Navigating Canada's Manufacturing Downturn: Risks, Opportunities, and Strategic Shifts for Investors

The Canadian manufacturing sector is grappling with its most severe contraction in years, as U.S. tariffs and supply chain disruptions amplify sector-specific risks for equity investors. The latest Purchasing Managers' Index (PMI) data for June 2025 reveals a manufacturing PMI of 45.6, marking the fifth straight month below the 50 expansion threshold. This downturn, driven by plummeting new orders, production cuts, and export declines, underscores vulnerabilities for firms reliant on U.S. trade. Yet amid the gloom, opportunities may emerge in sectors less exposed to tariffs or poised to benefit from stabilization.

Manufacturing Sector: A Perfect Storm of Tariffs and Trade

The manufacturing sector's contraction is most pronounced in export-oriented industries. New export orders fell to 40.2 in June—down from 42.0 in May—amplifying concerns about demand from the U.S., Canada's largest trading partner. Steel and aluminum producers face particularly acute pressure, with 50% tariffs distorting supply chains and pricing. The result? Companies are slashing production, reducing inventories, and trimming workforces for the fifth consecutive month.

The implications for equity investors are clear: companies in tariff-heavy industries, such as automotive suppliers or industrial materials firms, face margin compression and reduced profitability. reveals significant underperformance, with both stocks down ~25% over the period compared to a flat index.

Services Sector: A Fragile Stabilization

While manufacturing struggles, the services sector offers a mixed but cautiously optimistic picture. The May 2025 Services PMI rose to 45.6—a three-month high—but remains below 50, signaling the sixth consecutive month of contraction. Key sectors like retail and hospitality face lingering demand headwinds, but marginal improvements in employment and confidence suggest underlying resilience.

Notably, services firms are less dependent on cross-border tariffs, with domestic demand and innovation-driven industries (e.g., tech services, healthcare) offering relative stability. underscores the need for investors to distinguish between trade-exposed and domestic-facing subsectors.

Cost Pressures: A Shared Challenge Across Sectors

Both manufacturing and services face inflationary headwinds. Input costs surged in May 2025, driven by rising wages, tariffs, and supplier charges. Output price inflation hit a one-year high, squeezing margins even as companies pass costs to consumers. For manufacturers, tariffs exacerbate input costs; for services firms, labor shortages and wage growth compound challenges.

reveals that manufacturing input costs have risen ~12% since late 2023, while services wage inflation has averaged 4.5% annually. This divergence highlights the need for investors to favor firms with pricing power or cost-containment strategies.

Near-Term Recovery: Hinges on Trade Policy and Demand

A turnaround hinges on two critical factors: clarity on U.S.-Canada trade policies and a pickup in global demand. If tariffs are reduced or supply chain bottlenecks ease, manufacturing could rebound. However, with U.S. Federal Reserve rate cuts still uncertain and geopolitical risks lingering, the path to recovery is fraught with uncertainty.

Services may outperform if domestic demand stabilizes. Sectors like e-commerce, healthcare, and renewable energy—less reliant on cross-border trade—could outpace manufacturing in the near term.

Investment Strategy: Caution in Manufacturing, Tilt Toward Services

Sector-Specific Risks:
- Manufacturing Equities: Avoid overexposure to companies with heavy U.S. tariff exposure. Firms in steel, aluminum, and automotive parts face prolonged margin pressure.
- Cost-Sensitive Sectors: Utilities and telecoms, which benefit from stable demand and regulated pricing, may offer defensive plays.

Opportunities to Explore:
- Services Sector Plays: Target sectors with domestic demand resilience, such as tech services (e.g., CGI Group (GIB.A.TO)), healthcare providers, or logistics firms (e.g., Purolator).
- U.S.-Exposure with Caution: Consider companies benefiting from cross-border trade only if tariffs ease. Monitor U.S. Federal Reserve policy and trade negotiations closely.

Key Data to Watch:
- PMI Releases: Track monthly PMI data for manufacturing and services to gauge recovery momentum.
- Trade Policy Updates: U.S.-Canada trade talks or tariff revisions could trigger sector rotations.

Final Word: Patience and Selectivity

The Canadian economy's dual-track performance—manufacturing contraction vs. services stabilization—demands a nuanced equity strategy. Investors should reduce manufacturing exposure unless firms demonstrate tariff-proof business models or geographic diversification. A tilt toward services and domestic demand-driven sectors offers better risk-adjusted returns until trade uncertainties subside.

In this environment, patience and selectivity will be rewarded. Monitor the data closely, and avoid chasing a manufacturing rebound until tariffs and supply chains show sustained improvement.