First Quarter 2025 - The Land of Trade Confusion
Trump’s Tariff Talk Turns the Tables For Equity Markets As Investors Reverse Course and Flee U.S. Stocks for Foreign Stocks in Q1
Shortly after his inauguration on January 21st, U.S. president Trump, aka Tariff Man, made a trade war a top priority, threatening 25% across the board tariffs on Canada and Mexico unless these countries dedicated to do more to secure their borders. This tariff threat was ultimately delayed then softened to include only products not covered by the Canada-U.S.-Mexico Agreement (CUSMA). From there, Trump looked further out, slapping a 10% tariff on China (effective immediately), announcing a 25% tariff on aluminum, steel (effective immediately) and auto imports (as of April 3rd), and minimum 10% tariffs (trade-weighted) on all nations importing goods into the U.S. (as of April 5th), and select higher tariff levels (trade-weighted) for some individual countries (as of April 9th). Notably, Canada and Mexico are not subject to new tariffs as part of the ‘all nations, trade-weighted’ tariffs.
Yes, unnecessarily confusing. We’ll see how other countries respond in the coming days and weeks, which is sure to further complicate each individual country’s economic outlook. Here is how many countries have initially responded and telegraphed their approach to the tariffs.
It seems like there is a new announcement every day and by the time you read this, all of the above may no longer be relevant. This confusion has affected consumer and business sentiment alike, with these economic indicators plumbing multi-year lows despite an otherwise strong economy.
Trade uncertainty is beginning to have negative effects on the economic outlook as well. Fitch recently cut its 2025 US economic growth forecast by ~20% to below 2%, joining a laundry list of forecasters to lower their expectations as tariffs become a more tangible reality. Moody’s recently ran a simulation noting that 20% universal U.S. tariffs would cause a ~3% spike in the U.S. unemployment rate and a GDP decline of ~1.7%. The question many forecasters are asking these days is how much hurt is Trump willing to lay at the feet of the economy to achieve his goals.
During his first term, there was a clear hesitancy to rock the boat and negatively affect the economy, with Trump frequently touting “the performance of the U.S. economy and stock market” as gauges for his own presidential performance. During the current term, he has refrained from using these as benchmarks for his own success. When asked about the prospect of recession he replied “There will be a little disturbance, but we’re OK with that…You can’t really watch the stock market...You can’t go by that. You have to do what’s right”. That said, in his ‘Liberation Day’ speech, Trump noted that he believed the stock market would end up seeing tariffs as a positive thing and will end up reflecting the economic strength that US tariffs bring America, so the market is still very much on his mind.
Adding to the uncertainty is the Trump administration’s Department of Government Efficiency (DOGE) initiative, which is resulting in declining federal government employment, lower revenues and bookings for many businesses that deal with the US government, and as a result, an increased likelihood of a US recession in the first half of 2025.
Investors’ love affair with a now-not-so-overly-business-friendly Trump administration is over and US markets have given back all of the post-election gains, and then some. The prospect of permanent tariffs causing higher than previously expected inflation, trade friction, lower capacity utilization (i.e. potential for uneconomic factories), and less global economic activity overall is now overshadowing any business-friendly deregulation or tax benefits that may arrive in the coming months under Trump. Further, retaliatory tariffs and boycotts of U.S. goods, like the LCBO’s complete removal of U.S. products from its stores, and U.S. services, like markedly reduced travel activity to the U.S., has hurt the U.S. economic outlook specifically.
Pursuing a ‘Make America Great Again’ campaign isn’t working so well, at least when it comes to the U.S. stock market. We can see from the chart below that it is everywhere BUT the U.S. that has benefitted under Trump so far.
Performance of the S&P 500 (SPY, U.S., Blue), S&P/TSX Composite (XIC, Canada, Green), iShares Europe (IEV, Europe, Orange), iShares China Large Cap (FXI, China, Pink)
November 5, 2024 (U.S. Election Day) to April 3, 2025
While Trump’s trade approach hasn’t helped U.S. stocks, it is worth noting that part of the outperformance outside the U.S. can be attributed to a recent pivot to the political right and many countries appear likely to enact more business-friendly policy in the coming years. Additionally, an announcement by the new conservative government in Germany that it will seek to remove the country’s ‘debt brake’ and unleash unprecedented government spending to rebuild its military and invest in energy infrastructure may reignite European growth after decades of industrial contraction. The global economic outlook could flip positive very quickly once the trade war dust settles if investors shift their focus to a resurgent European economy.
