Tariffs likely to weaken economy and end outperformance of Canadian vs. US equities
The Canadian economy has managed several shocks in recent years, but will the trade disruption caused by tariffs be a shock too far?
Jack Manley, executive director and global market strategist at JPMorgan Asset Management has been telling Wealth Professional that he believes the outlook for the Candain economy is middling, with a considerable amount of downside risk and minimal upside risk, both of which are tied directly to trade.
“Put simply, Canadian GDP is heavily reliant on exports, particularly exports to the US,” he notes. “As such, the quality of any ‘deal’ that is signed between the US and Canada, and the time to reach that deal, are both key factors. A speedy deal with minimal Canadian concessions significantly reduces recession risk; a lengthy negotiation process or a deal with significant concessions would likely tip the economy into a recession. As it stands, the economy is vulnerable: the unemployment rate is high, progress on CPI is stalling out, and 1Q consumption was weak. Any further shocks might not be contained.”
Manley adds that this potentially challenging outlook extends to Canadian equities despite their remarkable rebound since volatility earlier this year and given that the TSX is outperforming the S&P 500, year-to-date.
“The nature of this performance suggests that the market itself is not primed for longer-term success: nearly half of YTD returns are from the Materials sector (buoyed by strong gold demand, as EM central banks look to “de-dollarize”), which might see structural support but nothing that will touch US growth equity performance prospects,” he says. “Moreover, the TSX has become more expensive, and the valuation argument that used to be so powerful is no longer compelling, with the energy sector the only significant component of the market trading at something of a discount.”
On energy, Manley says geopolitics might push oil prices higher, which would be supportive of that sector (up less than 1% YTD), but as with materials this is unlikely to be a major source of long-term returns. Although he does says it could be an interesting play.
“EM ‘de-dollarization’ is a long-term trend, which should be supportive of gold prices and Materials,” he says. “The Canadian equity market is ultimately a cyclical market, and for long-term investors, I’d consider Canadian equities as a potential complement to other DM cyclical markets (like Europe or Japan) that haven’t always lived up to expectations. I would not look to Canadian equities as a way to turbo-charge portfolio returns.”
With these risks in mind, Manley says investors should also be diversifying by “owning both domestic and US fixed income as ballast in the event of a recession in either country; and equities beyond just the TSX, including large-cap US stocks, European names benefiting from current trends (DM banks, aerospace and defense names, luxury goods), and certain ex-China Asian EMs.
