Trade tensions reach the Mexican border
If the financial markets in 2019 are remembered for anything, it’s likely to be trade. One day a trade agreement seems likely, and the markets rally. The next, hopes are dashed, and the markets retreat. Federal Reserve Chairman Jerome Powell even referenced trade negotiations in his recent remarks about potential monetary action this summer.
A potential new front in the trade war
For the most part, investors have zeroed in on trade skirmishes between the United States and China. But that changed on May 31, when President Trump trained his sights on Mexico—threatening tariffs on all Mexican goods coming into the US if a host of immigration issues weren’t addressed.
While the two sides have since come to an apparent resolution, the president has doubled down on tariffs as a potential lever if Mexico fails to send 6,000 troops to its southern border with Guatemala. So, the threat hasn’t disappeared entirely.
The sudden about-face on tariffs was cheered by the markets, but opportunistic investors could potentially benefit under either scenario.
Source: United Nations Comtrade
Mexico is a major US trade partner
Tariffs of any kind on Mexican imports would mark a sharp reversal in US trade policy, which exempts most goods originating in Mexico from customs duties.
Mexico’s favored trade status reflects its long-established importance to the US economy:
• Mexico has traditionally been the United States’ third-largest trading partner. However, year-to date, Mexico has surpassed both Canada and China in dollar-denominated US trade—with a notable assist from the US-China trade war.1
• Mexico was the United States’ second-largest export market in 2018 and its second-largest supplier of goods.1
• Mexico is by far the largest supplier of agricultural goods to the US, although motor vehicles, computers, and their component parts comprise the vast majority of imports from Mexico.2
So, yeah, Mexico is a pretty big deal. Which begs the question: Who would actually gain from a trade war with Mexico?
Let’s consider both sides of the coin.
Source: United Nations Comtrade
Potential winners in a US-Mexico trade war:
• Small-cap stocks: Although there are exceptions to the rule, smaller companies tend to have more of a domestic focus than their larger counterparts, making them less susceptible to tariffs and protectionist policies.
• Smaller agribusiness firms: It can be difficult to find agribusiness stocks with no international exposure, but there are smaller firms that source largely from the US. To the extent that protectionist policies make crops grown in Mexico more expensive, US-focused agribusiness firms could benefit.
• Short sellers: It’s possible to sell short the stocks of firms with the most to lose from a trade war, allowing investors to profit from falling share prices. Let’s take a look at those next.
Potential losers in a US-Mexico trade war:
• Funds with Mexico exposure: Exchange-traded funds (ETFs) come in all shapes and sizes, including funds with exposure specifically to Mexico. Country-specific ETF shares can rise or fall based on how the markets view increased trade barriers.
• Intermodal freight haulers: Freight haulers like Werner Enterprises, Landstar, and Kansas City Southern that derive a good portion of their revenue from trans-border trade could be at risk from increased tariffs.
• Multinational food and beverage companies: Multinational beverage producers that own iconic Mexican brands—think Constellation Brands (Corona, Modelo) and Heineken (Tecate, Dos Equis)—could take a hit from tariffs, as could multinational food producers dependent on Mexican growers. Agribusiness giants like Del Monte and Archer Daniels Midland not only grow crops in Mexico, but also have an extensive network of processing plants there.
• American manufacturers: US-based manufacturers have been offshoring production to Mexico for decades. Examples include Navistar (trucks), Lennox and Carrier (HVAC), GoPro (digital cameras), and Caterpillar (heavy equipment)—all of which have manufacturing operations south of the border. Tariffs could eat into these firms’ bottom lines, just as they have with companies dependent on inputs from China.
For now, a standoff with Mexico has been averted. But, as we've come to learn, conditions can change with a single tweet. If trade wars remain the norm, buy-and-hold investors could consider a more conservative approach to their asset allocation decisions, with an emphasis on fixed income and defensive holdings that can buffer against equity-market volatility.
While there's not much investors can do about US foreign policy, they can steel themselves for potential trade disruptions. And judging from the events of recent weeks, a little extra armor might not be such a bad idea.
1. United States Census Bureau, “Foreign Trade: Top Trading Partners,” April 2019, https://www.census.gov/foreign-trade/statistics/highlights/top/index.html#2019
2. UN Comtrade, “USA, Puerto Rico and US Virgin Islands exports of goods in 2018,” https://comtrade.un.org/labs/dit-trade-vis/?reporter=842&partner=484&type=C&year=2018&flow=2