The threat of tariffs and possible changes to Canadian fiscal policy could play into outlook for the banks this year
Consensus is that the US’ threatened 25 per cent tariffs on all Canadian imports would have an immediate impact on Canada’s nominal GDP. Retaliatory tariffs, significant losses for exporters, and higher costs overall could put this country into an immediate recession. However, one of the sectors most directly exposed to nominal GDP growth is currently behaving as though a deal might be struck. While the 30-day clock before Trump decides on tariffs ticks away, Canadian banks are still trading at 11.7x earnings for this year and 10.6x earnings for next year.
“We think its fair to say that the market is not pricing in a significant decline in nominal GDP growth from a tariff induced recession,” says Robert Wessel Executive Chairman and Co-founder of Hamilton ETFs. “One could reasonably infer that the market is adopting a ‘wait and see’ approach at minimum.”
Wessel outlined how macro risks from either Trump policy or internal Canadian fiscal policy might play out in Canadian bank stocks. He explained some of the factors that advisors may want to consider when looking at Canadian financials this year, in what he has called “the toughest stock picking environment for Canadian banks in 30+ years.”
At the core of his view on macro risks are the correlations between nominal GDP growth and bank revenues and the possible impact on credit. Tariffs, he notes, could negatively impact GDP and revenue growth for the banks, and potentially add to loan losses as well. . All of that would be bad news for the banks.
Despite that, the market has not fully priced in the GDP shock that would come with tariffs. Wessel says that this seems to reflect a degree of consensus that a deal could be struck between the US and Canadian governments. Should tariffs come, and if no agreement is made, there may be a correction in Canadian financials stocks, but Wessel notes that the market’s current stance is informed by history. During the first Trump administration he made bellicose tariff threats only for policy to manifest as something more muted and digestible. Right now, markets appear to be expecting a similar outcome.
The threat of tariffs has also spurred a degree of consideration around Canadian policy makers adopting more pro-growth fiscal policy, including removing internal trade barriers, and other means of stimulating economic growth like a more favourable regulatory environment for the energy sector. Wessel argues that some of those policy shifts may help support the banks should they be successfully implemented.
There are also calls to shift Canadian fiscal policy more fundamentally, cutting deficits. Wessel described Canadian fiscal policy for the past decade as “terrible” and argues that a more pro-growth fiscal policy could spur economic growth and support Canadian bank stocks. Possible cuts to Canadian spending, he notes, might provoke some short-term pain for the economy and for the banks.
“There could be some very painful cuts and depending on how those cuts are arranged and what their impact is on GDP growth, they could impact the financial sector,” Wessel says. “Many have argued that the current government has adopted a short-term gain, long-term pain approach, and the next government, by necessity, will have to adopt a short-term pain, long-term gain approach.”
Despite some macro uncertainties and possible short-term headwinds, Wessel remains relatively constructive on the banks. Fundamentally he sees them as great companies facing a fluid period. He argues that assuming there is no trade war that valuations are reasonable, it’s likely that loan losses will fall, and there is room for earnings to surprise to the upside.
Tariffs, he notes, are still more of a tail risk for the banks. He says he’s watching for any increases in performing allowances as the Canadian banks begin to report earnings. Those provisions, he says, are a means by which the banks will signal their concerns of potential economic trouble ahead.
In the meantime, diversification can also prove a useful strategy for advisors. Canadian lifecos, for example, have outperformed the banks of a recent period. They might offer a degree of diversification that could soften the impact of any tail risk to the Canadian economy. Amidst headlines and noise, Wessel drives home those first principles of diversification and historic performance as strong guides for advisors now.
“There’s a long history of buying and holding this sector and it has served people very well,” Wessel says. “We’re not sure that there’s anything right now that would suggest that this isn’t a valid strategy. They’re good companies, they’re very resilient, and a lot of the noise we’re now hearing will pass.”
