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Bull or Bear? NAFTA, China offer bulwarks against market decline

Chances are good that the American “bull run” in equities will continue in 2019, though gains will moderate from 2017 to 2018. The U.S. bull market since the Great Recession of 2008-09 has been the longest in history, but the U.S.
patriciamohr
Patricia M. Mohr

Chances are good that the American “bull run” in equities will continue in 2019, though gains will moderate from 2017 to 2018. The U.S. bull market since the Great Recession of 2008-09 has been the longest in history, but the U.S. economy was slow to fully recover from the mortgage-led recession of a decade ago, and it was not until 2013 that the S&P 500 regained its previous peak.

The recent outperformance of U.S. stock markets reflects U.S.President Donald Trump’s corporate as well as personal tax cuts and deregulation, which have lifted business investment in both technology and oil and gas and raised the animal spirits of consumer confidence across the United States. The unemployment rate at 3.9% is close to full employment and may fall further, with consumer confidence at its highest level since 2000, buoying consumer spending. While U.S. economic growth is showing signs of slowing, after surging by 4.2% in the second quarter, strong prospects for many of America’s major corporations should continue to lift earnings and equity valuations – particularly in leading-edge technology.

The trade conflict between the United States and China has escalated significantly and represents the largest downside risk to the global economy. U.S. import tariffs on US$50 billion of Chinese imported goods target technology imports related to China’s “Made in China 2025” industrial strategy, while retaliatory tariffs by China affect mostly U.S. agricultural goods, hurting prices for soybeans and other agricultural products. The U.S. has just announced an additional US$200 billion in tariffs on China — to go into effect September 24 — and could possibly impose more tariffs. There are no winners in a trade war, and dialogue on trade issues and intellectual property rights is the only solution.

In addition, a recent surge of international investment capital into the United States has lifted the U.S. dollar, causing currency challenges for some emerging-market (EM) countries. Many EMs will also be challenged by adoption of a less accommodative monetary policy by the Federal Reserve Bank and higher short-term interest rates.

Concern over a potential slowdown in China and in EMs has recently triggered a mid-cycle correction in base metal and other industrial commodity prices after a significant rally earlier this year, blunting the improvement in the all-important resource sectors on the Toronto Stock Exchange (TSX). China accounts for almost 50% of world demand for key base metals. Concerns related to the North American Free Trade Agreement (NAFTA) have also hurt TSX valuations. 

The impact of the 2008-09 recession on Canada was quite mild. This reflected a strong Canadian banking sector, with limited direct exposure to the U.S. mortgage market. In addition, massive infrastructure development and record credit expansion by China in November 2008 – to lift its own economy out of the global recession – led to a rapid recovery in oil and metal prices in the early days of January 2009 – enormously benefiting Canada.

The risks for Canada from a U.S.-China trade war are considerable. However, China has significant financial resources to buoy its own economy – likely to advance by 6.6% in 2018 and about 6.3% in 2019. Recent investment fund concern over a sharp slowdown in China, which would hurt commodity demand, is likely unwarranted. Commodity prices should snap back, with key commodities in short supply in the medium term. In addition, I believe that a new NAFTA for Canada is likely, given the tight supply chains between Canada, the United States and Mexico and the importance of trade with Canada in many U.S. states. Canada is the largest trading partner of the United States. Announcement of a NAFTA agreement between “the three amigos” would lead to a surge in North American stock markets.

Patricia M. Mohr is a Vancouver-based corporate director, economist and commodity market specialist.