No Portfolio Is Safe From Trade Winds

How the U.S. trade deficit affects your investments

This is another in an occasional series of stories on economic indicators.

The recent protests at the World Trade Organization's meeting in Seattle show that global trade is a controversial part of the U.S. economy, New or Old. As an investor, can you afford to be neutral about the latest trade developments? Perhaps, but only if your portfolio is fully insulated from international influences--a difficult undertaking in these increasingly global times.

Truth be told, the monthly announcement of America's foreign trade deficit usually has little immediate impact on the stock and bond markets, in part because it is released six or seven weeks after a given month's end. Where the trade data pack a wallop is on the currency markets, and that punch can trigger a reaction elsewhere. On Sept. 21, the Commerce Dept. reported that the July trade gap had widened to a record $25.2 billion--later revised to $24.9 billion. The dollar collapsed 2.7% against the Japanese yen, and the greenback's weakening contributed to the day's 225-point plunge in the Dow Jones industrial average.

The currency consequence means that the trade numbers may hit your portfolio if you hold international equity or bond funds that are not properly hedged. Don't think you're safe if you don't own overseas funds. Currency swings can skew the overseas earnings of U.S. multinationals, such as IBM or Coca-Cola, when profits are converted into dollars. And economists say the currency risk will increase as the ballooning trade gap widens the U.S. current-account deficit, a broader measure of foreign transactions that includes trade in goods, services, interest and dividend payments, and government transfers.

The trade deficit, which is simply the difference between exports and imports, tallies all goods and services traded between the U.S. and the rest of the world. That covers a wide range of items including aircraft, oil, cars, tourism, royalty fees, financial services, and software. The dollar values are adjusted seasonally, but not for price changes. Because the U.S. is such a huge importer, the trade deficit has soared in 1999 (chart). The consensus forecast is that the October deficit did not change much from September's huge $24.4 billion. You can get the report at when it is released at 8:30 a.m. on Dec. 16.

The monthly trade data are collected for almost all countries by the Commerce Dept.'s Census Bureau and the Bureau of Economic Analysis (BEA). For Canada, our major trading partner, Commerce uses data collected by Ottawa. Goods-export data come from shipping forms filed with U.S. Customs by exporters, forwarders, and overseas carriers. One criticism is that exports are undercounted, perhaps by as much as 10%, because businesses do not have to report shipments worth less than $2,500. Imports are better counted because tariffs must be paid on most incoming shipments.

HOT PACE. Since all shipments headed overseas must pass through Customs, goods bought on the Internet are picked up in the data. For services, such as software downloads, Christopher Bach, chief of the BEA's Balance of Payments Div. says, "Our feeling is that cross-border transactions are there, but not very big yet." Still, the BEA surveys companies to determine how many of their Net transactions are headed overseas.

Export and import trends are of keen interest to stock and bond investors. Rising imports indicate that U.S. demand is greater than producers can satisfy. Given that the Federal Reserve is bemoaning the hot pace of domestic spending, increased imports are an unsettling sight for investors who fear another interest-rate hike.

Stronger export growth, on the other hand, is a welcome sign that foreign demand is finally picking up after recessions pockmarked the world, starting in 1997. But again, there's the Fed factor. The U.S. economy benefited from the output slack caused by the fall-off in exports over the past two years. Strong demand from both domestic and foreign customers in 2000 could lead to production bottlenecks and price pressures. The Fed would then step in with another rate hike.

Economists are increasingly worried about how the mounting trade gap affects the dollar. So far, Wall Street has shrugged off the dollar's volatility this year: up 14% against the euro but down 9% vs. the yen. But the continued widening of the current-account deficit could trigger a widespread flight from the dollar which could hurt your investments. Jay Bryson, international economist at First Union in Charlotte, N.C., explains that a nation's current-account deficit must be financed by an inflow of foreign capital. High rates of return on stocks and bonds are needed to attract funds from abroad, and the inflow causes the nation's currency to appreciate.

The problem, says Bryson, "is that at some point, foreign investors may start to question our ability to repay our international debts," which now total $2 trillion. Foreigners would then begin to sell off their U.S. holdings. A sell-off, even if gradual, would cause the dollar to depreciate and exert downward pressure on the prices of your stock and bond holdings. You don't want that, of course. You want your portfolio to grow--and hope the trade deficit won't.

Before it's here, it's on the Bloomberg Terminal.