The threat of U.S. tariffs has captured the attention of Canadians to the point of obsession. Clichés like “Team Canada,” “All hands on deck” and “Canada First” inundate every discussion on the subject. Some Canadians seem to have acquired overnight expertise in international economics, much in the same way that many of us became world-class immunologists during the COVID-19 lockdowns.
Sarcasm aside, a 25-per-cent tariff on all Canadian goods exported to the U.S. would be very serious. Retaliating with tariffs and other measures would be catastrophic. Although it appears counterintuitive, imposing tariffs on another country imposes a de facto hidden sales tax on your consumers there – to the benefit of local producers. That is, if local suppliers exist or can gear up production. Canada putting a tariff on Florida orange juice is not going to result in orange trees magically appearing in Flin Flon, Man. The logic is true for the U.S. imposing tariffs on us.
Patriotic emotions aside, cooler-headed investors need to look at the possible effects this current animus between Canada and the U.S. might have on absolute and relative asset prices. And here is where Canada has more at stake.
Buying Canadian and choosing one ketchup brand over another may appeal to our jingoistic inclinations, but buying and holding Canadian investments based on patriotic emotion is a terrible investment strategy. Canadians have no control over the Trump administration and almost none, as individuals, over our own leaders. However, they do have power as individual investors over their futures.
Never forget, Canadian stocks and bonds make up less than 5 per cent of the world’s investment assets by market capitalization. Those investments could be severely affected by the continuing deterioration of Canada-U.S. economic and political relations.
We have seen volatility in the Canadian dollar recently as a result of this situation. Stock markets in both countries briefly showed volatility early in this drama, which may have influenced President Donald Trump’s decision to delay the tariffs. If we continue along this course, these market moves may end up, in hindsight, looking like foreshocks that precede a large earthquake. It is difficult to assess probabilities when so much depends on the actions of governments on both sides of the border.
There is a material chance that Canada will enter a financial crisis where bond prices, stocks, and the loonie all fall, and institutional investors flee Canada as our creditworthiness is questioned. This could happen if tariffs are further expanded beyond steel and aluminum and the government implements COVID-type bailouts to those Canadians negatively affected.
Think that’s impossible? Read some economic history. Sovereign debt crises used to happen more frequently. I doubt they have gone extinct. Also, Canada did have a debt crisis in the early 1990s. I experienced it firsthand as a bond manager and Canada is in even worse shape now.
Canadian government debt – whether when looking at total levels or as a percentage of GDP – is currently at similar levels as the debt crisis of the early 1990s.
These already-high debt levels could grow even higher if governments implement another COVID-style stimulation package. This could also add to inflation.
Let’s hope cooler heads will prevail, our relationship with the U.S. will improve and Canada will actively address the serious economic problems we have of our own making. As Roman emperor and stoic philosopher Marcus Aurelius opined: “Harmed is the person who continues in his self-deception and ignorance.”
Investors should not hold a false hope that divine grace will save us. It is wise to decrease exposure to Canadian assets. U.S. bond yield spreads over Canada bonds are near all-time highs and that extra yield makes U.S. debt more attractive for international investors. Although Canada has lower inflation, which is important in bond outlooks, that advantage may go away if the Government of Canada decides to expand the money supply and hand out cheques to workers hit by tariffs.
Meanwhile, investors will have to contend with currency risk. The Canadian dollar hit 62.5 US cents in 2002 in the long aftermath of the crisis of the early 1990s. Revisiting those lows shouldn’t be ruled out.
The iShares 20+ Year U.S. Treasury Bond Index ETF XTLT-T is a good way to hedge risk away from Canada bonds. Any U.S. government bond ETF will do this job but make sure that exposure to the U.S. dollar is not hedged out.
Caution is advised on Canadian stocks. Canadian financial institutions make up about 30 per cent of the TSX index weight. Their share prices are at risk in a financial crisis. The Canadian consumer is overburdened with credit card debt, and real estate would be affected. Canadian financial service stocks have risen about 50 per cent since the fourth quarter of 2023. Now is a good time to take some money off the table.
We live in volatile times and investors should take note. The investment portfolios of individual Canadians are not a priority for our leaders. Given the risks and uncertainties in Canada, “the juice ain’t worth the squeeze.”
Don’t look for international institutional investors to save us – they loathe country risk. They rather explain missing any future upside investing in Canada as risk avoidance than being overweight an economy that is facing a significant downturn.
Tom Czitron is a former portfolio manager with more than four decades of investment experience, particularly in fixed income and asset mix strategy. He is a former lead manager of Royal Bank of Canada’s main bond fund.