President Trump’s trade policies may have a more significant impact on the stock market than tax reform or infrastructure spending in 2017. Trade may be the most consequential issue for Trump’s core supporters, who believe that the North American Free Trade Agreement (NAFTA) and other free trade deals take jobs away from American workers.
Trump has already withdrawn the United States from the Trans-Pacific Partnership (TPP), and he plans to renegotiate NAFTA. Renegotiation of existing trade pacts is one element of Trump’s agenda, but other elements may include border tax adjustments and targeted tariffs on Mexican and Chinese imports.
Border tax adjustments are part of the widely-discussed plan to reform corporate taxes, adding a tax on U.S. imports while exempting exports from taxation. The consequences of border tax adjustments would be far-reaching for the U.S. economy and stock market. Major importers. including retailers, energy refiners and automakers, are considered among the most vulnerable to border tax adjustment, while major exporters would benefit.
Potential winners such as Boeing Corporation and General Electric are reportedly lobbying in favor of border tax adjustment, while potential losers such as Walmart, Home Depot and Target are reportedly lobbying against it. Some proponents claim that the dollar would appreciate in response to the change in tax policy, in essence offsetting the import tax. Many investors, however, consider the dollar argument as being overly simplistic given the multidimensional factors that influence relative currency values.
Trump’s threats to impose tariffs also is worrisome for many investors. Interconnected supply chains between American and Mexican companies complicate any policies directed at Mexico, as an estimated 40 percent of the value of imports from Mexico are sourced from the United States. Tariffs could backfire, with the potential for retaliatory actions creating both economic and geopolitical risks.
Trade restrictions often are designed to protect inefficient or uncompetitive domestic industries. Tariffs or import limits targeted at individual countries may not have the intended effect. For example, consumers may choose to import autos from Japan, Korea or Europe rather than “Buy American” if tariffs directed at Mexico drives up the cost of Mexican-sourced autos. Chinese steel is a popular and arguably justified target for proponents of a more forceful approach to trade, but Chinese steel is a small portion of China’s exports to the United States.
Manufacturing employment in the United States has declined from nearly 18 million people in 2000 to just a shade above 12 million people today. Trump hopes to reverse job losses and income stagnation for American manufacturing workers, but the growth of global trade may not be the primary cause of the decline in manufacturing employment.
Despite the decline in manufacturing employment, manufacturing output has increased, largely because of automation and advances in information technology. A Ball State University study reviewed the impact of trade and productivity to manufacturing employment from 2000 to 2010, concluding that productivity was a far more important factor than trade to the decline in manufacturing employment. According to the study, about 750,000 of job losses, or 13 percent, of the decade’s job losses were attributable to imports.
The stock market rally after Trump’s election was fueled by optimism that he would deliver on pro-growth promises, including tax cuts for small companies, infrastructure spending and a lighter regulatory touch. Trump’s approach to trade is considered to be less market-friendly, as most economists think that protectionist trade policies would slow economic growth while increasing consumer prices and inflation.
If Trump follows through with pro-growth initiatives, the market is likely to continue its upward trend, but if Trump’s populist impulses dominate, the markets are likely to suffer. The more that trade policies dominate the initial Trump policy agenda, the greater the likelihood that the stock market rally will stall or reverse course.
Daniel S. Kern, CFA, CFP, is chief investment strategist at TFC Financial Management in Boston, Massachusetts. He holds an MBA from the Haas School of Business at the University of California Berkeley.
The views of contributors are their own and are not the views of The Hill.