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Falling Trade Deficit is Good for Stocks: True or False?

The correlation among the stock market, economy and trade deficit might surprise you

by Bob Stokes
Updated: March 28, 2019

On March 27, CNBC said that "the U.S. trade deficit fell much more expected in January to $51.15 billion, from a forecast $57 billion. The decline of 14.6 percent represented the sharpest drop since March 2018..." This brings to mind the conventional wisdom that says a falling trade deficit is good for stocks and vice versa. Let'explore whether this widely held belief about trade deficits and the stock market is accurate.

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A common claim from economic and stock market observers is that a rising trade deficit is injurious to the economy, hence, bearish for stocks. On the other hand, a falling trade deficit is commonly believed to be bullish for stocks.

Sounds like common sense, but the price action of the main stock indexes often defy reason.

Consider this from CNBC on March 27, 2019:

The U.S. trade deficit fell much more than expected in January to $51.15 billion, from a forecast $57 billion.

The decline of 14.6 percent represented the sharpest drop since March 2018... .

Even so, on the day the news was released, the main U.S. stock indexes closed lower.

Over the years, countless investors have been baffled when the stock market has risen on bad news and fallen when the news was good.

And, many investors might also be surprised by the correlation between the trade deficit and stock market prices.

The evidence is easily demonstrated.

Let's do so by presenting news items and then providing Robert Prechter's contextual comments in brackets, courtesy of his 2017 book, The Socionomic Theory of Finance :

March 28, 1981

The Commerce Department... reported the nation's balance of trade deficit had improved in February. [The second of back-to-back recessions began just five months later.]

March 1, 1984

"... the trade deficit is an economic disaster," said [a] chief economist. [An eight-year boom was just getting going.]

April 12, 1985

The secretary of state said, "We can break the back of the trade deficit only through...a stronger worldwide recovery...." [Precisely the opposite was true; the trade deficit rose during the strong worldwide recovery.]

May 26, 1990

The better-than-expected trade performance sent many economists scurrying to revise their trade forecasts. [A recession started a month later.]

February 22, 2002

The nation's trade deficit narrowed by 11.4 percent in December. [The stock market was peaking and collapsed to new lows in October.]

February 15, 2008

[A chief economist] said that the smaller December trade deficit will help to boost overall economic growth. [The second-worst financial crash and economic contraction in a hundred years were already underway.]

And, on July 14, 2010, USA Today said:

Rising trade deficit could drag down U.S. recovery.

But, as we know, the economic recovery continued.

The Socionomic Theory of Finance also has this chart with the commentary below:

RisingTradeDefiitNotBearish

The chart reveals that had economists reversed their statements and expressed relief whenever the trade deficit began to expand and concern whenever it began to shrink, they would have quite accurately negotiated the ups and downs of the stock market and the economy over the past 40 years. The relationship, if there is one, is precisely the opposite of the one they believe is there. Over the span of these data, there has been a consistently positive--not negative--correlation among the stock market, the economy and the trade deficit.

Learn about other market myths in the the free report, "Market Myths Exposed."

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