between the EU and Canada.^[v] In April, the EU reached a deal to expand and modernize its two-decade old trade pact with Mexico. The updated agreement, which both sides expect to ink by yearend, builds on the existing one by adding digital trade, financial services and investment protections.

The once seeming—and still feared—anti-trade Trump administration is also laying the groundwork for more trade deals. The recent NAFTA revision is one example. But US trade officials have also formally notified Congress they are now seeking deals with the EU, UK and Japan. US and EU negotiators are aiming to zero out tariffs, non-tariff barriers and subsidies on non-auto industrial goods. Germany already waffled on earlier objections, agreeing in principle to buy more American liquefied natural gas. While it remains to be seen how or if a deal with the UK can be inked after Britain leaves the EU (scheduled for March), it seems US and UK negotiators are preparing for talks as soon as that is clear. And across the Pacific, US negotiators are angling for a Japanese deal, too.

US negotiators are also attempting to revive other transpacific trade ties that many thought abandoned. President Trump withdrew America from the Trans-Pacific Partnership (TPP) on day three of his presidency. The TPP’s original members—sans the US—have since resurrected it. If the US inks a series of bilateral deals with countries in the group, that would get the US to most of what the original TPP offered. We can’t say how successful these trade negotiations will be, but like NAFTA’s renegotiation, don’t underestimate their chances.

What about China? Those same unnamed sources familiar with the matter noted America’s (reputed) threat to tax all Chinese imports would only be enacted if trade talks between Trump and Chinese President Xi Jinping fail to produce any material progress in November. Which makes them seem like yet more maneuvering and posturing to pressure China. The US’s wide-ranging tariffs on Chinese goods, side deals with trading partners limiting their Chinese involvement and enhanced national security restrictions on Chinese investments receive great attention, but they are mostly symbolic. For one, tariffs are tiny and exporters can easily circumvent them. Also, the US’s trading partners were already pressuring China—that was the TPP’s intent. And increased Chinese investment scrutiny is largely business as usual. They don’t seem like the endgame. They look more like a means to an end, and if the end result is freer trade with China (and the rest of the world), that would be a positive development. And the opposite of a trade war!

Many still believe the global trading system is under assault and can’t fathom global trade ties strengthening. But strengthening seems much more common than the easily skirted tariffs America slapped on China. In our view, folks underestimating the state of trade seemingly sets up bullish surprise when a raft of trade deals dispels "trade war" rhetoric.