Market Extra: For the stock market, a trade-war win may be a hollow victory

Sometimes losing can pay dividends in unexpected ways, and that seems particularly true in the case of stocks and trade.

For the past five decades, the U.S. stock market has comparatively outperformed when the trade deficit widened and vice versa, suggesting that even if the U.S. emerges victorious from its trade war with China, investors may have few reasons to rejoice.

At face value, it may seem counterintuitive, but for the U.S., which relies on trade to fuel its economic juggernaut, a deficit can actually be a sign that all is well.

“Since at least 1970, U.S. stocks have done best when its trade deficit worsens,” said Jim Paulsen, chief investment strategist at Leuthold Group, who explained that if imports rise, it indicates that domestic consumption is healthy.

“And if exports go up, it means foreign demand is strong. So when we have a trade deficit, it means the U.S. is doing better,” he said.

A trade balance is the difference between how much a country sells and buys from abroad, and a deficit is often viewed as a negative, chiefly as it means a country is spending more than it is making.

But as the chart below demonstrates, U.S. stocks SPX, +1.29%  vis-a-vis foreign equities have done quite well notwithstanding all the depressing headlines over the years about how the rest of the world is taking advantage of the U.S.

“The relative performance of U.S. stocks has led the U.S. trade deficit by about one year,” said Paulsen.

Trade is among the main pillars of President Donald Trump’s “Make America Great Again” agenda, and he has not been shy about taking trading partners to task for what he believes are unfair practices.

The U.S. recorded a trade deficit of $49.3 billion in November versus $55.7 billion in October, but the total shortfall for 2018 is still likely to be the biggest in a decade.

Two years into his presidency, Trump has succeeded in pressuring China to come to the negotiating table, although an agreement has remained elusive after many months. But even if he walks away with a brand-new deal, it may end up being a hollow win for the stock market.

“If President Trump wins the trade war and this leads to an improvement in the U.S. trade deficit, investors should be over-weighted international stocks,” said Paulsen.

He recommended investors look to Europe and emerging markets, excluding China, for new investment opportunities.

As for the trade spat, Paulsen expects Trump to prevail but it will not be the earth-shattering event that some believe it will be.

“Both sides will declare victory but there won’t be a whole lot of change and they will just move on,” he said.

U.S. Trade Representative Robert Lighthizer and Treasury Secretary Steven Mnuchin are due to arrive in Beijing later this week for high-level talks, although expectations for a conclusive deal are fairly low at this time.

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