Why Good Trade Numbers Are Evidence Of Potential Market Trouble Ahead

This morning, the U.S. Commerce Department released figures that show the U.S. February trade deficit shrank a massive 17.2 percent as compared to January’s number. Given that most estimates were for a roughly flat number, that decline is a major shock, but what does it mean for investors?

The trade balance, also known as the balance of payments, is derived by subtracting a nation’s total imports from its exports. When imports are greater, as is the case with the U.S., the result of that simple calculation is a negative, indicating a trade deficit. In the most simplistic analysis a deficit is a bad thing, as it means that money has left the home nation’s economy to pay for goods and services overseas. One would think, therefore, that a smaller deficit, as reported this morning, would be a good thing for stocks; so why did futures of the major indices all move slightly lower on the news?

First it should be noted that the trade numbers weren’t the only thing released this morning. At the same time, the Bureau of Labor Statistics informed us that weekly jobless claims stood at 268,000, slightly better than the 285,000 expected. That difference will have, if anything, given a boost to stocks. It is better than expected, but probably still bad enough to delay any rate increase. Even so, we are still trading a little lower.

In fact, considering the makeup of the drop in the trade deficit, the stock market is holding up pretty well. A good improvement in the trade balance would be when exports are increased, indicating growing demand for a country’s goods and services. In February, however, exports decreased; it was just that imports decreased even more. In other words, trade as a whole was down significantly.

There is, of course, no shortage of reasons. The strong dollar was partially responsible for weaker exports, and the imports number can be attributed to any number of things. Declining oil prices, the West Coast port closures, bad weather and a host of other factors all may have played a part. The point, though, as I made clear last Friday, is that there is increasing evidence of a real slowdown, both domestically and internationally. One of the scary things about the corporate profits numbers referenced in that article was that they were the lowest since 2008. This trade deficit is the lowest since 2009. I am not suggesting that we are headed for another crash such as then; it would be both irresponsible and incorrect to conflate slowing growth with a credit crisis. It is most likely that the similarity in both cases to two scary years is just a coincidence, but it is a somewhat sobering one.

Figure 1: Seasonally Adjusted U.S. Trade Balance In Billions, Source: Commerce Dept.

With this new evidence, the “reasons” for the decline in economic activity increasingly sound like excuses.

One more question deserves our attention. If the evidence of a slowdown is mounting, why has the market not reacted? The answer lies with the Fed and other Central Banks. The continuation of ultra-low interest rates here in the U.S. and increased liquidity (via a form of QE) in Europe has been the focus of traders, not the underlying fundamental conditions that have prompted them. That is understandable. When Central Banks keep handing financial institutions big piles of cash, they will keep buying assets, pushing markets up and making the purchases a self-fulfilling prophecy. Unfortunately though, the history of markets tells us that reality has a nasty way of intruding at some point.

I should make it clear that I am no “perma-bear” who makes a living by growling loudly and scaring people. Since the recession I have stayed consistently bullish, as can be seen in the archive. It is simply that economic data are repeatedly suggesting a fundamental problem. The longer the market ignores that problem in pursuit of short term gains, the greater the reaction will be when it comes. Those that are prepared will have a great opportunity at that time to pick up some bargains, but those that simply believe the market’s current direction face some tough times.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

Martin Tillier

Martin Tillier spent years working in the Foreign Exchange market, which required an in-depth understanding of both the world’s markets and psychology and techniques of traders. In 2002, Martin left the markets, moved to the U.S., and opened a successful wine store, but the lure of the financial world proved too strong, leading Martin to join a major firm as financial advisor.

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