How investors looking for good returns can navigate Trump tariffs

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Investors can find unpredictable turns in stock markets hard to handle but their resolve will especially be tested this year due to U.S. President Donald Trump’s actions. Economists expect market volatility surges driven by a combination of policy changes, trade disruptions and economic and currency shocks from his administration.

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But market disruptions and downturns are always a possibility for equities investors and experts recommend avoiding panic and taking a longer-term view that sees markets rising over longer time frames.

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One of the main likely drivers of market volatility is the tariffs Trump has been threatening Canada and Mexico with since November, as well as other global markets. While any reprieves through negotiation may temper effects, the determination of the U.S. government to enact tariffs may lead to bumpy markets over the next four years, making it difficult for investors to predict returns and manage risk, market watchers expect.

If tariffs cause a sustained trade war, like they did in 1930 with the Smoot Hawley Act — which raised tariffs on 20,000 imported goods in an effort to help American farmers — it could affect stock markets around the world.

The protectionist attitude of the Trump administration poses risks to key sectors of the Canadian economy and the effect that such tariffs would have specifically on Canadian oil stocks, for instance, is already being seen. Add to that the fact that several Canadian natural gas and pipeline companies are trailing U.S. natural gas companies, and the obvious choice for oil and gas investors who want to eliminate tariff risks is simply to buy U.S. energy stocks and dial back on Canadian energy stocks.

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Other sectors, too, are not immune. Potential tariffs could affect the auto sector, economists have warned, stalling recent electric vehicle investments. And, according to the Conference Board of Canada paper, Trump, Tariffs and Trade, the U.S. is also aggressively attracting investment in the areas of technology, and research and development, potentially drawing resources away from Canada.

A trade war would be bad news for investors, market observers say, at least in the short term. According to a 2022 report by Canadian research firm Finder, about one in three Canadians had invested in stock market shares in 2021.

It is likely a significant portion of Canadian stock investors own bank stocks, either directly or indirectly through mutual funds or exchange-traded funds. Analysts at National Bank of Canada warn that a severe trade conflict could lead to a growth in bank loan defaults by businesses, as well as a 30 per cent drop in earnings per share for Canadian banks, compared with current estimates.

This is significant in itself but the broader economic effects of a trade war would affect the Canadian economy in general, and potentially cause unemployment to rise to 10 per cent from the current 6.7 per cent, affecting consumers buying from Canadian businesses, or defaulting on loans.

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And for investors in U.S. stock markets, tariffs could force companies to raise prices in response, causing inflation to accelerate and consumers to pull back on spending. Goldman Sachs Group Inc. strategists said there’s a risk of a five per cent slump in U.S. stocks because of the hit to corporate earnings, while RBC Capital Markets estimated the range at five per cent to 10 per cent.

So what are investors to do? Investment experts suggest not moving reactively and instead sticking to a balanced portfolio. Behavioural finance firm Oxford Risk Research and Analysis Ltd.’s analysis shows knee-jerk emotional reactions to market swings cost investors an average of three per cent each year in returns. The company predicts losses could soar this year as a perfect storm of volatility drives investors to make mistakes and invest in assets they may not even understand.

Steve Wendel, head of behavioural science for Morningstar Inc., notes that, “even if you aren’t likely to panic during a downtown yourself, the potential for panic by others affects your investment environment because of … the risk of … emotional selling.”

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Still, opportunities abound for investors willing to take on some risk and go against the market. Any increase in the sell-off among Canadian oil producers would create an excellent buying opportunity, since investment experts believe any tariffs on oil exports may be temporary.

Alternatively, the head of Norway’s US$1.8 trillion sovereign fund suggests a contrarian course, namely to consider selling technology stocks and boosting holdings in China. “The best thing to do is always to do the opposite of everybody else,” Nicolai Tangen said in an interview during the World Economic Forum in Davos in January. “What will that be today? Well, if you were to do the opposite of everybody else, it would be to sell the U.S. tech stocks, buy China, sell private credit, just buy stuff that is out of fashion.”

The good news is that despite the potential negative impacts, there may also be positives. In a recent paper, Angelo Kourkafas and Brock Weimer, chartered financial analysts with Edward Jones, note that tariff effects on the stock market could be less pronounced compared with their impact on the broader economy.

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“Approximately one-third of the revenue generated by companies in the S&P/TSX composite (index) comes from the United States, with the technology, industrials and utilities sectors having the highest share of U.S. revenue. However, some of those sectors that export large amounts of goods to the U.S. have small representation in the Canadian equity market. For example, automotive components are the second-largest category of exports after oil, gas and minerals, accounting for 10 per cent of Canada’s exports to the U.S. Yet, the industry only represents 0.5 per cent of the TSX’s total weight.”

They caution investors not to abandon long-term strategies in hopes of avoiding short-term dips, as historically, “fear and panic have not paid off.”

Both analysts conclude that, for investors, maintaining a well-diversified and balanced portfolio with different asset classes and geographic exposures may help spread out the risk of a trade war. They continue to recommend investors reduce slightly their exposure to Canadian large-cap stocks, offset with adding more to U.S. large-cap and U.S. small- and mid-cap stocks, as U.S. markets are believed to be better positioned to deal with tariffs compared with Canadian equities.

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Investors always need to keep in mind the long-term data of simply doing nothing and staying invested in equity markets. The average annual return of the S&P 500 over the past 40 years (1982-2022) is 11.6 per cent (including dividends). TSX returns have come in at a decent eight per cent to 10 per cent annually.

And finally, remember that you are always buying low assuming your time horizon is long enough. Your entry point into the market is irrelevant on a 40-year time horizon. As author and investor Nick Murray said, “I don’t worry about which way the next 20 per cent move in the market will be because I know exactly which way the next 100 per cent move will be. And I can’t run the risk of missing that move.”

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