Back by popular demand, due to an unpopular US policy change this weekend.

 

Here are some real-world questions and answers from us as market practitioners and everyday Canadians, not as economists. These views are our own, not the house-view:

 

How bad is this?

 

Pretty bad. It is the most restrictive trade change that the US has imposed on Canada in a century. At that time, it was the Smoot-Hartley Act in the 1930s, which applied 59% tariffs. That Act was an effort to protect US jobs during the Great Depression, and is now widely considered to have not only failed, but exacerbated economic problems during the period.

 

For current context, exports account for about one-third of Canada’s GDP. Of that, roughly 80% of exports are goods (as opposed to services); and of those, about three-quarters go to the US. The result is that tariffs are going to touch - with varying degrees of impact - roughly 20% of Canadian GDP. 

 

Is my cost of my day-to-day living about to skyrocket again?

 

That’s unlikely, for a few reasons. 

 

First, US tariffs affect the prices of our exports, not our imports. Prices for US goods here in Canada will generally only rise to the extent that we impose retaliatory tariffs. So far, we’ve announced those on a limited group of items like cosmetics, appliances, and some foods. A second round of tariffs slated for a few weeks from now appears quite broad, but is still targeted to products where non-US alternatives are available (including cars).

 

The cost of US goods also rise when our currency weakens. The loonie (“CAD”) has declined by about 10% against USD since September, including today’s move. However, CAD has not notably weakened against other major currencies over the same period.

 

Second, nose-bleed inflation in 2021/22 was the result of not being able to get goods from anywhere due to broken supply chains. This time around, goods are available…it’s simply US goods that are now going to be pricier. That means substitution is a very viable option, since there are no new tariffs being imposed against other major countries, and since our currency has been relatively stable aside from versus the USD. Also, from a behavioural perspective, non-substitutable US goods that go up in price are much more likely to simply be boycotted by consumers. This is in stark contrast to the “revenge spending” mentality post-COVID. 
 
Lastly, inflation is unlikely to spike because Canada is very likely headed into a recession - which is to say that people are going to lose jobs. Again, this is the opposite of 2021/22, where job hopping became a quasi-sport. In a recessionary environment, businesses are already facing declining sales and generally don’t want to risk losing more by hiking prices, except where absolutely necessary. Also, if a business imports a US item for $50 and sells that to its customers for $100, the 25% tariff applies to the cost. Since $50 x 25% = $62.50, even if the business chooses to pass through all of the tariff, the retail cost “only” rises from $100 to $112.50 (i.e. a 12.5% increase, not 25%).

 

Who is going to get hurt the most?

The manufacturing sector accounts for 70% of Canada’s total trade with the US. This means industrial companies that sell heavily into the US – such as manufacturers of autos, auto parts, aerospace and industrial equipment – will be ground-zero for the tariff impact in Canada. Among the provinces, Ontario is going to feel substantial pain.

 

By contrast, the energy sector is likely to fair pretty well (in our estimation). While the discount for Canadian crude has recently widened in anticipation of tariffs, the weakening currency has substantially offset that change. Additionally, US refiners do not have a viable replacement for Canadian heavy crude in the near-to-medium term, so ultimately tariffs will get absorbed by them or passed-through to US consumers via higher gasoline prices. That’s almost certainly why the US tariff on Canadian energy is a reduced rate of 10%. Canadian oil & gas producers could potentially be as profitable tomorrow as they were on average in 2024.

 

Agricultural producers (farmers) stand to be substantially negatively impacted in the near-term. Although their product can be routed to different end buyers, this can’t always been done on short-notice, and savvy buyers will be able to extract varying discounts.

 

Canadian retailers selling into the US also face significant risk. This is particularly true for smaller online retailers, since the US has eliminated the “de minimus exemption” as part of the new tariff regime.

