Lexicon Financial Group Weekly Update — February 5, 2025
“As history has repeatedly proven, one trade tariff begets another, then another - until you’ve got a full-blown trade war. No one ever wins, and consumers always get screwed.”
From the desk of Craig Swistun, CIM, MFA-P, Portfolio Manager, Raymond James Investment Counsel, and Wayne Hendry, Client Relationship Manager, Raymond James Investment Counsel
Looking Around
Topics for weekly updates often come from questions asked by our clients. It should come as no surprise that tariffs have been on everyone’s mind. How could they not be? It’s all the media has talked about for the past two weeks. So… whether tariffs are on, off, or off and then on, how does a tariff imposed by the United States (U.S.) on Canadian exports impact the economy, equity markets and, of course, investment portfolios?
Let’s go back to basics. Tariffs are simply a levy that makes imported products more expensive than those produced domestically. It can be used to protect domestic industry. If Canada has a cost advantage over the United States, a tariff will make Canadian goods more expensive to purchase south of the border. Economists would say that a “rational consumer,” assuming products are of equal quality, will pick the American-made product since they are now less expensive.
All governments use tariffs in some manner. They are often created to protect infant industries and developing economies. As we said, more advanced economies with developed industries may employ them to protect domestic employment, consumers, national security industries (for example, defence) as well as a retaliation measure against a trading partner who is perceived to have not played by the rules.
The exporting country does not pay the tariff. A Canadian business exporting to the United States does not pay the tariff. The importer pays the tariff. They are collected by the customs authority of the country imposing the tariff and are, in effect, an indirect tax on consumers. (1)
General economic theory would suggest that a “rational business” passes those costs on to consumers in order to protect profit margins.
Tariffs can have effects that go beyond what was intended. These include:
Making domestic industries less efficient and innovative by reducing competition.
Generating tensions by favouring certain industries, or geographic regions, over others.
Pressuring a trading partner country to the point where a relationship can devolve into an unproductive cycle of retaliation, otherwise known as a trade war.
Tariffs often affect lower-income consumers disproportionally, as tariffs can lead to higher prices for imported goods, including food. This places a heavier burden on individuals who have limited financial means and typically spend a higher percentage of their income on basic necessities. Small businesses that rely on imported materials or products that are subject to tariffs face the challenge of higher costs, which they will have to pass onto consumers. (2)
Goldman Sachs analysts modeled out how the tariffs could impact U.S. markets, and potentially reduce the S&P 500’s fair value by roughly five per cent. Tariffs, according to these analysts, will either shrink U.S. profit margins by raising input costs or, if higher costs are passed on to consumers, slow down sales. They estimate that every five-percentage-point increase in the U.S. tariff rate would reduce S&P 500 earnings per share by about 1-2 per cent. Tariffs can and have amplified economic and political uncertainty, which usually reduces the equity market’s appetite for risk. According to Goldman Sachs, last Friday, the U.S. Economic Policy Uncertainty Index jumped to 502 - its highest level since March 2020. Historically, this level of uncertainty has translated to a three per cent reduction in the S&P 500’s forward P/E ratio. That’s a fancy way of saying analysts believe tariffs will reduce economic output in the United States.
Other analysts have made more dramatic forecasts. Bank of America analysts this week estimated that a trade war between the U.S. and its largest trading partners could translate into an eight per cent hit to the S&P 500’s aggregate earnings. (3)
Without a doubt, if tariffs are reinstated, they will have a significant economic impact because our businesses and their supply chains are interconnected. This was one of the byproducts of NAFTA and its successor agreement, USMCA.
For example, in the production of a Chevy Silverado or a Dodge Challenger, components cross borders multiple times before being assembled into a final product. As a result, imposing a 25 per cent tariff every time a product crosses borders adds up quickly. Retaliation by Canada and Mexico to these tariffs will only multiply these effects. (4)
As you can see from the graphic below, President Trump is targeting the biggest trade partners of the U.S.
However, these tariff plays are reminiscent of President Trump’s trade policy in his first term, namely, threaten draconian tariffs resulting in widespread outrage and pushback, allow a last-minute deal to emerge and the tariffs are called off, except on China. (5)
This is somewhat supported by the fact that President Trump has already postponed the implementation of tariffs on Canada and Mexico until March this year. However, this is not a reason to believe that the conversation about tariffs is over. The Canadian, Mexican, and other governments don’t believe that, and neither do we.
While nobody has a crystal ball, we have adjusted many portfolios to become a little bit more resistant to tariffs, should they be re-initiated. But it’s important to note that what happens on Main Street does not necessarily correlate to investment performance on Wall Street. Large, multi-national conglomerates trading on U.S. exchanges have access to global markets and are diversified across multiple industries. A small business owner who relies on cross-border supply chains does not have the same opportunity to pivot and adjust.
We are also here to walk you through how we do this; all you need to do is contact us.
