Market Reaction to New NAFTA Makes Sense in Some Areas and Doesn’t in Other Areas

When it was learned late Sunday night that Canada and the U.S. had reached a trade deal that would ensure that NAFTA would remain as a trilateral agreement, stock futures jumped sharply—S&P, Dow, Nasdaq, and Russell futures. The overall euphoria didn’t last long though.

Shortly after the opening bell, the Russell 2000 turned lower and would lose 1.39% by the end of the day. The Nasdaq opened higher and was in positive territory for most of the day, but ended up finishing with a small loss on Monday.

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The Dow was the biggest winner of the main indices on Monday with a gain of 0.73%. Given that the Dow is made up of large-cap stocks with a number of industrial companies, it makes sense that it would perform well.

What doesn’t make sense is why the Russell lost so much ground. Because the Russell is made up of small-cap stocks, it wasn’t getting hit as hard from the trade dispute. Small-cap stocks don’t tend to rely on overseas sales as much as bigger companies do. When the trade dispute first shocked the market back in January, the Russell outperformed the other three indices for a great deal of time.

It made sense that the Russell didn’t lose as much as much ground, the companies didn’t have as much to lose. With the trade dispute between the NAFTA countries being settled, it doesn’t hurt those companies. Why would small-cap stocks get hit as hard as they did?

For the Nasdaq, it makes some sense that it lost ground as it is heavily populated by technology companies. The trade dispute between the U.S. and China is a bigger concern for the tech sector and therefore a small loss is understandable since there hasn’t been an agreement reached on that front.

Looking at the sector performances from Monday, there are more instances where the trading action made sense. The top three performing sectors were energy (+1.39%), materials (+1.00%), and industrials (+0.88%).

The energy sector stands to benefit from the new trade deal with the easier movement of oil between the three countries. The materials sector was one of the key sectors in the trade dispute with the steel industry in particular a focal point. The industrial sector includes industries like automobiles, aircraft, and building materials. These industries rely heavily on free trade on the North American continent.

There were four sectors that lost ground on Monday—telecom, utilities, consumer discretionary, and consumer staples. Telecom is more reliant on the trade dispute with China, so the fact that the sector was down is understandable. The same could be said for the consumer discretionary sector. The utilities sector lost ground just because it was a “risk-on” kind of day on Monday.

The one that doesn’t make much sense at all is the consumer staples sector. Yes, the sector tends to lose ground on risk-on days, but in this instance, the sector had a lot to gain with the trade deal being announced. Many consumer staples companies had expressed concerns about the tariffs increasing packaging costs (aluminum and steel). With the new deal in place, I would have thought the consumer staples sector would have moved higher.

In an article last month, I suggested that we would see progress made on at least one front in the trade war ahead of the midterm elections. That prediction proved to be correct, but I look for more news to come in the next five weeks. The deal with Mexico and Canada benefits certain sectors, but has little impact on others. If the consumer discretionary and tech sectors are going to follow suit with what we saw from energy, materials, and industrials, we will need a trade deal with China.

Such a deal would give the Trump Administration a major victory ahead of the midterm elections and could give Republican candidates a big boost in the polls. I wouldn’t be surprised if major progress is made in the next month.

About Rick Pendergraft

Rick has been studying, trading, analyzing and writing about the investment markets for over 30 years. He has worked for some of the largest financial publishers in the world and he has been quoted in the Wall Street Journal, USA Today, the New York Times and the Washington Post. In addition, he has been interviewed on Bloomberg, CNBC and Fox Business News. Rick’s analysis process includes fundamental, sentiment and technical analysis. Rick started college as an education major, wanting to teach economics, but eventually changed to majoring in Economics and received a Bachelor of Science in Economics from Wright State University. His desire to inform and educate people is at the heart of his writing.

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