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Posted on FEB 13, 2017

Johnson Bank Wealth Weekly Investment Commentary | Monday, February 13

This is part of an ongoing series of Weekly Commentary articles published by Johnson Financial Group.
This week's issue is written by Brian Andrew, SVP, Chief Investment Officer.

Road Trip

My wife's difficulty with altitude sickness has turned our annual skiing sojourn to Colorado into a road trip, as we use time in the car to acclimate to the thinner air found in the mountains. For the economically minded, 32 hours on the road provides insight into over‐the‐road commerce, the value of the dollar and inflation. Let me explain.

Heartland Trade

Using the amount of left‐over election signage as an indicator of the new president's popularity in Midwest states, it was easy to see that he had many supporters as we made our way across rural Wisconsin, Illinois, Iowa, Nebraska and northeastern Colorado. These areas are home to manufacturers like John Deere as well as farms and ranches for grain and cattle production. Much of the trip is spent on Interstate 80. (For the uninitiated, traveling cross country on I‐80 also provides an opportunity to see the largest truck stop in the world in Walcott, Iowa.) The I‐80 corridor runs from New York to San Francisco and carries a lot of our nation's goods both by rail and by truck. As a result, any change in trade policies will be felt here.

During the president's inauguration speech, he spoke about putting “America first ” and that “protection will lead to prosperity.” As he settles into the job, we are learning that campaign trail rhetoric is more than just vote‐getting; it belies action as well. President Trump has already asked his trade representative to remove the U.S. from the Trans‐Pacific Partnership (TPP) trade deal and has upped the ante on re‐negotiating the North American Free Trade Act (NAFTA). Reshaping this act can have a material impact on trade with Canada and Mexico because they account for half of our nation's trade deficit.

The heartland is home to much of America's food production and also hosts thousands of small businesses, many of them manufacturers. These are some of the most likely beneficiaries of a renegotiation of NAFTA. Small company stocks, then, should also benefit more so than those stocks of the largest multi‐national companies who may find it more difficult to access cheaper labor markets. Smaller companies will likely also be larger beneficiaries of any reduction in the corporate tax rate.

Dollar Value

The average price of premium gas during our trip was near $2.85. In 2015, 40% of our petroleum imports came from Canada, 9% more than we imported from OPEC countries. Any change in trade policies will most likely affect the cost of energy, as a renegotiation of NAFTA has the potential to alter the value of the exchange rate between the U.S. dollar, the Canadian dollar (loonie) and the Mexican peso.

While President Trump and Treasury Secretary appointee Steve Mnuchin have both made comments about a desire to see a weaker U.S. dollar, the opposite may occur. (A confirmation vote for Mr. Mnuchin is due Monday.) With the promise of greater fiscal spending and reduced taxes, the Federal Reserve may feel the need to continue raising interest rates. This alone could strengthen the dollar as our monetary policy in the U.S. becomes more restrictive while central bankers in Europe and Asia continue to provide easy money.

To be sure, Mr. Mnuchin's suggestion that “a strong dollar may have negative short‐term implications on the economy ” is a departure from decades of the currency manager in chiefs' talking up the dollar. Perhaps the statement is an expression of a more realistic view that the government shouldn't try to manage the value of the currency; rather, it should provide a business and tax environment that is favorable. The promise of tax reform, reduced regulation and a fairer trading platform has provided a lift to small company stocks. If promise turns into policy, then we would expect to see that trend continue.

The value of the dollar will be impacted by our future trade policy. How far that dollar goes for the consumer may also be in play.

No More Fast Food

One of the hazards of road travel is the inability to find healthy food, even though fast food restaurants and truck stops abound. What you notice about the availability of a quick meal is that it comes cheap. My favorite example was 10 chicken nuggets for $1.49 (this is just an example, I didn't order them). With the cost of gas and fast food low, we wonder about the aforementioned policies' effect on the cost of these items in the future.

The value of the dollar has an impact on the cost of goods for consumers and businesses alike. A decline in the value of our currency would bring higher inflation because the cost of imported goods would rise. However, if you are trying to reduce the U.S. trade deficit, that is a good thing because people may look for domestic alternatives, thereby reducing imports. If you are in the export business, a cheaper dollar is also a good thing because the lower cost of your goods overseas makes them more attractive. If you are the president or a policymaker interested in bringing jobs to the U.S., reducing the trade deficit and increasing exports, a lower dollar helps.

So the risks of the decline in the dollar's value as well as higher inflation ultimately make things more difficult for those consumers you are trying to help. In other words, much like keeping a family happy for 32 hours in the car, future trade policymaking requires a delicate balance.

Brian Andrew
As Chief Investment Officer, Brian Andrew leads Johnson Financial Group's investment strategy
to provide consistent, actionable investment solutions for our clients.

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