Unique opportunities in Canadian equities for 2025

Path to above-trend returns despite tariff threat

Canadian equities offer both some unique opportunities and some potential challenges in the year ahead. After a solid 2024 that saw the S&P/TSX Composite Index (TSX) notch an all-time high in the summer and then continue to power higher in the fourth quarter on the back of better-than-expected earnings, declining interest rates, and a weaker Canadian dollar, the focus has now shifted to how equities will handle another Donald Trump administration and what potential tariffs, related to Canada as well as other parts of the world, may mean for equities. On balance, we see a solid runway for Canadian stocks in 2025, supported by valuation upside and the potential for stronger global growth to propel cyclical sectors higher, leading to renewed interest in the Canadian market.

Let’s start with the macro backdrop in Canada. The landscape as it relates to growth, inflation, interest rates, and consumer spending has improved on all fronts from this time last year and looks likely to get even better as we enter 2025. Inflation is now back to the Bank of Canada’s target range and is finally putting less pressure on consumer spending, which is showing early signs of starting to pick up after 18 months of weak readings. As a result, interest rates have been lowered and are on track to see several more downward adjustments over the first half of 2025. This could further alleviate concern around elevated debt levels across the country or the ability for consumers to simultaneously service those loans and spend to create economic growth.

Lower rates should also help spur on the housing market, which has seen a lull in activity for the past 24 months. Given the high sensitivity of the Canadian economy to housing, any improvements could be a benefit to Canadian GDP. Finally, consumer confidence is on the mend; if that continues to get better, spending should follow suit with a slight lag.

On the earnings growth side – the primary determinant of long-term stock market movements in most global regions – the picture for Canadian equities is getting a little brighter. Recent consensus estimates (as of November 11, 2024) were that TSX earnings will expand by 12.8% in 2025, led by a resurgence in cyclical sectors including Materials and Industrials. All 11 subsectors in Canada are forecast to grow in 2025 compared with 2024. That would be a reflection of the improving landscape in Canada after a few years of less robust growth, due in large part to rising interest rates, which strained consumer finances and put incremental stress on the housing market.

Our thinking remains that cyclical industries with ties to consumption and global growth could outperform defensive industries, as pro-growth policies south of the border will extend into Canada. Areas like Financials, Industrials, and Commodities stand to potentially benefit from a return to trend in long-term GDP growth, and these groups account for 75% of the TSX. An environment of more pro-growth policies and less regulation in the U.S. should benefit Canadian financials with exposure to the U.S. market, driving better loan growth and the potential for improved profitability as margins improve.

The Trump factor

And then there are the potential challenges. Economic policies focusing on protectionism are likely to be a high priority in Trump’s second term in office. His first term had a mixed impact on Canada; however, if the Trump administration implements immediate tariffs in his second term, it would create additional risks for the Canadian market in the next several years. Trade relations between the U.S. and Canada were strained during Trump’s first term, with the renegotiation of NAFTA and the imposition of tariffs on several Canadian industries (steel and aluminum) being flashpoints. A second term could see continued pressure on Canada’s trade surplus with the U.S., particularly in sectors like automotive and agriculture.

However, it’s also possible that Trump’s desire to further reduce U.S. reliance on China and other foreign producers could result in increased demand for Canadian materials and energy commodities, as well as greater access to U.S. markets for certain Canadian exports. We believe, if the U.S. continues to focus on energy independence, Canadian energy stocks could benefit as increased demand for Canadian oil and gas over other international sources would result in expanded access to the U.S. market. Higher cash flows and profitability would be the likely result.

Overall, then, we foresee a path to slightly above-trend returns for the TSX Composite in 2025. Despite tariffs and other unknowns related to the political environment in the U.S., the Canadian economy is in a much better position than it was a year ago, and earnings growth suggests the TSX has decent upside from here.

Mike Archibald, CFA®, CMT, CAIA, is Vice President and Portfolio Manager at AGF Management Ltd. He is a regular contributor to AGF Perspectives.

Notes and Disclaimer

© 2024 by AGF Ltd. This article first appeared in AGF Perspectives. Reprinted with permission.

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