Trade War and Market Strategy: A Canadian Investment Perspective

Executive Summary

On February 3, Canadian Prime Minister Justin Trudeau and U.S. President Donald Trump completed their second phone call of the day. Both Mexico and Canada received a one-month reprieve on tariffs. In exchange, Canada has committed to a $1.3-billion border plan to curb the flow of fentanyl, deploying nearly 10,000 frontline personnel and appointing a Fentanyl Czar to lead a Canada-U.S. Joint Strike Force against organized crime, fentanyl trafficking, and money laundering. 

The current trade environment reflects deeper strategic considerations beyond immediate tariff negotiations. Although the latest agreement signals an effort by both nations to avoid a trade war, significant economic tensions remain. 

“My style of deal-making is quite simple and straightforward. I aim very high, and then I just keep pushing and pushing and pushing to get what I’m after. Sometimes I settle for less than I sought, but in most cases I still end up with what I want.” - Donald Trump, The Art of the Deal 

President Donald Trump’s book, The Art of the Deal, published nearly 40 years ago, offers insight into his negotiating philosophy. His approach is to assert dominance at the outset and gradually recalibrate as negotiations unfold. However, he is unlikely to back down easily from tariffs.  

We believe that President Trump is using tariffs to expedite the reshoring of U.S. manufacturing and as a revenue generator to offset the extension of the personal income tax cuts from his first term. As a result, a swift resolution to this trade war may be unlikely. 

While it can often feel like periods of uncertainty are a time for dramatic portfolio changes, it is more likely a time for patience and trust in a long-term approach. Focusing on diversification, adaptability, and disciplined risk management is more critical than ever.

Nicola Wealth focuses on diversification and proactive adjustments to navigate tariff risks while identifying potential opportunities. By continuously adapting our holdings, we aim to protect long-term goals and capitalize on emerging opportunities in a volatile environment.

Comments from the Desk of John Nicola

Below is an important summary of the key points regarding President Trump’s tariff strategy and its possible impact on the Canadian economy and various asset markets. I want to add a few thoughts to keep in perspective.

Trump cannot inflict significant damage without causing negative repercussions for the U.S. economy. Tariffs are effectively a tax, and it is the buyer, not the seller, who bears the cost. This dynamic puts everything from inflation to interest rates to employment levels on the table, both in the U.S. and in any country from which he chooses to extract tariffs.

Portfolio Manager Ben Jang provides details on the Nicola Wealth Core Model and its historical ability to navigate market crises. The accompanying chart illustrates the performance of the Nicola Core Composite during the four major crises of the past century, reinforcing our confidence in its resilience (Figure 1).

Figure 1

Note: The situation remains fluid and is likely to evolve further. The analysis below was completed just before the decision to postpone the tariffs.

The Economic Impact of U.S. Tariffs on Canada

Before a one-month reprieve was announced, President Trump declared that as of February 4, Canadian and Mexican imports to the U.S. would face a blanket 25% tariff, while an additional 10% tariff would be imposed on China. Energy resources from Canada would be subject to a reduced tariff of 10%.

In response, Canada announced a retaliatory 25% tariff on $155 billion of U.S. goods in two phases. This retaliation could escalate tensions further, as the presidential executive order highlighted that the U.S. may increase tariffs if any country retaliates.

The deep integration of the Canadian and U.S. economies makes trade policy crucial to Canada’s economic outlook. As one of America’s largest trading partners and its primary export market, roughly 77% of Canadian goods are exported to the U.S.

After more than 30 years of trade agreements between the U.S., Canada, and Mexico, many industries have become deeply interdependent across borders. This interconnectedness means that even small shifts in trade policy can have significant ripple effects across the Canadian economy.

Recent research from the Bank of Canada suggests that reciprocal tariffs could cause Canadian GDP to contract by as much as 6%, potentially triggering a recession if the tariffs remain in place for an extended period. Certain industries are more vulnerable than others, highlighting the high stakes involved.

While the U.S. economy remains relatively strong, President Trump has maintained his view of tariffs as a tool for growth. However, historical evidence shows that protectionist measures can hurt the imposing nation as well. For example, tariffs imposed during the previous Trump administration led to reduced household income, diminished employment, and lower economic output for both businesses and consumers.

The Bigger Picture: What’s Driving U.S. Tariff Policy?

The U.S. administration has primarily justified tariffs on concerns about illegal immigration and fentanyl imports, but we view this as a red herring, especially regarding Canada. Last year, only 20 kg of fentanyl was seized at the northern border, compared to 9,570 kg at the southern border. Less than 1% of fentanyl seizures and illegal crossings into the U.S. originated from Canada. By citing these issues as national security risks, the administration can invoke the International Emergency Economic Powers Act to avoid legal challenges.

While improving border security and addressing concerns about the illegal drug trade would be an added benefit for the U.S., the main objective seems to be expediting the reshoring of U.S. manufacturing. Tariffs may encourage companies to relocate factories to the U.S. and use domestic inputs. Additionally, President Trump likely seeks to expedite renegotiations of the free trade agreement between the U.S., Canada, and Mexico (USMCA), which is scheduled for a formal review in 2026.

We believe that another key motivation behind the tariffs is their potential as a revenue generator. Earlier this month, President Trump established the External Revenue Service, citing weak trade agreements and a desire to collect tariffs to ensure that other countries “pay their fair share.” Tariffs could raise upwards of $250 billion annually for the federal government, although consumer behaviour changes could reduce this amount by half. Currently, almost all U.S. goods and services tax (GST) revenues go to state and local governments, and relative to GDP, the U.S. has the lowest GST among G7 countries.

