Rising uncertainty amid tariff threats―what does it mean for Canadian investors?

On Monday, February 3, in a demonstration of how fluid the situation remains, both Mexican President Claudia Sheinbaum and Canadian Prime Minister Justin Trudeau announced that after a conversation with the President Trump, the United States agreed to wait a month before the tariffs would take effect.

On March 4, that 30-day delay came to an end and the previously announced tariffs came into effect. In response, Canada announced reciprocal tariffs of 25% on $155 billion of U.S. goods imported into Canada. These tariffs will be implemented in phases with the first phase affecting $30 billion in goods immediately and an additional $125 billion in goods to be tariffed 21 days later.

Canada, Mexico, and China are the United States’ largest trading partners, and a protracted trade dispute would likely negatively affect all three countries.

The reaction from investors wasn't surprising. Markets closed Tuesday with the S&P 500 Index, the NASDAQ Composite Index, and the S&P/TSX Index down 1.2%, 0.4%, and 1.7%, respectively.¹

While most investors know not to make knee-jerk investment decisions, it isn’t always easy to do so. Might lessons from 2017/2018 provide some insight? 

"While most investors know not to make knee-jerk investment decisions, it isn’t always easy to do so." 

Donald Trump’s victory in last November’s U.S. presidential election made headlines around the world and generated countless analysis and opinion pieces. Among them, the view that the new U.S. administration was looking to introduce tariffs of up to 25% on Canadian exports to the United States.

Speculation heightened in the lead-up to the inauguration ceremony on January 20, but few could have anticipated the turn of events that followed. The morning brought relief as news outlets reported that in place of a tariff announcement, a broad memorandum would be issued, directing U.S. government agencies to study the country’s trade deficits and evaluate U.S. trade relationships. That evening, however, brought news that Washington could impose 25% tariffs on Canadian goods from February 1. Here we are, a month later, and the tariffs have been implemented, but uncertainty remains. 

As noted earlier, tariffs in any form are likely to have a negative impact on Canada’s economy. That said, it’s worth bearing in mind that the economy is distinct from the markets.

It’s impossible to predict how Washington’s policies will evolve over the coming months. Will the Trump administration quickly pivot if gasoline prices begin to rise materially or inflation increases due to the likely extra cost of tariffs on the U.S. consumer? Or will this become a long, drawn out battle? For now, any discussion around quantifying the impact on the economy would amount to, at best, false precision and, at worst, pure speculation. That said, it’s important to understand the economic relationship between Canada and the United States as well as the investment landscape that we were operating in the last time we experienced tariff uncertainty (i.e., in 2017/2018).

Historically, Canada and the United States have enjoyed one of the most extensive and mutually beneficial bilateral relationships in the world, characterized by deep economic, cultural, and political ties.

Following, we list some key aspects of their interdependence.

1 Trade: the world’s most comprehensive trading relationship

It’s no coincidence that Ottawa and Washington have long described trade between both countries as “the world’s most comprehensive trading relationship.” Goods and services worth nearly CAD$3.6 billion (US$2.7 billion) crossed the border each day in 2023. It shouldn’t surprise anyone that Canada and the United States are each other’s largest export markets. Similarly, the United States is the single largest investor in Canada while Canada returned the favour by being the biggest source of foreign direct investment to its neighbour to the south at the end of 2023.²

2 Energy: a key component of U.S. energy security

Canada is a major supplier of energy to the United States, including oil, natural gas, and electricity. In fact, it’s the United States’ single largest foreign energy supplier,¹ thereby making the country a crucial component of U.S. energy security. Canada exports nearly four million barrels of crude oil to the United States every day, powering some six million U.S. homes. U.S. refineries, particularly those in the Midwest and around the Gulf Coast, are set up to process Canadian crude as opposed to crude from the Middle East or Venezuela. 

3 Supply chains: state of interdependence

It’s common knowledge that the two nations have highly integrated supply chains. Infrastructure that connects both countries has been built over decades, linking industries such as automotive, aerospace, and technology. Parts and materials often cross the border multiple times during the manufacturing process. In 2023, a hefty 72% of U.S. freight with Canada was transported by land—the old-fashioned way using truck and rail. The extent to which the two economies are dependent on it was laid bare last August when a labour dispute led two rail companies to shut down freight traffic on Canada’s two largest railways. Cue numerous headlines on how the shutdown would roil North American supply chains and inflict damages to both the U.S. and Canadian economy.

