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PRINT EDITION
Why U.S.-dollar assets are best bet if NAFTA talks fail
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By DAVID BERMAN
  
  

Email this article Print this article
Wednesday, January 10, 2018 – Page B1

If the United States withdraws from the North American freetrade agreement, Canadian investors are going to be scrambling for the best ways to protect themselves from the economic fallout.

The best way: Simply buy U.S. dollars. Now.

Economists, strategists and analysts have been busy over the past several months forming contingency plans should NAFTA talks fail this year.

The latest round of talks begins Jan. 23, in Montreal, and the outlook is hardly optimistic among those in the know.

"I think the probabilities are increasing that you'll have some type of dynamic where there is an announcement of a scrapping of NAFTA," Dave McKay, chief executive officer at Royal Bank of Canada, told his audience at a financial conference on Tuesday.

No doubt, scrapping NAFTA could have a profound impact on many Canadian companies, but it's unclear right now exactly what investors should be doing with their Canadian stocks because there are so many unknowns at this point.

BMO Nesbitt Burns released an exhaustive 42-page report on the subject on Tuesday, which underscored this complexity.

"We routinely receive questions from investors as to which companies would be affected the most if NAFTA is terminated. The answer is complex given the ensuing changes to the trade landscape," Carl Kirst, director of U.S. equity research, and Bert Powell, director of Canadian equity research, said in their introduction to the BMO report.

That is, what would take NAFTA's place? It could be a bilateral free-trade agreement between Canada and the United States that leaves out Mexico. Or it could mean World Trade Organization-level tariffs.

Or even a zombie-NAFTA, in which the Trump administration terminates the agreement but the U.S. Congress and business groups put up resistance.

And, of course, NAFTA could be renegotiated under different terms.

So when it comes to making calls on key sectors and companies, analysts can do little more than sketch out various scenarios.

Auto parts? Peter Sklar, a BMO analyst who covers the sector, believes the termination of NAFTA would cause an immediate sell-off in auto-parts stocks, including Magna International Inc., given his view the stocks are not reflecting this outcome.

But termination of NAFTA could lead to very high U.S. tariffs, lower most-favoured-nation tariffs or a bilateral free-trade agreement - each with remarkably different outcomes for auto-parts companies. For now, Mr. Sklar has a "market perform" recommendation on Magna, suggesting he sees little reason to run from the stock.

How about apparel retail?

John Morris, a BMO analyst, noted Lululemon Athletica Inc. already imports its yogawear from outside North America.

Canada Goose Holdings Inc. is more vulnerable, but Mr. Morris believes the company could share some of the pain with wholesalers and consumers. He has a "buy" recommendation on the stock.

Canadian railways could get hit by lower trade volumes crossing the U.S. border: Crossborder trade accounts for an estimated 30 per cent of revenue for Canadian National Railway Co. and Canadian Pacific Railway Ltd.

But BMO has "outperform" recommendations on both stocks, so again, the threat seems too vague to actually sell the stocks and run.

In contrast, though, betting the Canadian dollar will decline looks to be an opportunity that has some upside, and very little downside, should NAFTA survive.

The BMO report is peppered with the forecast that termination of the trade agreement would send the loonie down about 5 per cent as the Bank of Canada reacted to the prospect of weaker domestic economic activity.

"It is critical to note that policy would not stand still in the event of a negative outcome for NAFTA," Douglas Porter, BMO's chief economist, said in the report, pointing to looser monetary policy as an example.

If the Canadian dollar could fall against the U.S. dollar, then buying U.S.-dollar assets today - perhaps U.S. stocks, U.S.

fixed-income exchange-traded funds or even plain cash - looks like a good idea. On top of whatever you might earn through dividends, distributions or capital gains, there's also the potential for a 5-per-cent currency tailwind.

With the loonie trading above 80 cents against the greenback - up more than 2 cents since mid-December and up 7 cents since May - the Canadian dollar doesn't look as though it is reflecting the end of NAFTA yet.

And if NAFTA survives unscathed? Then rising U.S. interest rates could give you a currency tailwind anyway. Or, at worst, you've diversified beyond the Canadian dollar at a decent price.


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