I think most would agree that the world seems to move at a faster and faster pace. Immediacy has become the norm. Have a question, and you can usually get an answer right away from Google or ChatGPT. Have the munchies, and Uber will cure your craving pretty quickly. Want to order a few books for an upcoming beach vacation? Amazon, for a bit extra, can get them to you later today. Faster is better, which may be progress.
There may be a byproduct of this increased immediacy: patience appears to be diminishing. We are sure traffic is worse, or perhaps, with less patience, being stuck in traffic is less tolerable. Or take the subway: are there more delays now, or is it just us? Both, it’s them too. Toronto subway delays are up 53% from 2019 levels, according to all-knowing Gemini. Perhaps that’s a bad example.
Nonetheless, immediacy is the norm. Delays are unacceptable. Everyone is less patient, as this is the NOW world.
This greater sense of immediacy creates some issues, notably in the investment world. A headline or event can move markets immediately because participants try to incorporate the news into where they are willing to buy or sell. It’s a crowd-sourced giant guessing machine, and it moves fast.
But the impact on the economy or earnings is not fast, often involving long delays and more gradual trends. When the Fed cuts interest rates, markets react in real time. However, the impact on the economy is slow, with some saying it takes one to two years. This, of course, doesn’t jibe with our general impatience bias. Or take tariffs: the market reacted very negatively earlier this year, but as the economy continued to endure and corporate profits remained resilient the last couple of quarters, concerns subsequently dissipated.
The challenge is that tariffs have a delayed impact on the economy and earnings. Initial overreaction may have morphed into underreaction today.
Tariff announcements are sudden events, but the actual impact is gradual and delayed. The cost of tariffs is borne by three parties: exporters, importers, and end clients.
The exporter may reduce their prices, especially if there are other providers or substitutes. If demand is inelastic, they won’t absorb much of the impact. The importer can absorb a portion of tariffs, often driven by the willingness of their clients to pay higher prices. This impacts margins. Alternatively, a portion of tariffs can be pushed through to the end client. This sharing of the impact is neither equal nor constant, as it changes as time progresses.
This is where patience comes in. Companies didn’t raise prices at the onset of tariffs. Instead, they likely pulled levers or ran down older inventory to keep prices stable and maintain margins. But as those and other options are used up, the impact of tariffs may gradually become more apparent. It doesn’t happen all of a sudden, and not equally, but it may be starting to impact corporate margins.
Arguably, the most at-risk sector may be Consumer Discretionary, as it includes retailers, household products, apparel, and auto companies. As a sector, it brings in a lot of stuff from markets outside the U.S. and sells to the hungry American consumer. The first chart below shows the median operating margin for S&P 1500 consumer discretionary companies. Clearly, there’s a downward trend that’s starting to accelerate.
Many market participants may be missing signs of margin deterioration because it isn’t happening as much among the megacaps. Larger companies generally have more levers to pull to help protect margins compared to smaller companies. Plus, market capitalization-based indices naturally put more weight on those megacap tech names that are benefiting from a lot of this data centre-related spending. As an example, the operating margins for the S&P 1500, which is market-cap-weighted, are steadily rising while the median margin among index constituents has started to fall.
We believe tariffs may put pressure on margins; not immediately, as soon as they are implemented, but over time, as offsetting efforts run out of steam. This could be gradual and may go unnoticed initially, later becoming a larger issue. Also, companies may start to raise prices to protect margins, feeding inflationary pressures. These risks are building beneath the surface.
Are Banks Impatient?
The Canadian banks have enjoyed a strong year, up 33% year-to-date. While there are many moving parts in their earnings, loan loss provisions may be evidence of impatience. As tariffs were thrust upon Canada, a clear risk to our economy and the banks’ clients, they reacted quickly by raising loan loss provisions in Q2 (the period ending April 30th). Seems logical, but as loans continued to perform, all the banks reduced provisions in Q3, providing a boost to earnings.
Now the banks have a much better line of sight into their clients. But they may have been too quick to react to tariff risks and now too quick to unwind those previous reactions. We don’t believe a company that gets hit by tariffs is going to stop paying its loans immediately. No, they may try to adjust operations, maybe reduce headcount, or try to find other markets. Defaulting on loans is an option, but could be further down the list of potential actions.
Jobless claims and unemployment have been trending higher in Canada, perhaps signs of other levers being pulled. Defaulting on loans may be moving its way up the list, and now banks have brought down loan loss provisions. The next few quarters will be insightful.
Final Thoughts
Markets react very quickly to news, often overreacting. As time ticks by, markets can begin to forget about it or underreact. Meanwhile, the impact of events such as rate changes, tariffs, and policy uncertainty slowly makes its way into the economy and company earnings.
Sometimes you have to be patient. Just because it hasn’t shown up yet doesn’t mean it isn’t coming. And given that it’s usually a gradual process, these things can easily sneak up on us and the market in general.
Impatience bias isn’t a behaviour bias as far as we can tell, but maybe it should be.
— Craig Basinger is the Chief Market Strategist at Purpose Investments
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