NAFTA 2.0: Economic and market implications

After many starts and stops, negotiators for the U.S. and Canada have reached a deal on a revamped North American Free Trade Agreement (NAFTA). The deal, which brings Canada into the fold of a previously negotiated pact between the U.S. and Mexico, will now be known as the United States-Mexico-Canada Agreement (USMCA).

While key details are still forthcoming, based on what has been released thus far, our portfolio managers are viewing the resolution as broadly positive for Canada. Our equity markets and economy both stand to benefit, thanks to an expected boost to business and foreign investment, retail spending and the auto industry. The deal also means the Bank of Canada will likely move ahead with rate hikes, which trade-related uncertainty had put on hold.

Below are some initial thoughts on USMCA from six of our portfolio managers.

  • We expect the Canadian dollar to appreciate
  • The automotive industry, and heavy industrials such as steel distribution, should also benefit
  • Canadian banks should see some support, particularly those with no U.S. exposure
  • The deal should also be a positive for the retail sector
  • As noted in recent conference calls and video commentaries, we expect the deal to be the first key catalyst for the narrowing of the valuation gap between the S&P 500 Index and the S&P/TSX Composite Index; however, we do not expect the gap to shrink to the historical average in the near term
  • Since trade represents close to 25% of Canadian GDP, it was imperative for Canada to reach an agreement
  • We believe the deal is quite positive for Canada – there are a few interesting victories, and key concessions should not be very harmful
  • The provision that more automotive products (40–45%) should come from higher-wage jurisdictions will clearly help Canada relative to Mexico, where jobs have migrated in the past
  • The tradeoff is that Canadian and Mexican auto production has a cap of 2.6 million annual units going forward, but this leaves ample room for growth, as each country is currently producing less than two million units a year
  • NAFTA’s dispute resolution process remains unchanged, in exchange for limited (3.5%) access to Canada’s dairy market
  • The deal lasts six years before a mandatory review process kicks in, which can take up to 10 years; so the deal will effectively hold for up to 16 years
  • U.S. steel and aluminum tariffs remain in effect until further resolution, but this is not really hurting the Canadian economy in a measurable way, and can be addressed later
  • All in all, Canada played its cards well and was able to get the best deal it could get by pushing the U.S. up to the calendar limit
  • This leads us to call for two rate hikes from the Bank of Canada before the end of the year (October and December), followed by three or four hikes in 2019
  • We also like the prospects for Canadian equities, which have clearly been discounted by the uncertainty that preceded the deal
  • The deal removes a significant source of uncertainty for the markets and business leaders
  • We expect increased capital expenditures, as businesses can now move ahead with investment plans that were stalled by lack of clarity on the trade front
  • Increased spending will provide a firmer footing for the economy
  • Rate hikes from the Bank of Canada are more likely
  • We expect no significant impact from the deal itself, as the changes were negligible
  • We view this as essentially Trump flexing his muscles – lots of money and time spent negotiating but ultimately little real change in terms
  • However, having a deal is good for Canada’s markets and economy, as foreign investors were avoiding Canada with so much uncertainty surrounding trade
  • This uncertainty also discouraged business investment from Canadian companies
  • With a deal in place, Canada will once again be viewed as an attractive market for investment
  • Martinrea International Inc., a metal parts producer for the automotive industry, has seen its stock go up significantly on the news

Terry Thib, iA Clarington Investments

  • From a Canadian perspective, the “red line” items were NAFTA’s dispute resolution process and protections for Canadian news and cultural industries; USMCA keeps both in place
  • Dairy was opened up to U.S. imports, but the outcome is probably better than what many were fearing
  • There is a limit on Canadian auto imports, but it is 44% above our current production rate
  • We have a minimum of 16 years of certainty on trade
  • The only negative is that steel and aluminum tariffs were not removed
  • Overall, the deal should be characterized as a “win” for Canada
  • Along with an increasingly bullish outlook for oil, the deal should help Canadian markets perform well over the next few months
  • With this agreement, we expect the Canadian economy to continue on its modest growth path
  • IA Clarington Growth & Income Fund and IA Clarington North American Opportunities Class are well positioned to benefit, as they are heavily weighted to Canada, and we have avoided investments in interest rate sensitive securities

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