4 Canada-United States: the best of friends and the closest of allies

It's clear that the United States and Canada rely heavily on each other for economic prosperity, energy security, and regional stability. It’s why the two nations have often been described as the best of friends and the closest of allies.

While tariffs are in place in the near term, we believe it’s unlikely that significant tariffs—the variety that would have a materially adverse effect on both economies—will be in place by the end of the year. Retaliatory tariffs have been announced but, ultimately, most would agree that neither side stands to benefit from a prolonged trade dispute. As such, we think investors should ignore the short-term headline noise as it’s unlikely to affect investment returns over the long run.

That said, curious mind wants to know how a trade dispute between Canada and the United States might affect investment returns.

Comparing then and now

For much of the first two years of the first Trump administration (2016–2018), the U.S. equity market, as measured by the S&P 500 Index, fared well―until around the last quarter of 2018 trade disputes between the United States and China escalated. The index subsequently dropped nearly 20%, hitting a bottom on Christmas Eve that year.

As we’ve mentioned earlier, the stock market is distinct from the economy; however, some market commentators see it as a forward-looking indicator of where the economy might be heading. In this instance at least, it proved prescient: In 2019, a year after tariffs were implemented, the United States lost as many as 43,000 factory jobs and domestic business investment declined. 

Unsurprisingly, investors are concerned that history could repeat itself. Their fears are perhaps accentuated by the market environment in which we find ourselves―lofty stock valuations. Looking back to 2018, however, it seemed clear to us that there was much more going on behind the scenes that could have influenced market performance―tariffs were only one part of the equation.

In 2018, the U.S. Federal Reserve (Fed) was in the process of getting its policy rate back to its target levels following a prolonged period of low interest rates in the wake of the global financial crisis. The Fed began its rate-hiking cycle in December 2015, when the target range for federal fund rate was 0.25% to 0.50%. By September 2018, the target range had risen to 2.00% to 2.25%.³

At the time, the fear was that the tariffs would result in a global economic slowdown and that the U.S. economy might be more negatively affected as a result of the Fed’s tightening bias. U.S. equity market valuations declined amid economic and earnings uncertainty. The global equity markets also experienced a significant drawdown, derailed by the prospect of a global recession.

Compare that with today, where the Fed has arguably exhibited an easing bias, having already cut rates by 100 basis points since September 2024.² What this tells us is that in the event the U.S. economy shows signs of weakening as a result of heightening trade disputes, the Fed has much more room to stimulate the economy through further rate cuts than it did in 2018.

While we think a repeat of 2018 is unlikely, we believe it makes sense for investors to be proactive and take steps to insulate their portfolios from the threat of tariffs.

In this environment, we favour taking a balanced approach to portfolio construction. We believe investors’ focus should be on security selection―in both equity and fixed income―rather than on broad index allocation. In our view, there’s also an opportunity to identify areas of the equity markets that are less sensitive to potential trade disputes. U.S. mid-cap companies, for instance, are a way for investors to gain exposure to procyclical/“America First” policies. From a sector perspective, industrials form the biggest component of this segment of the market. This is significant because it’s the group that’s highly likely to benefit from onshoring initiatives and have the ability to provide some protection against further U.S. dollar appreciation (potentially more so than their large-cap peers since a larger portion of their revenue is earned domestically.) 

Navigating uncertainty

Following the material pullback in the U.S. equity markets in the fourth quarter of 2018, investors were eventually rewarded with a strong recovery the following year. To us, this is yet another proof point showing that short-term trade skirmishes may not have a long-term impact on market returns. As such, it’s critical that investors don’t make impulsive investment decisions on the back of unsettling news headlines.

It’s impossible to eliminate uncertainty―it’ll always be a part of the investment journey although its triggers may be different. What’s important in times of heightened uncertainty is to retain objectivity and clarity of thought, adhere to established principles of investing, and focus on our individual investing goals.

This article was originally published on February 5, 2025, and updated on March 5, 2025.

1 Bloomberg, as of March 4, 2025. 2 Government of Canada, January 22, 2025. 3 U.S. Federal Reserve, January 29, 2025.