Portfolio got the NAFTA jitters?

A recent report that the US is considering terminating NAFTA caused the Canadian dollar, major Canadian blue-chip stocks and government bond yields to sink. What should you do to prepare for the end of NAFTA?

MarketOutlook Reports and rumours that the US will soon withdraw from the North American Free Trade Agreement, or NAFTA, have caused nervousness in Canadian markets. Reuters recently reported that Canada has become more convinced that President Donald Trump will pull the plug on the trade deal that has benefited Canada, the US and Mexico since 1994.

Though the White House poured cold water on the idea that it will pull out of NAFTA, the fact remains that Mr. Trump has hinted he’s willing to end the agreement if a new deal can’t be reached. This raises the question: What would a NAFTA termination mean for the Canadian economy and the country’s financial markets?

NAFTA and your stock portfolio

Our view is the threat posed by a NAFTA termination is too vague for you to respond by making dramatic changes to your investment portfolio now. After all, the potential outcomes are too numerous and bewildering to assess with any reliability. For example, some have suggested the Canada-US Free Trade Agreement of 1988 would come into force with the end of NAFTA. Or perhaps World Trade Organization tariffs would apply. A termination, of course, would not rule out the possibility that a new deal under different terms could be negotiated.

And what if the US Congress and business interests rebel against a NAFTA termination? What then?

How would these different outcomes apply to a manufacturing stock like Magna International (TSX—MG)? As a large exporter to the US, the auto-parts giant is considered to be particularly vulnerable to a NAFTA termination. But if NAFTA were ended, would that mean higher US tariffs on auto parts, or some other, more favourable, treatment stemming from a new bilateral or multilateral trade agreement?

The same types of queries could be made about Canada’s railway companies—Canadian National Railway (TSX—CNR) and Canadian Pacific Railway (TSX—CP). Together with Magna, the railways, which get about 30 per cent of their revenue from Canada-US trade, are among the major Canadian companies most vulnerable to a trade disruption. Yet little is known about the impact of such a disruption given the possible outcomes.

The fact is, no one knows what will happen in the event of a NAFTA termination by the Trump administration. It follows, then, that you should not be making major changes to your portfolio in anticipation of an event whose outcome is not known.

That is, you shouldn’t need to make big changes if you’ve been following our advice all along. We’ve always advised that you should balance your portfolio across the five major economic sectors, not seeking too much exposure to any one sector. If that’s what you’ve been doing all along, you should have limited exposure to the Magnas, the CNRs, or CPs of the world. And that’s about all you can do to protect your portfolio from a worst-case scenario, aside from the following suggestion.

Buy US dollars

One thing you can do to help insulate your portfolio against a potential NAFTA termination is to buy US dollars. The Canadian dollar will likely decline in such an event, causing the value of your US holdings to rise. We think it’s a good idea, then, to consider buying US dollars, especially if the loonie rises above US$0.80.

Whether your US-dollar assets are held in stocks, fixed-income or exchange-traded funds, they should hold up better than your Canadian holdings if NAFTA expires.

This is an edited version of an article that was originally published for subscribers in the January 26, 2018, issue of The Investment Reporter. You can profit from the award-winning advice subscribers receive regularly in The Investment Reporter.

The Investment Reporter, MPL Communications Inc.
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