January Market Newsletter

As the year 2025 commences, financial markets are positioned to extend their upward trajectory, though this optimism is tempered by a backdrop of increasing uncertainty and a complex macroeconomic environment. The preceding two years have been characterized by robust economic expansion and exceptional equity market returns, culminating in a 23.3% surge in the S&P 500 during 2024. This impressive rally has generated a considerable wealth effect, enhancing household financial stability amid declining interest rates and moderating inflation. Together with improving income levels, enhanced job security, and a reinvigorated housing market, consumer expenditure is anticipated to remain a principal engine of economic growth.

The outlook for the U.S. economy remains broadly constructive, with real GDP projected to expand by 2.3% in 2025—a deceleration from the 2.8% observed in 2024 but nonetheless exceeding consensus expectations. Underpinning this optimistic forecast are fiscal policies designed to alleviate the financial burdens on consumers, including proposed tax relief on gratuities, overtime pay, and senior benefits. Although these measures may not be enacted until 2026, they have already fostered elevated consumer sentiment. Furthermore, corporate investment is poised to benefit from deregulation and prospective reductions in corporate tax obligations, thereby creating a supportive climate for capital expenditures.

Notwithstanding these positive indicators, significant risks persist. Foremost among these is the threat posed by heightened trade protectionism, particularly if tariffs targeting imports from Canada, Mexico, and China are imposed. Such policies could disrupt global supply chains, intensify inflationary pressures, and undermine corporate profitability. Compounding these concerns is the looming possibility of an East Coast port strike in mid-January, which could exacerbate existing logistical bottlenecks. Additionally, the 7.1% appreciation of the trade-weighted U.S. dollar in 2024, while reflective of economic strength, has adversely impacted export competitiveness. Despite these headwinds, we anticipate that the U.S. economy will demonstrate resilience, maintaining a stable unemployment rate near 4.3% and gradually converging toward the Federal Reserve’s 2.2% inflation target.

The sensitivity of equity markets to interest rate fluctuations continues to be a pivotal factor influencing performance. Notably, the inverse correlation between bond yields and equities became increasingly pronounced during the latter part of 2024, as rising yields were driven by an elevated term premium and persistent concerns regarding inflation. This underscores the strategic imperative of identifying firms with minimal foreign revenue exposure, particularly given the uneven impact of currency fluctuations on earnings. Companies with a predominant focus on domestic markets are better positioned to withstand the adverse effects of currency-driven earnings volatility.

While overall growth expectations remain robust, equity valuations are increasingly susceptible to corrections, influenced by constrained financial conditions and enduring inflationary pressures. The Federal Reserve’s limited capacity to further ease monetary policy without clear evidence of inflation moderation amplifies downside risks to asset valuations. Nevertheless, the prevailing macroeconomic conditions continue to favor moderate earnings growth, underscoring the importance of maintaining a diversified investment portfolio capable of navigating episodic volatility.

Several structural forces are poised to influence investment landscapes in 2025. Foremost among these is the ongoing reconfiguration of global supply chains in response to escalating geopolitical tensions and shifting trade policies. This trend is likely to catalyze significant capital inflows into localized manufacturing and infrastructure development. Concurrently, demographic shifts, particularly aging populations in developed economies, are anticipated to drive sustained demand for healthcare innovations, workforce solutions, and retirement planning services. The energy sector remains at the forefront of transformation, with a dual focus on enhancing energy security and advancing decarbonization initiatives. Additionally, technological innovation, particularly in artificial intelligence and its industrial applications, is expected to remain a critical driver of productivity enhancements and corporate profitability.

Canada’s Outlook: Navigating Political and Economic Headwinds

The economic outlook for Canada is overshadowed by considerable political uncertainty following the resignation of Prime Minister Justin Trudeau. This abrupt leadership transition coincides with mounting economic challenges, notably the potential imposition of 25% tariffs on Canadian exports to the United States. Should such tariffs materialize, the resultant disruption could precipitate a recessionary environment. The interim period, characterized by a leadership contest within the Liberal Party and the potential for snap elections, may impede the timely formulation of critical economic policies.

Among the notable contenders for leadership are Mark Carney, the former Governor of the Bank of Canada and Bank of England, and Chrystia Freeland, Deputy Prime Minister and a key architect of Canada’s economic policy framework. Carney’s entry into the race signals a potential shift toward technocratic leadership, with a focus on fiscal discipline and climate policy. Conversely, Freeland’s candidacy represents continuity with the Liberal Party’s existing agenda, emphasizing progressive social policies and international trade relations. Adding to the dynamic, reports indicate the possible emergence of additional candidates from the private sector and academia, reflecting a broadening of the contest for leadership. The outcome of this race will shape not only the Liberal Party’s future but also Canada’s approach to trade negotiations, fiscal policy, and international diplomacy.