President Trump’s Tax Cuts and Jobs Act (TCJA) introduced significant individual income tax cuts, set to expire in 2025. If extended, it could add $4.6 trillion to U.S. deficits over the next decade. While tariffs appear designed to have foreign countries fund the tax cuts, U.S. consumers will likely bear the increased costs, effectively acting as a national sales tax.

How This Impacts Investors

Markets have largely remained calm in response to the potential tariffs, though the aggressiveness and potential for further escalation have caused some weakness in equity markets, particularly in Canada. Overall, the impact has been relatively muted. Trade is not a zero-sum game, and in a trade war, all parties stand to lose in some way.

Given the current circumstances, there does not appear to be an easy path to a resolution. In fact, it’s unclear what would appease President Trump, as his demands are not being spelled out with specifics. The Canadian economy is currently in a weaker position than the U.S., and with the government in prorogation, concerns are heightened.

While the specifics of a trade war are unpredictable, our diversified approach is designed to help manage risk in uncertain times like these and maintain exposure to potential opportunities when market conditions improve.

Maintaining a Disciplined Investment Approach Amid Uncertainty

Nicola Wealth

The key foundational piece for one’s portfolio is starting with a resilient strategic allocation. 

• Broad Diversification: We incorporate private capital and real estate alongside public assets to create diversified portfolios. Additionally, our Core model does not have a home country bias where investors are over-exposed to domestic equities. The Nicola Core Portfolio Fund has roughly a 5% weight in both Canadian and U.S. public equities while our current U.S. dollar exposure is close to 50%. 

• Minimizing Downside Risk: We are reducing exposure to sectors most vulnerable to tariffs and increasing defensive positions. 
• Targeting Resilient Sectors: We are maintaining or increasing exposure to areas such as critical minerals and integrated energy producers, which are less negatively impacted by current conditions. 
• Flexibility and Monitoring: We are closely monitoring developments and positioning our portfolios to benefit from potential opportunities and to adapt quickly as market conditions evolve. 

How This Impacts Markets

Equity Markets

While tariffs generally create market headwinds, companies’ individual exposure varies based on their supply chains and pricing power.

Nicola Wealth’s equities strategy focuses on being defensive, including bolstering exposure to companies and sectors less vulnerable to tariff impacts, such as:

• ATS Corp (TSX:ATS): As a systems integrator and provider of automation solutions, ATS is less likely to be affected by U.S. tariffs. Although the company manufactures some proprietary products in Canada, it can shift manufacturing capacity to the U.S. if necessary. Furthermore, its global footprint and diversified supply chain across North America and Europe may help mitigate tariff-related risks.
• ServiceNow (NYSE:NOW): ServiceNow is an American software company that develops a cloud computing platform to help companies manage digital workflows. Generally, companies which provide digital services and software versus physical goods may be less impacted. These companies have their revenue generated from subscriptions and licensing, which are not directly affected by tariffs on physical goods.
• Walmart (NYSE:WMT): Retail giants such as Walmart are also likely to be less impacted due to their size and scale, which enable them to manage supply-chain pressures more effectively.

Fixed Income

If trade restrictions further weaken an already slowing economy, the Bank of Canada may lower interest rates, benefiting the bond market. Recently, we slightly increased the duration of the Nicola Bond Fund, but with rates already low, we remain cautious.

Tariffs are expected to drive up prices in Canada and the U.S. as companies adjust to higher costs. The Canadian bond market is focused on the economic risks of a trade war. If tensions persist, we expect the Bank of Canada to continue normalizing the overnight rate, potentially leading to a steeper yield curve and higher bond prices.

The Bank of Canada may accelerate this process to support the economy during uncertainty, but any action will be measured, especially if inflation rises, as the Bank of Canada would need to proceed cautiously.

Energy Sector

Energy remains a key focus, as reflected in the reduced 10% tariff. Companies with higher production costs may face greater challenges, but firms like Suncor, which handles both production and refining, may be better positioned. Suncor processes around 80% of its oil through Canadian refineries, so even if trade restrictions impact a portion of its production, its efficient operations could help maintain profitability at current oil prices.

Critical Minerals and Nuclear Energy

Recent U.S. energy policies, particularly those focused on boosting domestic energy production, have drawn attention to essential minerals like uranium. This creates an interesting opportunity for companies like Cameco, which is a major uranium producer with operations in both the U.S. and Canada. Over the long term, the outlook for uranium appears relatively strong, particularly given America's focus on energy independence and the growing role of nuclear power in energy plans.

Beyond uranium, other critical minerals like cobalt may offer growth potential due to their strategic importance to U.S. energy and technology sectors.

Private Equity

While deal-making may slow, significant opportunities for distressed mergers and acquisitions could emerge, potentially benefiting companies with cash reserves and private equity firms with capital to deploy.

Real Estate

Historically, rents and inflation have been closely linked, so inflationary pressures could prove beneficial for commercial real estate as an inflation hedge. Additionally, with interest rates moving lower, particularly in Canada, borrowing costs are more favourable, which could support flat or declining cap rates. However, given the economic uncertainty, we will maintain relatively low overall leverage, focusing on multi-family residential, specialty, and regional retail properties.

Final Thoughts

The unpredictable nature of President Trump’s actions and policies can add complexity to investing. While it can often feel like these are times for dramatic portfolio changes, it is more likely a time for patience and trust in a long-term approach.

Nicola Wealth focuses on diversification and proactive adjustments to navigate tariff risks while identifying potential opportunities. By continuously adapting our holdings, we aim to protect long-term goals and capitalize on emerging opportunities in a volatile environment.

Discover how Nicola Wealth’s asset management strategy is designed to help grow and safeguard your wealth. Learn more: https://nicolawealth.com/asset-management