Canadian Equity Update - A Tumultuous First Quarter of 2025

Can you comment on the Canadian equity market in the first quarter of 2025?

The initial optimism at the start of 2025, which saw the Canadian market reach an all-time high on January 30th, quickly faded due to rising political tensions and evolving tariff wars. These factors further exacerbated economic uncertainty and dampened market sentiment, leading to negative returns in February and March.

Although the S&P/TSX Composite TRI managed to end the quarter on a positive note, the modest 1.5% advance was primarily driven by a significant surge in gold prices, which ended the quarter up 18% at US$3,122.80/oz. Market performance was also aided by strength in certain defensive sectors of the market, in particular Utilities, as "shelter-seeking" behaviour intensified as the quarter progressed.

Significant market volatility driven by the protectionist rhetoric from the Trump administration along with the yo-yo effect of the on-again and off-again tariff threats and retaliatory measures from trading partners resulted in a decline for the US market.

Additionally, the AI industry and financial markets were shaken by the news that a Chinese start-up DeepSeek has developed an open-source, cost efficient AI model. This development could potentially threaten investments across various segments of the AI infrastructure value chain, including semiconductor giants, data centre infrastructure providers and power suppliers.

Against this backdrop, the US market declined 4.3% (4.4% in C$ terms) during the first quarter.

Tariffs have been front and centre since President Trump took office, with trade tensions escalating more recently.  Can you provide your views on the evolving tariff situation and potential implications for Canada?

The Trump administration's protective rhetoric and inconsistent tariff threats have recently culminated in the announcement of a 10% minimum baseline global tariff, along with higher individual reciprocal tariffs on various countries, a move that dubbed Aril 2nd as "Liberation Day”.

The tariff impacts for Canada and Mexico were “better than feared”, as no retaliatory tariffs were announced.

United States–Mexico–Canada Agreement (USMCA) compliant goods remain exempt, while non-compliance is subject to a 25% tariff on all goods and commodities from Canada, except for energy and certain resources where non-compliance is subject to a 10% tariff. De minimis exemptions were also eliminated, affecting consumer discretionary industries that directly export to the United States. Additionally, 25% tariffs have been placed on Canadian steel and aluminum, as well as autos (excluding US content). Canada has responded with reciprocal counter tariffs of 25% on billions of US imports, including US-made automobiles that are not compliant with USMCA.

The tariffs are undoubtedly a headwind to global growth. The potential for tariff-induced recessions has extended beyond just North America and will have impacts on global GDP growth, unemployment, inflation and interest rates.

The first-order effects of tariffs will include decreased competitive standing for companies importing into the US, likely leading to inflation in necessary goods and a decrease in discretionary spending. The high likelihood of retaliatory tariffs from trade partners globally is expected to further complicate the situation. 

President Trump's “America First” trade policy and ambition to revitalize American manufacturing remains highly uncertain as companies weigh the potential unwinding of well-established supply chains and commitment of capital to long-term projects.

For Canada, this could potentially force the Bank of Canada to administer more pronounced policy easing and increase the likelihood of targeted fiscal support for impacted industries.

Amid evolving trade tensions, what is your take on the current state of the economy?

Recent developments have undoubtedly been harmful to Canada's economy, despite the "better-than-feared" tariff treatment by the US administration. Canadian business and consumer confidence remain weak, indicating the beginning of a challenging period for business investment in Canada due to increased uncertainty.

The potential for a tariff-induced recession is expected to have impacts on GDP growth, unemployment, inflation and interest rates with the possibility of stagflation— a dreadful combination of stagnation and inflation – being a likely scenario.

The discouraging reality has led to the realization that Canada has been overly dependent on its southern neighbor. Canada’s future success is now tied to becoming a more prominent global player. Although there is significant potential in various initiatives, such as efforts to diversify energy end markets (TMX Expansion, LNG Canada), investment in export debottlenecking and more diversified capabilities, shifting focus in manufacturing, and alleviating interprovincial trade barriers and regulatory burdens, achieving this goal will take time and will partly depend on the country's leadership in the foreseeable future.

Can you comment on the performance of Growth versus Value in recent quarters?

Chart 2 shows the US MSCI Growth and Value Indices from the beginning of 2023 through to the end of the first quarter of 2025. Growth handily outperformed Value through the end of Q4, 2024 which is similar to most periods since post the Great Financial Crisis, with 2016 and 2022 notable exceptions. Growth in the US equity market, experienced a remarkable run over this period as the economy was surprisingly strong, companies generally met or exceeded expectations, Artificial Intelligence emerged as a strong investment theme, and investors felt a need to have exposure to the evolving industry leaders.

Q1 marked a notable shift away from this trend, with the Magnificent Seven broadly underperforming. During this period Value outperformed Growth, with Value gaining 2.7% while Growth declined 10.9%.

What factors have been driving the divergence between the performance of the US and Canadian markets and is the US dominance sustainable?

Until recently, over the past decade and a half the US market has significantly outperformed the Canadian.

America, with its entrepreneurial culture and abundance of capital, has fostered the formation of several technology-based business that have benefitted from their ability to scale globally, providing strong leadership for the US market. This narrative has recently been referred to as American exceptionalism.

Although we acknowledge the powerful business models of these market leaders, epitomized by the “Mag 7”, their valuations have increasingly reflected the strong underlying fundamentals and growth prospects. This has recently culminated with investors’ fascination with AI-related themes, including LLMs, hardware, data centres and power capacity, to name a few.

In the meantime, Canada, being a resource and manufacturing-oriented economy, has offered limited investment options in this arena. At the same time, fundamentals of Canadian equities have been overlooked in comparison, with many sectors reflecting concerns about macro headwinds for some time.

Most recently, the resilience of American exceptionalism has been called into question, with concerns further exacerbated by President Trump’s heavy-handed protectionist agenda.  Since June 19, 2024, the S&P 500 TRI has lagged the S&P/TSX Composite TRI, returning 8.6% ($CAD) while the S&P/TSX Composite TRI advanced 18.2%.

Can you discuss the sector returns for the S&P/TSX Composite Index in the first quarter of 2025?

The Canadian equity market’s advance was narrow during the first quarter of 2025, with only four of 11 GICS sectors posting positive returns: Materials, Utilities, Energy and Communication Services.

Materials was by far the strongest performing sector, posting a total return of 20% as gold prices surged 18% to end the quarter at an all-time high of US$3,123 per ounce.

“Shelter-seeking” behaviour propelled the Utilities sector higher, which advanced ~5% during the quarter. 

The Energy sector was broadly solid, with crude oil prices relatively flat ending the quarter at US$71.48/bbl (West Texas Intermediate) and NYMEX natural gas prices increasing 13% to US$4.12/mmbtu (NYMEX).

On the flip side, outside of weakness in the Health Care sector, Information Technology was the worst performing sector with broad-based weakness across its constituents.