Service businesses offer tariff-risk management

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Welcome to Advisor to Go, brought to you by CIBC Asset Management, a podcast bringing advisors the latest financial insights and developments from our subject-matter experts themselves. 

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Natalie Taylor, portfolio manager, CIBC Asset Management 

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In terms of the trends impacting equities in 2025, the market backdrop has shifted significantly over the last six months, from a soft landing with low interest-rate trajectory to a market where tariffs and a global trade war could both slow growth and re-accelerate inflation. 

Of course, the reason for this shift is the return of Donald Trump to the White House and his very aggressive and unconventional policy priorities. While Trump has been clear all along on what he would like to achieve while in office — such as improved government efficiency, lower immigration, a rebalancing of global trade, lower energy prices, deregulation and a weaker U.S. dollar — the market has been struggling with the pace, prioritization and chaotic delivery of new policy initiatives. 

Ultimately, we believe that global markets will end the year higher. However the path to get there will be choppy. We see global markets driven by the strength of the U.S. consumer, continued pace of investment in AI infrastructure which has many knock-on effects to industries such as semiconductors, power, industrials, real estate and early adopting enterprises. 

For Canadian markets in particular, the outcome of the potential trade war and renegotiation of USMCA will be very important. 

Our largest exporting sectors are energy and auto manufacturing, which notably are in Trump’s crosshairs. A hollowing out of these industries could have significant negative implications for the economy overall, to a tune of 5% contraction in GDP. 

With the state of the government also uncertain, it’s fair to say that this magnitude of negative shock will be met with significant monetary and fiscal stimulus, and hopefully a long-term plan to improve Canada’s competitiveness. 

In the absence of tariffs, we believe the Canadian market can see a relief rally. However the upside in the near term is not as strong for Canada as investment dollars will likely continue to favour the U.S. until competitiveness is improved. 

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Dividend investing makes a lot of sense in the current backdrop. Dividend-paying stocks and funds tend to do well in periods of uncertainty, such as what we’re experiencing currently. As an investor, you get paid to wait and have certainty of return with regards to the yield. 

Dividend stocks also tend to provide better downside protection, given that dividend payers have proven business models, generate good free cash flow, have more capital discipline and less operating variability. They are generally higher quality businesses. 

But with dividend paying stocks, you don’t need to sacrifice upside in the event that the market recovers. 

In the scenario currently, underlying fundamentals are solid. For the most part, the consumer is healthy, businesses are growing and investing. But the potential for an exogenous shock — no matter how small the probability — could have serious consequences. 

Therefore, you can get paid to wait out the uncertainty, protect your downside, and participate when the market returns. 

If we look back at the last few years of asset class returns, 2022 was a difficult market for investment returns. Cash was the top performing asset class, but Canadian dividend was a close second with flat returns. 

The following year, markets rebounded and U.S. equities were the top performing asset class. But Canadian dividends delivered a respectable 10% total return. 

Similarly, in 2024, Canadian dividends delivered a 20% total return, keeping pace with global equities. 

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So where are we currently seeing opportunities? 

First, the threat of 25% tariffs in Canada and Mexico initially caused meaningful drawdowns in the auto sector, Canadian energy and businesses with exposure to Mexico. 

However, the negative impact has somewhat reversed as tariffs were delayed for 30 days. 

As we come up on that deadline, it seems very little discount remains in potentially impacted sectors. And as such, we believe a wait-and-see approach is more prudent currently. 

On the flip side, investors appear to be hiding out in service businesses with little tariff risk. 

As is always the case, we see more nuanced opportunities presenting themselves. 

For example, at first glance, [Toronto-based] Element Fleet, a fleet management company, appears at the nexus of tariff risk, with exposure to both the auto sector and a portion of its business in Mexico. However, on closer examination, the fleet management and services the company offers are likely to become more sought after in a more complex backdrop if tariffs were imposed. The business itself is not subject to tariffs, being a service business primarily in the U.S. And the Mexican portion of the business is small, at less than 10%, with little reliance on the manufacturing sector. We believe that Element Fleet offers a solid runway for growth, is relatively defensive, and is attractively valued as risks related to tariffs are misunderstood. 

Second, inflation expectations have also moved higher over the last six months, driven by the risk of tariffs. 

Interest sensitives have sold off on fears of higher-for-longer rates in the U.S. and many Canadian interest sensitives have traded in sympathy. 

However, if tariffs in Canada are imposed, we expect we will see significant monetary and fiscal stimulus and much lower rates over time. High yielding and defensive sectors such as telcos and utilities are well positioned to benefit. 

Even if tariffs are not imposed but headline risk remains, we do not see a scenario where rates move higher in Canada. 

Apart from the direction of interest rates, the telco sector has been beat up over the last few years, driven by increased competition. There are signs that the competitive environment is thawing somewhat. We think that a company like Telus — that is yielding 7% plus, appears to be out of the crosshairs of direct competition, and is reasonably valued with modest downside to earnings if an economic downturn were to occur — appears to be a sound investment currently. 

Of course, if we do see a resolution of tariffs and the economic impact is manageable, we could see confidence returned to the market, as well as a release of pent-up demand. 

There are many industrial and consumer-facing businesses that have undergone a period of destocking. 

Transports in particular — such as TFI and the rails — have experienced freight recession going on its third year. Low consumer confidence in the face of tariffs is delaying a potential recovery. However we expect the cycle to turn at some point, and transports can be among the biggest beneficiaries of a restocking. 

Lastly, if we think regionally, a theme over the last few years has been technology sector and the promise of AI. The advancement in efficiency by Chinese company DeepSeek cannot be ignored by the industry and could have real implications for the AI value chain, including semiconductors, hyper scalers, industrials, and power companies. 

We think that if these efficiencies can be harvested, enterprises and users of AI stand to benefit, versus the infrastructure companies. We continue to believe that AI buildout will continue. However, a period of consolidation and optimization is increasingly becoming more likely at some point. 

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The uncertainty and range of potential outcomes is vast and makes investing with conviction challenging. 

We believe calling the ultimate outcome accurately is near impossible. As such, our approach is to take advantage of the opportunities that present themselves and invest in high-quality, growing businesses that will manage through any environment. The portfolios we manage are constructed to benefit in a range of different outcomes. 

The biggest risks facing the markets currently are not the risks that we’re aware of but the risks that were not aware of, or these exogenous shocks that the market does not see coming. The only way to protect against this is to invest in high-quality, well-managed businesses that can withstand challenges that come their way, and to invest in a well-diversified portfolio.

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