The Trump Administration announced on Monday that it had reached a preliminary trade deal with Mexico and would pursue immediate negotiations with Canada with the goal of shoring up a revised North American Free Trade Agreement, possibly by the end of this week.
President Trump has resisted calling the new agreement “NAFTA” as a way to differentiate it from the original 25 year-old agreement - which he has been openly critical of since the 2016 campaign - but the difference is largely semantic as the new agreement largely concerns the same set of trade issues, with specific terms and conditions modernized for current times.
Canada and Mexico combined would be the largest trading partner of the U.S. with more than $1.1 trillion worth of goods and services being traded annually which is divided essentially equally between the two North American companies. The U.S. balance of trade with Canada is balanced with a deficit or surplus of less than $20B, depending on the method of measurement. The U.S. is currently running an annual trade deficit of approximately $70B with Mexico.
Our single largest trade partner is China with $636B in trade and a $375B deficit. Reducing that deficit has been a priority of President Trump and the new North American agreement could help rekindle trade negotiations with China.
NAFTA – A Brief History
The original North American Free Trade Agreement actually had its genesis way back in the 1980’s during the Reagan administration. After years of negotiations, the current deal was finalized in 1993 and went into effect at the beginning of 1994.
The main goal was to reduce trade barriers between the three North American nations, allowing basically free trade while still protecting intellectual property rights, formalizing environmental protections and ensuring that key industries in each nation - especially agriculture and transportation – were not damaged by inexpensive foreign competition.
At the time, trade between the U.S. and Canada was already close to tariff-free, and the agreement gradually phased out almost all tariffs between the U.S. and Mexico. Most economists agree that the effects of NAFTA have been largely positive, increasing productivity and trade across North America and lifting millions out of poverty, especially in Mexico.
Those effects have been negative however for some U.S. industries – most notably manufacturing – as the increased availability of less-expensive Mexican labor contributed to a slowdown in U.S. manufacturing and held down the wages of some American workers. It was specifically this imbalance that President Trump sought to rectify in the current negotiations as part of his pro-industry stance in the U.S.
The New Agreement
The “United States – Mexico Trade Agreement” penned this week will cover a period of 16 years with a provision to review the terms every six years. The U.S. agreed not to impose a cap on vehicle imports from Mexico, but tariffs on steel and aluminum instituted earlier this year will remain in place. Mexico in turn will purchase an increased amount of U.S. agricultural products and also agree to produce 75% of automobiles’ final value in North America and utilize at least 40% of parts that were produced by workers earning $16 or more per hour – an important concession to American Labor Unions.
Regulations on the oil and gas, energy and telecom industries will be relaxed on both sides of the border.
The initial negotiations involved only the U.S. and Mexico because several of these issues are unique to those two countries, though Canada has shown a willingness to join a three-nation trade agreement once those original issues were settled. Canada’s foreign minister, Chrystia Freeland, commented that “Canada will be joining the talks to work on both bilateral and our tri-lateral issues.” Freeland traveled to Washington on Tuesday to continue those negotiations.
Is China Next?
After a protracted war of words earlier in 2018 between the U.S., our North Americans partners, the European Union and China, it finally seems that mutually beneficial agreements are possible with Canada and Mexico - as well as the EU after a productive meeting between Trump and EU Commission president Jean-Claude Juncker in July after which they jointly announced that they had decided to move toward removing all trade barriers on both sides.
Lining up the rest of our most important allies on trade is likely to put pressure on China to resume the stalled trade negotiations, especially in the face of their own sluggish economy and poorly performing equity markets in an environment of increased tariffs.
Equity Markets Cheer the Deal
U.S. Equity markets rose across the board on Monday after the deal with Mexico was announced with the Dow and Nasdaq each gaining more than 1% and the S&P 500 adding 0.8%. All three indexes are now at or near all-time highs. The trade war had been seen as a limiting factor in equity appreciation this year and these important steps toward an orderly resolution promises to propel stocks even higher.
U.S. Manufacturers of automobiles and heavy equipment were among the biggest winners on Monday.
Caterpillar Inc (CAT - Free Report) with its huge exposure to international markets, gained 2.8% on the day.
Shares in Ford Motor Company (F - Free Report) , which have been hurt recently by increased steel and aluminum costs also rose 2.8%, even though tariffs on those materials remain in effect for the time being.
Auto-parts manufacturer Dana Incorporated (DAN - Free Report) was one of the biggest gainers on the day, rising 4.8% on the news that an increasing amount of the parts for new vehicles would be required to be produced in North America.
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