Read and Watch
Want deeper insight into topics in your Weekly Update? Then, read and/or right click:
Trump's tariff shock forces rethink of Canada's stock benchmarks
EU tariffs 'pretty soon' but UK can be worked out - Trump
‘Bring me my tariffs’: how Trump’s China plan was 40 years in the making
Looking Back
The Toronto Stock Exchange’s S&P/TSX composite index (TSX) managed to eke out a slight positive return last week despite the threat of tariffs hanging like the Sword of Damocles. January was a good month for the TSX, as it ended up 3.3 per cent. The news of a postponement of the implementation of the tariffs until March 1 was positive for the TSX. The Canadian dollar lost about one per cent last week and about six per cent since October 2024, thanks to the Bank of Canada (BoC) cutting interest rates more aggressively (it cut rates again last week) than the U.S. Federal Reserve (Fed) as well as rising uncertainty around trade policies. (6)
U.S. stock markets were volatile last week and finished mostly lower, except for the Dow Jones Industrial Average, which rose modestly to record its third straight week of gains. The technology-oriented Nasdaq Composite fell steeply last Monday, thanks to a sell-off in tech stocks in response to the emergence of DeepSeek, the flavour du jour Chinese artificial intelligence (AI) developer.
The second week of the Trump administration brought with it a stack of political headlines which appeared to influence investor sentiment, especially in terms of the administration’s plans for global tariffs. This came after the prior week’s comments from President Trump, which gave investors hope that he would take a softer-than-anticipated stance on global tariffs. Meanwhile, the Fed concluded its first meeting of 2025 last Wednesday and announced, as expected, that it would be holding its policy rate range steady at 4.25 to 4.50 per cent. The Fed’s decision was influenced by continued solid U.S. economic activity, positive labour market conditions and inflation that continues to be only somewhat elevated.
In Europe, the pan-European STOXX Europe 600 Index gained 1.78 per cent last week. Strong earnings results and the European Central Bank’s (ECB) decision to cut its interest rate by a quarter of a percentage point to 2.75 per cent bolstered investor sentiment. Other major European stock markets also ended higher last week.
Japan’s stock markets registered mixed performance over the week. A sell-off in major Japanese technology stocks early in the week, resulting from the emergence of Chinese company DeepSeek, weighed on the share prices of Japanese chip companies. Domestic stocks were also pressured by the Bank of Japan’s (BoJ) hawkish stance on interest rates. It raised interest rates for the third time within a year and revised its inflation forecasts upward at its January 23–24 monetary policy meeting. BoJ Deputy Governor Ryozo Himino reiterated that the BoJ will raise rates if the economy and prices move in line with its forecasts.
Mainland Chinese stock markets slid lower last week in a holiday-shortened week. One of the reasons for this could be the government data released last Monday, which revealed that China’s economy kicked off 2025 on a weak footing. Profits at China’s largest industrial companies fell 3.3 per cent in 2024, marking the third straight year of declines. Economists believe the drop in industrial profits reflected the deflationary pressures on China’s economy, which is entering its third year of economy-wide price declines amid a persistent real estate downturn that has curbed domestic demand. (7)
The opinions expressed are those of Craig Swistun and not necessarily those of Raymond James Investment Counsel which is a subsidiary of Raymond James Ltd. Statistics and factual data and other information presented are from sources believed to be reliable, but their accuracy cannot be guaranteed. It is furnished on the basis and understanding that Raymond James is to be under no liability whatsoever in respect thereof. It is for information purposes only and is not to be construed as an offer or solicitation for the sale or purchase of securities. Raymond James advisors are not tax advisors, and we recommend that clients seek independent advice from a professional advisor on tax-related matters.
The Basics of Tariffs and Trade Barriers, Brent Radcliffe, Investopedia, February 2, 2025
What Are Tariffs and How Do They Affect You? By Jacob Berstein, Investopedia, January 31, 2025
How the Trump Tariffs Could Affect Your Stock Portfolio, Colin Laidley, Investopedia, February 3, 2025
Trump’s 25% tariffs on Canada and Mexico will be a blow to all 3 economies, Joshua P. Meltzer, The Brookings Institution, February 3, 2025
The real reason for Trump’s tariffs, Heather Long, The Washington Post, February 4, 2025
Canadian dollar whipsawed amid uncertainty over tariffs, while TSX slides into the close, The Globe And Mail, January 31, 2025
Global markets weekly update - ECB reduces rates while the Fed holds steady, T. Rowe Price, January 31, 2025
SUBSCRIBE
If you’d like to automatically receive the weekly Market Update by email, enter your email address in the box below.
We respect your privacy, and you can always remove yourself from the mailing at any time.
Looking to Learn?
If you want to know more about some of the topics we wrote about this week, just click on the links below:
Trade Wars: History, Pros & Cons, and U.S. - China Example
Tariff War: What It Means, Effect, History
Evaluating the potential impacts of US tariffs – Bank of Canada