Does International Investing Make Sense With Trump's Trade Policies?

How Trump's Trade Policies Could Impact International Investors

President Trump has been critical of free trade agreements and foreigners buying United States assets, which could have a significant near-term and long-term impact on international investors.

How will President Donald Trump’s trade policies impact domestic and international financial markets and how can investors position their portfolios?

Trump’s Global Trade Impact

President Trump has been critical of international trade agreements—such as the North America Free Trade Agreement—and foreign direct investment into the United States by countries like China.

The repeal of free trade agreements is widely seen as having a potentially positive short-term impact and likely long-term negative impact on the United States. The short-term benefits manifest in more domestic jobs, but over the long-term, the Institute for International Economics estimates that trade liberalization has brought an additional $9,000 per year to the typical American household over the past 50 years in the form of lower consumer prices.

Other countries could experience more severe near-term negative consequences if their economies rely substantially on the United States. For example, Mexico’s economy had nearly $360 billion in exports with more than 80 percent of those going to the United States. A reduction of trade with the U.S. could significantly reduce its overall gross domestic product (“GDP”) growth. Higher tariffs could also hurt countries like China that export heavily to the U.S. market.

Reducing trade deficits could also reduce foreign direct investment into the U.S. and encourage more investment in foreign domestic economies. After all, when the U.S. runs a trade deficit by importing more than exporting, it means that the rest of the world is investing in U.S. assets like Treasury bonds to finance that deficit. A reduction in FDI could hurt U.S. asset prices, but potentially bolster foreign asset classes due to greater capital inflows.

Effects on International Investors

President Trump’s trade policies could have many different effects on international investors depending on the country or region being targeted.

Not surprisingly, countries with a high level of trade with the United States could suffer the most in the near-term and perhaps over the long-term. Mexico, Canada, China, Japan, and Germany are some countries that top the list of trading partners, but Mexico and China have the most to lose given their reliance on trade with the U.S. Both countries rely on the U.S. as a key export market with exports accounting for a significant portion of their GDP.

A stronger U.S. economy over the near-term could also put pressure on trading partners like China. For instance, the Federal Reserve’s recent rate hikes prompted Chinese regulators to do the same since a narrowing interest rate differential could put the yuan on a downward path and trigger capital outflows. China’s move to hike interest rates have a negative impact on its economic growth but discourage capital outflows.

Finally, a stronger U.S. economy could also hurt emerging markets over the near-term as rising interest rates take a toll on dollar-denominated debtholders. Emerging markets with exposure to slower U.S. trade could face a double-threat from Trump’s trade policies.

Hedging an International Portfolio

There are many ways that investors can hedge their portfolios against the potential impact of President Trump’s trade policies over the long-term. Passive investors may want to consider sticking with their existing allocations and simply waiting out the volatility over time, but active investors may want to act to limit their risk. This may be especially important for investors approaching retirement and seeking stability.

The first step is to reduce exposure to markets that could be threatened by adverse trade policies or rising U.S. interest rates. Mexico and other emerging markets are perhaps the best examples of these types of situations, although it’s worth noting that these markets trade at a significant discount to U.S. equity valuations. Investors should factor in these discounts when evaluating how much to reduce exposure.

The second step is to hedge against near-term volatility using equity options or other instruments. For example, an investor may want to consider purchasing put options on an emerging market index fund to limit downside without sacrificing potential upside.

The Bottom Line

President Trump’s trade policies could impact international investors in many ways, but active investors can take steps to hedge their portfolio by simply reducing exposure or using equity options. In either case, these actions can help reduce volatility stemming from free trade agreement issues or other economic factors influencing global markets.