August 22, 2025
Anil Tahiliani
The U.S. administration is now using tariff rates as a baseball bat against its trading partners to force them into one-sided trade deals. Recent examples include Japan and the European Union. According to The White House's July 31st press release:
"In a massive deal with the European Union, the EU has agreed to purchase $750 billion in U.S. energy and make new investments of $600 billion in the United States, all by 2028, while accepting a 15% tariff rate."
"Japan has agreed to invest $550 billion in the United States to rebuild and expand core American industries, as well as to further open its own market to U.S. exports, all while paying a baseline 15% tariff rate."
Canadian and U.S. trade negotiations continue. However, the Canadian federal government has accepted that no trade deal is better than a bad trade deal. On August 1st, the U.S. announced a tariff of 35% on Canadian goods that were not covered under the Canada-U.S.-Mexico Agreement.
Recently, the U.S. President has mentioned that new tariffs are coming on semiconductors and up to 250% on pharmaceuticals. Although re-shoring manufacturing sounds great, the truth is that the cost of U.S. labour and inputs is significantly higher than in the rest of the world. Therefore, re-shoring means higher prices for goods made in the U.S.
So far, U.S. administration officials continue to deny that U.S. tariffs are bad for their economy, even though history and the basics of supply and demand show otherwise. They continue to believe that any inflation hit to the economy will be one-time or transitory. In fact, today the estimated new U.S. tariff rate globally is 14.5% - the highest since 1941! (see chart).
I question how a one-time rise in the price of goods of say 10% - 15% can be good for consumers. The true amount of increase to the consumer is hard to calculate since American companies will likely absorb some of the tariff costs so that consumer demand does not fall off a cliff. Either way, higher inflation means less discretionary spending in the economy, which means slower economic growth.
In the last three weeks, we have seen data pointing to a slowing U.S. economy. This slowdown is largely due to business uncertainty caused by the tariffs.
Several key indicators show this trend. First, during the second quarter earnings season, many companies reported significant profit hits from tariffs. Lower corporate earnings create two problems: companies have less money to reinvest, and stock valuations decline.
Second, recent net revisions to U.S. job growth figures point to a sharp slowdown in hiring.
Third, the July ISM Manufacturing Index showed declining new orders and lower employment.
The three economic data points confirm what we also see in the U.S. Conference Board Leading Economic Index, which points to slower growth ahead.
The U.S. stock market has rallied in the last week on the hopes that the U.S. Federal Reserve will cut interest rates in September. Today, the U.S. Federal Reserve Chair Jerome Powell opened the door to potential interest rate cuts in the near term based on weaker-than-expected U.S. economic data. As a result, global stock and bond markets have again moved higher. Even if interest rates decline, the Federal Reserve will be walking a very fine tightrope. They know that if they cut rates too much, inflation will head higher and they may be forced to reverse course and raise rates to ensure that inflation does not spike like it did in 2022.
We still believe that U.S. inflation is likely headed higher over the next year as the full impact of tariffs is felt by consumers. Recently, several U.S. retailers such as Walmart, Home Depot and Crocs have started to see reduced demand for select items due to the higher tariff costs. We believe that stagflation will be the next buzzword for investors in 2026. Stagflation means higher inflation with lower economic growth.
Portfolio Implications
Although I am responsible for two Canadian-focused funds – Matco Canadian Equity Income and Matco Opportunities – understanding the state of the U.S. economy and its direction has important consequences for our holdings since they may generate revenues from the U.S. directly or indirectly.
Since the beginning of the year, our playbook for the portfolios has remained the same. We have eliminated our direct exposure to U.S. discretionary spending. Our key investments are focused on three long-term secular themes.
Heightened Geopolitical Risk
Increased global defence spending is anticipated as countries counter rising military and economic pressures from non-U.S.-aligned nations. This trend favours sectors such as surveillance, military equipment, advanced technology, and commodities.
Rising Power Consumption in North America
Growing demand for artificial intelligence applications and data centres will necessitate significant upgrades to the electrical grid and investment in new energy sources.
Infrastructure Renewal
Canada faces aging infrastructure. Investment in roads, highways, bridges, ports, terminals, and critical national security projects is likely to intensify, supported by fiscal spending.
Summary
The U.S. tariff strategy is backfiring. With tariff rates at their highest since 1941, we're seeing corporate earnings decline, hiring slow, and manufacturing weaken. While markets hope for Fed rate cuts, we expect stagflation—rising prices with slower growth—to emerge in 2026. For Canadian investors, this reinforces our strategy of avoiding U.S. discretionary exposure while focusing on defence, power infrastructure, and Canadian infrastructure renewal. We remain committed to high-quality companies with strong cash flows that can weather these macro headwinds.
At a company level, we are focused on owning high-quality companies generating free cash flow, reasonable leverage, trading at an attractive valuation, and having company-specific drivers not impacted by the uncertain macro environment.
If you have any questions about your portfolio, please reach out to your Matco portfolio manager. We are here to guide you through uncertainty.
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