What bank earnings, GDP print, tell us about the chances of a Canadian recession

Last week might have left advisors a bit conflicted about the state of the Canadian economy, its resilience in the face of tariffs, and the likelihood of a fall into recession. On the one hand, bank earnings offered a glimmer of hope. Not only did all six of the big banks beat earnings expectations, they noted lower loan loss provisions than analysts had predicted, which appears to highlight the resilience of Canadian borrowers in the face of US tariffs. At the end of the week, however, Statistics Canada revealed Q2 GDP growth numbers, noting an annualized drop of 1.6 per cent largely on the back of tariff-driven hits to exports.

Michael Archibald, VP & Portfolio Manager at AGF Investments, is constructive on Canadian financials and sees last week’s earnings reports as a sign of both the promise of that sector and the underlying resilience of the Canadian economy in the face of tariffs. BeiChen Lin, Senior Investment Strategist and Head of Canadian Strategy at Russell Investments, is more neutral on Canadian financials and offers a view that Canada is more likely to head into a recession, citing both Q2 GDP numbers and a potential underlying reason for the lower loan loss provisions that is less about resilience.

“I wouldn't necessarily interpret the lower provision as necessarily being indicative of the macro picture getting better. Rather, I think this is a story of banks becoming more prudent,” Lin says. “It's the bank's pivot to focusing more on higher quality loans and higher quality borrowers, that's enabled them to be able to weather this economic this period of economic difficulty better than people were expecting, rather than necessarily the macro headwinds coming off.”

Lin cites the Bank of Canada’s quarterly senior loan officer survey, which has seen the non-interest rate component of lending conditions tightening for several consecutive quarters. Banks have been surveying the Canadian economy closely and have elected to tighten their lending standards to protect against loan losses from tariff impacted businesses.

Rusell Investments’ view, according to Lin, is that Canada is now at high risk of a recession due to tariffs. Despite that likely cyclical impact on Canadian financials, Lin remains neutral on the sector because of that aforementioned tightening of lending standards. He argues that the banks are already preparing for a recession, with the big six banks maintaining capital requirements above OSFI minimums. That preparation should, in turn, mitigate some of the headwinds that these banks might face if Canada does fall into a recession.

For Michael Archibald, however, the bank earnings as well as some underlying data in the Q2 GDP print speak to greater resilience in the Canadian economy and better future prospects for Canadian banks.

“My sense from talking to companies within the financial sector and across the Canadian landscape, is that they are still managing to run their businesses and preserve margins,” Archibald says. “Despite what we're seeing with respect to tariffs they haven't had to really significantly raise prices. The Canadian consumer, at least, from the data that we look at, is still in a relatively decent position.”

Archibald’s view of consumer resilience was backed up by the Q2 GDP numbers, which saw household spending increase 1.1 per cent across those three months, up from a 0.1 per cent increase in Q1. He acknowledges that tighter lending standards may play a role in the banks’ lower loan loss provisions, but argues that is both a positive for the banks and is one of several factors which include unexpected resilience in the Canadian economy.

Overall earnings increases, across Canadian companies, also speak to a more resilient Canadian economy according to Archibald. He notes that when earnings grow at the rates they have, a recession in the underlying economy becomes quite unlikely. Lin, for his part, acknowledges that earnings growth but notes that many if not most of the largest companies on the TSX earn around half their revenues overseas.

Looking specifically at the banks, this latest round of earnings has Archibald quite constructive on the big six within the wider financials sector. Up until recently, he notes, the lifecos were considered more attractive against concerns around the banks’ loan loss provisions. Now, he argues that has reversed and the overall growth potential of these companies should be viewed favourably, especially as they’re trading below long-term PE averages.

Despite disagreement on the likelihood of a Canadian recession and resilience in the face of tariffs, both Lin and Archibald stressed a message of discipline and long-term positioning that they believe advisors and their clients should adhere to.

“Emphasize having a long-term orientation and staying disciplined,” Lin says. “There are going to be times when sometimes the news headlines might seem a little bit scarier than normal, but it's amidst those periods of volatility that I think advisors can sometimes find the best pockets of opportunity.”

“We think that you're going to get paid better to be optimistic than pessimistic over the next 24 months,” Archibald says. “The tariff situation was scary, and the market reflected that. But we've we had almost a 20% down move in a very short window of time and the economy has not gone into recession. And a recession is not our base case on a go forward basis. If that's your view, then I think you still want to continue to have an allocation into financials, and into the Canadian economy.”