As we approach the half-way point of 2025, Canadian stocks are in a much better position than many expected.
Despite all the political and economic developments that could have weighed heavily on valuations, investors are flocking to Canadian and other non-U.S. markets in anticipation of the damage tariffs are expected to inflict on the U.S. economy and financial markets.
For example:
To be clear, the equity market continues to face challenges, and returns are hardly cause for celebration. As of May 15, Canadian stocks gained 4.7% for the year, while the U.S. market was up 0.6%.2 But we continue to see the domestic market as attractive, fertile grounds for long-term growth opportunities in portfolios diversified across geographic regions and asset classes.
Short-term Pain in the U.S.
The good news is that Canadian investors appear to have moved past the peak of tariff-related anxiety. We still expect tariffs, but they are unlikely to be as heavy as first expected. President Trump has been walking back some of his most extreme threats, including a blanket 25% tariff on Canadian goods, and modifying his rhetoric in response to declining approval ratings at home and the uncertainty they added to the U.S. stock market.
In addition, tariffs are on hold for sectors that are compliant with the Canada-United States-Mexico Agreement (CUSMA). That trade agreement protects a wide variety of exports in categories such as agriculture, manufacturing, digital trade, and intellectual property.
It appears, at least for now, that tariffs are hurting U.S. consumers, businesses, and investors more than Trump and many others expected. They are pushing up retail prices and will continue to work against the Federal Reserve’s mission to keep inflation contained at around 2%. While the Fed has made progress in this area, U.S. inflation remains stubbornly high.
Businesses in the U.S. cannot pass on all tariff-related costs to consumers without discouraging sales, which will erode profit margins and weigh on economic growth. Tariffs on aluminum and steel imported from China could be particularly damaging—a fact that we believe is underappreciated by investors at the moment. These are observations about the risks that we see, and not necessarily foregone conclusions.
Canada’s Solid Financial Sector
Despite all these headwinds working against the U.S. stock market, there has not been a significant reset in valuations. Price-to-earnings (P/E) multiples are above their long-term averages, whether they are measured on a trailing or forward-looking 12-month basis.3 They do not reflect the very real risk of an economic slowdown or recession in the U.S.
Canadian stocks, on the other hand, are priced at or near their long-term average.4
The heavy weighting of technology stocks in the S&P 500 Index can work in favor of the U.S. stock market or against it, as witnessed by their recent decline. Tech stocks are not prominent in the Canadian market, making up just 9% of its value, with just one well-known competitor in the online retail space. What we do have, however, is one of the soundest financial sectors in the world. Financials account for more than 30% of the market, and banks alone represent around 20%. Our banks are fairly well provisioned, well managed, profitable, and are not subject to tariffs because their business is primarily domestic.
Canada also has the advantage of a central bank that can cut short-term interest rates more quickly, significantly, and effectively than the Federal Reserve if the U.S. economy stalls or slips into a recession. U.S. inflation has been decelerating, but it hasn't fallen at the pace we have seen here at home. If the U.S. does slip into a recession, Canada will definitely feel the pain. But the Bank of Canada is in a much better position than the Fed to reduce rates to stimulate the economy.
Finally, political uncertainty has eased now that the election is behind us. Ottawa can explore stimulating the economy with targeted fiscal policy. And it appears that Canadians have become somewhat united in our desire to wean ourselves off of our reliance on the U.S. as a trading partner; find alternative markets for our exports over the longer term; and reduce interprovincial trade barriers (different licensing requirements, manufacturing standards, etc.) that have been a real impediment to economic growth in this country.
Balancing Risk and Reward
You might be wondering: if the situation in the U.S. is so dire, why do we maintain considerable exposure to U.S. stocks?
The answer is that despite everything that's going on, hard data on the U.S. economy is still relatively solid. GDP and corporate earnings are still growing, albeit at a slower pace. So, it is within the realm of possibilities that the U.S. could emerge from this tariff storm without serious structural damage.
Also, keep in mind that while the economy and financial markets are aligned, they are two completely separate forces. The market is forward looking, and if we have reached “peak tariff risk,” investors will look for opportunities to wade back into U.S. stocks.
Our fundamental goal is to earn attractive returns while maintaining a prudent level of exposure to risk in our portfolios. We have a dynamic investment process with respect to asset allocation and as market conditions improve, we have the ability to fine tune those allocations.
Nobody can predict the future. But we can say with some degree of certainty that the fundamental power of diversification will continue to serve us well.
1. Financial Post, Portfolio managers see TSX as long-term winner, April 23, 2025.
2. S&P Dow Jones Indices, May 14, 2025.
3. Guru Focus, S&P 500 charts, May 14, 2025.
4. SimplyWallSt.com, Market Valuation and Performance, May 15, 2025