Below we see periods of U.S. versus international equity market performance since 1975. Could we be entering a period of international outperformance? European stimulus, U.S. trade policies which alienate the U.S. from the rest of the world and commodities hitting all-time highs (e.g. gold, copper) hints that now could be an especially good time to invest in Canada and abroad relative to the U.S.
How To Position Portfolios Going Forward?
Economic uncertainty remains high but as we noted, the outlook in some areas of the world (e.g. Europe, China, Canada) seems to be improving, aside from short-term trade friction. Coming into 2025, due to many years of higher earnings growth rates, U.S. stocks traded at a near record valuation premium relative to international stocks. Now that Germany is seeking to spend upward of €500 billion over 12 years on military and energy infrastructure, and other countries are becoming more business-friendly, investors are likely to look beyond the U.S. for investment now that expected growth rates outside the U.S. have risen.
The past three months has highlighted the value of geographic as well as sector diversification better than almost any other period. Maintaining a highly diversified portfolio will help limit volatility and help attain returns from around the world, wherever they are being produced. Broad and low-cost exposure to international markets via the iShares MSCI Total International Stock ETF (IXUS) or the iShares MSCI Emerging Markets ETF (IEMG) are good ways to get exposure to a growing Europe. North American stocks in the energy, materials, and industrials sectors could also benefit from higher growth in Europe.
Not to say that U.S. stocks won’t benefit in the coming years. Longer term, small- and mid-cap U.S. stocks could see improved outlooks due to U.S. deregulation, more favourable tax policy, and potential U.S. reshoring of industry. These stocks performed well throughout Trump’s first term and will likely benefit when there is a shift from tariffs to other presidential priorities in the coming months. Like the historic valuation gap between U.S. and international stocks, there is a valuation gap between U.S. small- and mid-cap stocks and large-cap stocks that is nearly as profound. The Vanguard Midcap ETF (VO), Vanguard Small-Cap ETF (VB), and First Trust SMID Cap Rising Dividend Achievers ETF (SDVY) are great ways to get exposure to these areas of the market.
Stocks in the dividend paying utilities, consumer staples, and real estate sectors performed well on average in Q1 as investors preferred the overall stability and lesser tariff sensitivity of these companies. These companies also saw a boost from falling interest rates in Q1 due to tariffs and falling economic growth expectations. Interest rates in Canada continue to appear destined to fall until the tariff tussle is a thing of the past, so Canadian dividend payers may continue to perform well in 2025.
Canadian perpetual preferred shares as well as Canadian fixed income, which also benefit from falling interest rates, may continue to perform well throughout 2025, after a strong Q1.
Our allocation to alternative investments continues to generate consistent yields with very little volatility, something that is prized more than ever as we head into a period of elevated political risk and trade policy uncertainty.
Although we see pockets of opportunity together with pockets of risk, maintaining a diversified portfolio tailored to your risk tolerance is the best way to avoid major negative surprises and participate in the upside provided by asset markets over time.
The first glimmer of hope for a European industrial renaissance in decades presents new opportunities in foreign equity markets as well as for companies operating around the world that service the European industrial machine. Aggressive fiscal stimulus in Germany could end up being followed by fiscal stimulus in other European nations, presenting even more opportunities down the road. You can be sure that we are tracking all market developments and are making portfolio adjustments to manage risk and pursue returns as investment opportunities arise.
We understand how overwhelming the constant talk of tariffs can be. The news in 2025 has been particularly unsettling, and we want to acknowledge the frustration and uncertainty you may be feeling. You're not alone in this.
If you ever have any questions or concerns about your portfolio or the investment markets in general, please feel free to reach out to us.
Sincerely,
Steele Wealth Management
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