 

What is less certain for the Canadian economy are the negative secondary effects of the tariffs. For example, if a manufacturing plant in Ontario is forced to layoff 5,000 workers, shops and restaurants in the surrounding communities are almost certainly going to see less business. The aggregate impact of this is unknowable, and also highly dependent on the length of tariffs.

 

On the brighter side, significant parts of the economy are likely to be far less directly affected, or perhaps completely insulated. These include the education sector, health care, accommodation & food service, government, and financial services. Additionally, interest rates are almost certainly going to continue falling, which may provide a long-awaited and much needed boost to the real estate and construction sectors.

 

What about stocks?

Stocks of Canadian companies will generally decline, and in our estimation, will likely do so following the themes above. Despite being insulated from tariffs directly, sectors like Canadian financials are also likely to be sold due to the potential earnings hit from a recession. For the initial few days, simple money flows will also play a role in pricing.

 

Given that Canadian interest rates are now very likely to continue falling (RBC Economics currently estimates a 2% Bank of Canada rate by year-end), interest rate sensitive sectors like telecoms, utilities and to some extent REITs may perform relatively well as institutional money managers look to “hide out” in these stocks.

 

US stocks will no doubt initially sell-off as investors digest the modest negative growth impact of tariffs becoming reality, and speculate about how far this escalation will go globally. However, in addition to the US economy being relatively self-contained, it can also look forward to stimulus from likely personal and corporate tax cuts in the year ahead (which will no doubt be pitched as being “paid for by tariffs”). In addition, the Fed to still has very substantial room cut interest rates in order to support the US economy. While a higher USD relative to all currency is a headwind, barring major unforeseen developments, the US equity market will likely hang-in quite well.

 

Lastly, acquisitions of Canadian companies by US corporations and private equity firms seem likely to kick into high gear.

 

Is the Canadian government just going to hand-out free money again?

Well, let’s hope not. Stimulus will definitely be provided, but unlike the pandemic, broad-based support will be less effective than targeted support since tariffs will affect certain sectors and regions much more than others. Also, broad-based stimulus, especially if sent directly to consumers, has proven to be highly inflationary.

 

That said, there is a federal election coming by October at latest, so political motives may trump economic ones (sadly, pun intended).

 

Are the tariffs just a bargaining tactic that won’t even go into effect on Tuesday, or that will go into effect but quickly be rescinded?

OK – we’ll definitely agree that anything can happen in a Trump-led government. But even so, this one is a trick question.

 

From an official perspective, Finance Minister LeBlanc has said that he is “very pessimistic” a solution will be found by Tuesday, and wistfully added that Howard Lutnick suggested “perhaps there’s a window” in March.

 

From a practical perspective, though, we’re not sure that it matters – the genie is out of the bottle. How can a company now have confidence investing in a major build out in Canada – or realistically in any country – if they expect to be selling their product or services into the US? Tariffs will put them at a cost disadvantage, and even if there is a free trade agreement in place, it can apparently be ripped up overnight.

 

Regardless of if the tariffs go back to zero in the coming weeks – and that is a very big “if” – it is now clear that the US is willing impose tariffs on countries at any time of their choosing. That means a US-focused business can only responsibly invest in Canada if they feel that they can get consistently cheap land, labour and equipment here. Which is to say that as a nation, we either need to be more productive, earn less, or have a persistently weak-ish currency…or more likely, a combination of all three. The tariffs can be rescinded, but the long-term change in corporate decision-making is done.

 

Where does this leave us?

From a personal perspective, I think it leaves us all a bit sad and stung. From a financial perspective, your portfolio will weather the storm – the substantial US equity holdings we own, our focus on high-quality companies, and our belief in diversification all tend to shine through in portfolios during moments like this. 

 

Looking ahead, despite the initial pain and discomfort, these major policy changes provide a unique opportunity as a wake-up call for us as a nation to become a fit, united, competitive Canada. Sometimes a big change – no matter how unpleasant – is just the thing to catalyze surprising and unexpected growth.