US trade deficit comes down but remains elevated: Is that good or bad for investors?

A perspective from E*TRADE Securities 04/18/19

On Wednesday the government released the latest trade data: Driven in part by increased shipments to China, the trade deficit fell to an eight-month low in February but remains near record highs on an annualized basis.1

Trade tends to get a lot of ink, in part because it’s intuitive. Although the balance of trade has many variables, a trade deficit occurs when a country imports more than it exports. Not surprisingly, trade deficits tend to be frowned upon. After all, it’s better to be a net exporter, right?

Not always. As with most everything in economics, there’s a lot of nuance to this issue, and the truth lies somewhere in the gray zone.

To be sure, the balance of trade is instructive in gauging the macro environment, and for more active investors it can help signal which sectors to target. But the same data can also be a red herring. While it may seem like Uncle Sam is getting kicked in the teeth when the trade gap increases, a widening trade deficit can in fact signal a strengthening economy—and a trade surplus can represent just the opposite.

More on that in a minute. First, the latest numbers:

US trade deficit falls in February

In February, the US trade deficit, including goods and services, narrowed 3.4% to $49.4 billion, driven in part by an improved balance of trade with China and rising shipments of civilian aircraft, passenger cars, and medicine.1

It’s important to keep the numbers in perspective. The trade deficit also narrowed for three straight months in 2018 (March–May), and the deficit in goods still ended the year at a record high of $891 billion.1 International trade can vacillate widely on a monthly basis, and it’s hard to draw conclusions this early in the year.

US balance of trade, 1978-2018

Data source: U.S. Bureau of Economic Analysis, U.S. Census Bureau


Trade deficits get a bad rap ...

At first blush, the notion of a trade deficit of any stripe seems alarming. According to a 2018 Harvard University/Harris poll, more than 71% of Americans surveyed believe the US should take steps to correct the trade deficit with China, while a majority support tariffs on Chinese imports.2

… but they can be a sign of a strong economy

But a growing trade deficit may also reflect a healthy US economy. With expanding economic growth comes increased consumer spending, which comprises more than 70% of US gross domestic product. Given that Americans consume more than they produce, a strong economy can increase Americans’ appetite for foreign-made products and contribute to the trade deficit. By most standards, that’s better than seeing consumers in pullback mode, which is often the case during an economic contraction.

That isn’t to say trade deficits don’t have the potential for harm—they do. But consider that the narrowest the US trade imbalance has been over the past 30 years was around the recession of 1990–1991. The best trade results before that? Just after the recession of 1981–1982.3

US trade deficits have contracted around periods of recession

Data source: U.S. Bureau of Economic Analysis, U.S. Census Bureau


The dollar’s effect on the trade deficit

Currency valuations also affect international trade. Generally speaking, a strong US dollar encourages Americans to buy relatively cheap foreign goods while discouraging US exports. There’s certainly reason to believe the dollar's resilience contributed to last year’s record trade gap. But a strong dollar also encourages foreign investment in the US, which makes trying to depreciate the dollar a thorny issue.

So, what are investors to make of trade deficits?

•  To the extent that trade deficits reflect rising US incomes and increased demand for foreign goods, investors have little to fear. An expanding economy is generally supportive of corporate earnings and stock prices.

•  Trade deficits can also help international manufacturers and retailers that benefit from increased US consumer spending. Investors might therefore consider ETFs that target international economies dependent on US consumers.

•  Are there downsides to trade deficits? Sure. Reduced net exports hurt US multinationals, and higher interest rates can choke off economic growth. But there are also other forces at work. For example, US-imposed tariffs have recently crimped the earnings of steel producers, chip makers, and agribusiness firms.

The balance of trade is just one of many economic variables that can have an impact on one’s portfolio, and it’s certainly something to keep an eye on. But sometimes the bark of a trade deficit doesn’t necessarily translate into a bite.

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1. U.S. Census Bureau, “U.S. International Trade in Goods and Services, February 2019,” April 17, 2019, https://www.bea.gov/system/files/2019-04/trad0219.pdf

2. Center for American Political Studies at Harvard University, “CAPS - Harris Poll on Gun Control, Trade, and Foreign Policy,” April 4, 2018, https://caps.gov.harvard.edu/news/caps-harris-poll-gun-control-trade-and-foreign-policy

3. U.S. Census Bureau, “U.S. Trade in Goods and Services - Balance of Payments (BOP) Basis,” March 27, 2019, https://www.census.gov/foreign-trade/statistics/historical/gands.pdf

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