Investor sentiment has already reflected these uncertainties, with the Canadian dollar experiencing heightened volatility and depreciating by nearly 8% against the U.S. dollar over the course of 2024.

Further complicating the macroeconomic landscape, Canada concluded 2024 with an unexpectedly strong labor market performance. Employment surged by 91,000 positions in December, significantly surpassing the consensus estimate of 25,000 and representing the most substantial monthly increase in nearly two years. Job creation was widespread, encompassing both the public and private sectors, and contributed to a modest decline in the unemployment rate from 6.8% to 6.7%. The services sector emerged as the primary driver of employment growth, with notable gains in education, transportation, finance, and healthcare, while the goods-producing sector also exhibited a marked recovery following earlier contractions.

Despite the robust employment figures, wage growth among permanent employees decelerated to 3.7% on a year-over-year basis, falling short of market expectations. This moderation in wage inflation may provide the Bank of Canada with greater flexibility in its monetary policy stance. Additionally, a 0.5% increase in seasonally adjusted hours worked underscores the ongoing recovery in economic activity.

While the labor market’s strength alleviates immediate pressure on policymakers to implement further rate cuts, persistent geopolitical risks and the potential escalation of trade tensions could necessitate additional monetary easing later in the year. We continue to project three 25 basis point reductions in the policy rate throughout 2025, culminating in a terminal rate of 2.5%.

Despite these risks, Canada remains well-positioned to capitalize on interest-sensitive growth sectors. The Bank of Canada’s proactive monetary easing, which resulted in a cumulative 175 basis point reduction in 2024, has alleviated debt servicing costs for households and businesses. The resultant rebound in housing market activity, evidenced by a sustained recovery in existing home sales, has fostered a positive wealth effect conducive to increased consumer spending. Key sectors such as energy, financial services, and real estate present compelling investment opportunities, particularly in the absence of tariff-induced disruptions and with the restoration of political stability.

Nonetheless, structural impediments persist. Reduced immigration targets are projected to dampen long-term population growth, thereby constraining labor force expansion and overall economic potential. While this policy shift may temporarily ease pressure on housing markets, it introduces longer-term risks to Canada’s growth trajectory. Concurrently, inflationary pressures have abated, with the annualized inflation rate declining to 1.9% in November. We anticipate that inflation will average 1.8% in 2025, affording the Bank of Canada latitude to maintain an accommodative monetary policy stance.

Monetary Policy: Balancing Caution with Flexibility

The Federal Reserve’s policy outlook for 2025 will be a critical determinant of market sentiment. Following a cumulative reduction of 100 basis points in 2024, the Fed now operates in a significantly constrained policy environment. With policy rates approaching a neutral stance, the scope for further rate cuts remains contingent upon clear evidence of disinflation. While a policy pause is widely anticipated at the January meeting, we foresee an additional 75 basis points of rate reductions over the course of the year, slightly exceeding market expectations. The Fed’s cautious approach is reflective of persistent core inflation, particularly in service-oriented sectors, where cost pressures remain entrenched despite declining energy and commodity prices.

The bond market is expected to remain volatile, influenced by fiscal dynamics and inflation expectations. Despite the accommodative stance of central banks, the 10-year Treasury yield rose by nearly 70 basis points in 2024, driven by concerns over inflation and a burgeoning federal deficit exceeding $2 trillion. However, we anticipate a gradual decline in yields in 2025, supported by continued monetary easing and a stabilizing inflation outlook. In contrast, corporate bonds, which outperformed Treasuries in the preceding year, may face headwinds should geopolitical risks escalate or if corporate earnings disappoint.

Positioning for 2025: A Delicate Balance

As we navigate the complexities of 2025, our investment strategy emphasizes balancing opportunity with vigilance. While the global economy remains resilient, it is not without significant challenges, including geopolitical tensions, elevated fiscal deficits, and the specter of stagflation. The interplay between these factors necessitates a disciplined approach to portfolio construction, with a focus on diversification, quality, and risk mitigation.

Equity markets are expected to offer selective opportunities, particularly in sectors poised to benefit from structural growth drivers such as technological innovation and demographic shifts. High-quality equities with robust balance sheets and consistent earnings growth remain our preferred allocation. Sectors including financials, healthcare, and industrials present attractive valuation profiles, particularly as market leadership broadens beyond the technology-centric rally of recent years.

In the fixed income space, a selective approach is warranted given the potential for widening corporate spreads and episodic volatility in sovereign yields. We continue to favor shorter-duration instruments and high-grade corporate credit, which offer compelling yield opportunities in a low-rate environment.

In conclusion, while the investment landscape of 2025 presents a myriad of complexities, we remain steadfast in our commitment to prudent risk management and long-term value creation. By maintaining a disciplined and adaptive investment approach, we are confident in our ability to navigate the evolving macroeconomic environment and deliver sustainable outcomes for our clients.

Debbie, Chris, Mark and Rosemary