Canadian Stocks Are Ignoring Escalating Trade War With U.S.—for Now

Alcohol has been caught up in the U.S.-Canada trade war. (Heather Diehl/Getty Images)

Key Points

• The U.S. expanded its trade dispute with Canada by banning certain Canadian goods and keeping Canadian products out of government purchases.
• The trade dispute unfolds as the U.S.-Mexico-Canada trade pact hangs in limbo after the U.S. decided not to renew the agreement.
• Analysts will monitor the tone from leaders in the next couple of weeks for any signs the two sides are negotiating again.

The Canadian stock market hasn’t been bothered much by the country’s deteriorating relationship with the U.S., even as the border trade war has escalated beyond tariffs to include the Trump administration’s ban on some Canadian alcohol and cheese.

The iShares MSCI Canada ETF, in fact, is up 3.2% over the last three months, just a bit behind the State Street SPDR S&P 500 ETF’s 3.7% gain.

One reason: The Toronto Stock Exchange’s benchmark S&P/TSX Composite Index is dominated by energy, materials and financials, which have been relatively untouched by the trade war. The index also has been helped by strong demand for commodities and rising oil prices.

The sectors directly affected by the trade issues account for less than 10% of the stock market index, according to Doug Porter, chief economist at BMO .

But Porter is concerned about more escalation—or a stalemate that keeps the relationship strained. In addition, the broadening aspect of the trade war is troubling. Autos, steel, aluminum and lumber are the sectors directly in the crosshairs that get much of the attention, but niche areas like honey producers are also getting hit.

“A lot of relatively small- and medium sized businesses are being swept up in this,” he says.

The U.S. this week expanded its trade tit-for-tat by banning certain Canadian goods—including motorcycles, molasses and whey protein—and removing products originating in Canada from what U.S. government agencies can purchase.

The move came as Canada imposed retaliatory tariffs of up to $20 billion of goods in response to the U.S. doing the same last month. Those U.S. tariffs came after trade talks between the two sides fell apart at the last minute, and after President Donald Trump threatened to keep Canadian aerospace company Bombardier from selling its jets in the U.S. unless.

The dispute unfolds as the U.S.-Mexico-Canada trade pact, which governs as much as $1.8 trillion in trade, hangs in limbo after the U.S. decided not to renew the pact that was signed during the first Trump term.

The effective tariff rates on Canadian goods have risen from 5% a month ago to 7.5%, and would hit 9.5% if the threatened tariffs on autos are implemented Jan. 1, according to Robert Embree, senior economist at Rosenberg Research & Associates.

If the tariffs stick, Embree expects 0.4% lower economic growth in the third quarter, 0.5% lower in the fourth quarter and 0.6% lower in the first quarter. He also expects the unemployment rate to rise from 6.4% to 7.2% in six months.

The good news is that Canada’s fiscal health is one of the strongest in the Group of Seven countries, giving it room to offset some of the near-term hit from the trade war.

The dispute has prompted to Canada to focus on bolstering its economy, speeding up, for example, timelines for infrastructure buildouts, says Maryscott Greenwood, head of geopolitical consultancy Ottawa Street Strategy.

Prime Minister Mark Carney is also looking to diversify trading relationships and draw investment into the country. But these measures will play out over years. In the near-term, economists worry about the impact the strained relationship with the U.S.—its second-biggest trading partner after Mexico—will have on hiring and investment decisions.

The uncertainty is in part fueled by the bans the Trump administration unveiled this week. Bans are typically used as part of sanctions, national security-related issues or when there are diseases affecting cattle.

“Using a ban as part of a trade dispute is extremely unusual,” Embree says. “The total size of the category effected by bans is just CD$1 billion to CD$2 billion but it sends a terrible message and is going to only increase uncertainty as every industry in Canada will be wondering about whether they could be hit not just by a tariff but a ban,” Embree says.

If that uncertainty persists, it could find its way to the stock market. But for now, Canadian stocks on the whole may be able to plod along, with one caveat. If the U.S. actually begins the six-month wind-down of USMCA, Embree warns of a deep recession in Canada along the lines of the 1990s.

Such a move could leave Canada disadvantaged to rival Mexico, which could end up with a bilateral pact with the U.S. resulting in lower tariffs. Companies could reassess the integrated supply chains they have built up over decades in Canada—and where to put new investment.

Scrapping USMCA and the chaos it would create in deeply intertwined supply chains would rattle not just Canadian stocks but also the U.S. market and intensify affordability concerns, among the reasons analysts see low odds of such a move for now. However, they see a higher chance of Trump threatening or actually giving the required 30-day written notification needed to pull out of USMCA.

That, paradoxically, could result in an off-ramp for a resolution that each side could claim as a win, says Greenwood. One possible scenario, she says, could be Canada agreeing to an oil pipeline, increased access to its critical minerals and building out some data centers to ease the pressure in the U.S. to further buildouts, in return for a return to the zero tariffs on Canadian goods as outlined in the USMCA. That, she says, could be spun as a win for both sides.

If the dispute simmers for a while and tariffs stay in place, that could slow loan growth and deteriorate credit for the banks, potentially putting some pressure on the stock market.

Analysts at Oxford Economics also caution that the tariffs will translate into higher prices for intermediate goods—think machinery and construction materials—that could eat into profitability. In a note to clients, the analysts write that Canadian companies will pay for at least half of the country’s retaliatory tariffs through margin compression and higher prices for sectors directly affected.

Further escalation is also a risk. Canada’s biggest leverage is its energy and electricity exports to the U.S. Another concern: That the spat expands beyond trade to military or other fronts. Analysts will monitor the tone from leaders in the next couple of weeks for any signs the two sides are negotiating again.

Write to Reshma Kapadia at reshma.kapadia@barrons.com

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