Stocks continued to soar, and corporate bond credit spreads compressed ever lower to near record expensive levels, undeterred by the noise of tariffs. In their latest quarterly Market Observer, the team at Canso Investment Counsel Ltd., a leading Canadian institutional investment management firm, points out that things are still unclear, and so, their strategy is to step back from these hot markets, even at the risk of being left behind. Click here for the full Market Observer.
Canso’s October Market Newsletter begins by pointing out that bad news seems to be out of vogue, as financial markets ignore negatives in their surge to ever more expensive levels.
The S&P 500 returned 8.1% in the 3rd quarter, improving it to 14.8% year-to-date, the tech and Magnificent Seven heavy NASDAQ index was up 11.4% in the quarter, improving to 17.9% year-to-date. But surprising to the Canso team was the standout performer–the Canadian TSX index, up 23.3% in the quarter and 27.7% year-to-date.
“Any new Trump tariffs were treated as noise to be filtered out by the financial markets, and it was back to business as usual for financial assets, getting more expensive. Stocks continued up and corporate bond credit spreads compressed ever lower to near record expensive levels,” the Market Observer noted.
Trump trumps TACO, even as tariffs continue
The team at Canso wrote that despite his TACO (Trump Always Chickens Out) label, U.S. President Donald Trump actually followed through and applied many tariffs at substantial levels after his July 9th deadline for his 90 promised deals that never happened.
“Psychologists and propagandists will tell you that if something is repeated enough, you tend to believe it, even though you know it to be false. Perhaps Trump’s repeated characterization of his tariff policy as ‘Beautiful’ has rebranded it to investors as positive or at least not as negative as predicted by economic theory. It could also be that investors are drunk on the testosterone generated by their financial success, as Professor John Coates of Cambridge has shown in his research.” Adding that they are not so sure that things are as rosy as the financial markets seem to believe.
“Financial markets demand immediate answers and often come quickly to the wrong conclusions, that’s why they go up and down. The Trump tariff strategy is anything but normal. Trump has turned the seemingly inexorable move towards international free trade and globalization on its head, making them the root cause of voters’ economic problems and not the solution to better a country’s citizens’ lives,” they warn.
Tough times ahead for Canada
Though Trump loves his tariffs, U.S. trading partners, except for China and Canada, have so far not retaliated with counter tariffs, and that has permitted Trump’s trade aggression to continue unhindered.
“Fighting an enemy that unilaterally surrenders, as most countries now have, makes the cost of fighting a trade war much lower for Trump. The Carney government in Canada has now moved from its ‘zero tariffs’ and ‘fighting back’ rhetoric during the recent election campaign to appeasement by removing trade ‘irritants’ in the hopes of getting Trump to enter negotiations,” the Canso team wrote.
The authors add that the Carney government attempts to ‘remove irritants’ didn’t help, as Trump has since added more tariffs on Canadian goods.
“In our view, the Carney government has just unilaterally surrendered its trade weapons and is tapping out of the trade fight. Even though the trade minister responsible for negotiations with the U.S., Dominic Leblanc, claims that Canada still has some leverage, it is hard to see what,” the newsletter points out, adding that if things don’t go well, it is implausible that the Carney government would put any tariffs back on. That could likely be viewed as a direct provocation by the Trump Administration, given the looming United States-Mexico-Canada Agreement (USMCA) renewal.
“The cash is rolling in and Trump is winning his trade war. He wants Canadian companies to move to the U.S., so why would he change his tariff strategy? Trump is a real estate developer and sees his tariffs as lease revenues. A cardinal rule of real estate is to never lower a client lease rate since that lowers the valuation of your property. That will make it very hard for the Carney government to get Trump to relent, absent buying a huge amount from the U.S. or funding part of Trump’s Golden Dome missile defence program,” they noted.
Other problems: Trade overexposure, housing, immigration
Years ago, when free trade was first proposed between Canada and the U.S. in 1988, some argued that if Canadian producers scaled to serve the U.S. market, then they would be highly exposed if the U.S. eventually backed out. “That day is now here, despite no formal end to the Canada-United States-Mexico Agreement (CUSMA). We think that we Canadians are in for some very heavy economic weather ahead,” the Canso team warns.
They add that the problem now for Canada is that we represent 10% of the combined U.S. Canadian market and we’ve given up production of many domestic goods. Rebuilding that manufacturing capacity without tariff walls to protect it would be reckless.
On the other hand, the go-to Canadian economic solution for recession–the Canadian housing market–will be unlikely with the post-pandemic Canadian real estate mania finally sputtering to a close with listings soaring and sales at record lows. The team at Canso doesn’t believe there’s the capacity or consumer belief to create another real estate boom. “The roll back of the insane Trudeau government temporary immigration surge is good policy and politics so increasing demand by stoking the immigration fires is also unlikely,” they wrote.
For now, the authors expect the Bank of Canada to ease alongside the Federal Reserve, since the last thing the Canadian economy needs is a stronger Canadian dollar.
What happens next?
For the Canso team, things are just as hazy as they were last quarter. It is too soon to see the effects of Trump’s “Trade War on the World”. Exports and production priced out of the U.S. market by Trump’s tariffs are looking for other markets and anywhere, but the U.S. seems vulnerable. Canada has already seen tariffs from China on Canadian canola exports, due to Canadian “Dumping” (selling below cost) tariffs on Chinese steel and other goods.
“Canada is in a particularly bad position, as a small market now heavily dependent on exports to the U.S. after years of free trade,” the newsletter pointed out.
For now, the Canso team is keeping an eye on the investment markets, even as they seem to defy gravity and continue their upwards strength.
“It takes considerable courage as a trader or portfolio manager to step back from these hot markets, risking being left behind and possible career peril, but that’s what we’re doing. Indexing and quantitative/Artificial Intelligence (AI) trading strategies are simply trend following strategies, despite their grand names. What goes up, goes up more, attracts more investment flows and keeps going up. Until it doesn’t,” they wrote.
Disclaimer: This story was created by Canadian Family Offices’ commercial content division on behalf of Canso Investment Counsel Ltd., which is a member and content provider of this publication