How a NAFTA resolution could boost Canada’s market

This is part two of a two-part series on issues affecting the Canadian market. Read part one, which focused in part on what to expect from the federal government’s fall economic update. 

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NAFTA uncertainty continues to put pressure on the Canadian economy and market as negotiators seek common ground.

Prime Minister Justin Trudeau and Foreign Affairs Minister Chrystia Freeland attended the United Nations General Assembly in New York this week, where they expected informal talks to continue. U.S. Trade Representative Robert Lighthizer warned at a separate event that Canada is running out of time to strike a deal alongside the U.S. and Mexico, which are looking to finalize an agreement before December.

In August, when the U.S. and Mexico agreed to a bilateral deal, the threat of 25% auto tariffs on Canada was introduced.

CIBC Asset Management associate portfolio manager Catharine Sterritt is watching negotiations closely.

Read: What to watch for in feds’ budget update

“We’re anticipating there will be a resolution—certainly there’s already been lots of indication that the auto piece has been agreed to in principle,” she said in a Sept. 19 interview.

However, Canada is also focused on making sure it’s protected “from these national security reviews that the U.S. has used as a premise for putting this deal and the aluminum tariffs in,” she added.

If a NAFTA deal is agreed upon, Canadian auto suppliers will benefit most “because they truly do have integrated operations,” Sterritt said, pointing to Martinrea and Magna International plants in Ontario.

She favours Magna in particular because “it’s a global player with a good R&D position.” Also, it’s been “held back by the uncertainty around NAFTA, and we do see that as an opportunity.”

A NAFTA resolution would also be a positive for the Canadian dollar, said Sterritt, who co-manages the Renaissance Canadian All-Cap Equity Fund.

The loonie “has been weaker throughout this whole period of uncertainty,” she said, and that would continue without a NAFTA deal and if tariffs were introduced. In that scenario, “it is highly likely that the only way that the Canadian government could mitigate negative cost pressures [would be] to let the dollar be weak.”

The value of the loonie was US$0.772 as of Sept. 25, only slightly lower than the 12-month average of US$0.779.

Bank of Canada’s response

Due in part to economic uncertainty and how that’s impacted the dollar, the Bank of Canada has been “going slower than anticipated in bringing interest rates up,” Sterritt said. “It didn’t make sense [for the BoC] to add volatility if we were going to need to use a weaker [loonie] as an offset to the trade situation.”

In its September rate announcement, the central bank maintained its 1.5% target for the overnight rate. It also said it was “monitoring closely the course of NAFTA negotiations and other trade policy developments, and their impact on the inflation outlook.”

If a deal is reached, “we’re going to be able to see the Bank of Canada carrying on with a steady increase in interest rates, and that’s going to be favourable to our financial sectors,” Sterritt said. BMO and TD are examples of banks that would have “positive margin expansion with rising interest rates.”

Companies are also awaiting a Canadian response to U.S. tax reform,” she said. “There’s been a lightening of [capital expenditure], and therefore there hasn’t been the same level of funding required by the banks.”

One potential upside, she said, is “a relative outperformance in the financials” in the fourth quarter and into the first quarter of 2019.

What about U.S.-China tensions?

The ongoing trade negotiations and tariff dispute between China and the U.S. are an additional and equally important issue, Sterritt said. “As we’ve seen an escalation of the back-and-forth tariffs, it certainly has put at risk the synchronized global growth that we had been seeing,” she said.

Read: What happened to synchronized global growth?

“If we do end up with protracted tariffs on both sides, it’s going to increase costs through the global trading system,” she said, which would result in slower global GDP growth.

Canadian-based but globally active metal players such as Toronto-based First Quantum Minerals could be impacted. First Quantum has “a very strong management team,” Sterritt said, and is also set to benefit as production ramps up at a holding in Panama in the midst of “a very tight copper market.”

If little movement is seen on the China-U.S. situation, she added, the environment may not be as favourable for such companies and projects.

She pointed to some positive signs in the negotiations. “We do think that the elevation of the negotiations to political levels to deal with some non-trade issues, like the safety of national intellectual property, will help lead to resolution there,” she said.

Despite current economic hurdles, Sterritt said, “we are in front of a lot of macro news that we think is going to have a potential to create some true opportunities for specific companies. We continue to regard this as a marketplace that offers a lot of opportunity for active management and stock picking.”

This article is part of the AdvisorToGo program, powered by CIBC. It was written without input from the sponsor.