Winter 2025 economic outlook

Sébastien: Welcome to the “In Your Interest!” podcast. My name is Sébastien Mc Mahon and this week, what we offer you is a look at winter 2025 for politics, for the economy and for the markets.

We've been producing these quarterly updates for a while, but I would say that this one is the one maybe that comes with the most uncertainty. And, full disclosure, as we're recording this, we're about a week before the inauguration of President Trump at the White House—so there's still a lot of unknowns. There are some known unknowns and some unknown unknowns here, but we're starting still to have a good idea about how the tariff and the trade policy could start to take shape. But again, this is still speculation. We don't have any announcements.

Let's dig right into the topic of politics. We'll go through the Trump 2.0 agenda in 2025 and beyond. What's interesting now is that there seems to be a clear link between national security and trade policy in the US. So, if you're the president of the United States, if you're a US senator, if you're a US Congress member and you believe in America first, it does make a ton of sense to link the two. And the reason is that, you know, tariffs could be part of the solution for the US if they want to extend their reach around the world to get the most of what they can get from their position of power. And what we're starting to see is that there could be three groups: the friends, the allies, but that are excluded from the defense umbrella, and the foes.

So, all of this goes through the tariffs. The first question is: who is going to be tariffed? Of course, China. It's been shown in the past that maybe the commercial practices were not really honest all the time, so China seems to be a prime target for tariffs. The European auto sector has been targeted often by Mr. Trump, so it seems to be likely that there will be tariffs also on those. Remember that the tariffs are paid by the US importers, so if you're a US firm and you import, you're the one who pays the tariff to the government, and then after that you need to raise the price or get a better deal from the exporter to make up for that fee. The idea here is to discourage the imports from the importers and to hurt the exporting country. But you know, how extensive will those tariffs be? Will we see like 2%, 5% or 25% like what's been proposed for Canada? Will they be tariffing oil exports and gas exports? Because it's not true that the US can just pivot away from Canadian energy: the refineries are geared for our oil. To bring another kind of oil to those refineries, it would take investments in transportation or maybe regearing the refineries.

So, all of those questions here raise the question about who will be paying those tariffs in the end. The US consumer, the US importer or the exporter? And always the question is retaliation. Will other countries retaliate? Now Canada said that they will be retaliating. The US says: “Well, if you want to be a friend of the US, you will pay the tariff. You will carry your own weight for the defence spending and you won't retaliate. You'll just pay us. If you retaliate, we will stop protecting you. So, you'll become an ally, excluded from the defence umbrella. Or you're just a foe.”

As you can see, there's kind of a cataclysm that's coming here in international relations. Let's see how it happens. Let's see if tariffs are blanket tariffs from day one or if they are phased in slowly, so leaving time for negotiations and at some point, you know, maybe the removal of some of those tariffs. There are so many unknowns here, it's hard to tell. But we'll be following that, and we'll keep you posted on how things evolve and how our views evolve on all of this.

Now turning to Canada. There is a government change that is very likely in May or June. We should be going to the polls in the country. The Conservatives are really the favourites to win the next election. But in the meantime, who's going to be negotiating with the US? There's an economic risk that comes here with this lack of leadership in the meantime, while there's a leadership race on the Liberal side and we're waiting for a new government with a clear mandate to come on board. So, politics, first topic, very complicated one. Very packed one. Lots of uncertainty. We’ll keep you posted.

Now turning to the economy, we see that there's slightly better Canadian economic data. Household confidence has risen. Consumer spending is resilient. There is some uncertainty over tariffs, though, that is starting to hinder investments. Business investment has been hindered by all of this uncertainty. If you're a Canadian business, you're delaying right now projects for investments, for hiring new resources, because you don't know what the rules of the game will be maybe in a week or in a few months. And we already have issues with productivity and competitiveness in this country. So, this is a big problem that is becoming even bigger.

Bank of Canada, you know, we still think that they will continue to cut rates. Everyone agrees that there is going to be a cut in late January, bringing the rate from 3.25% to 3%. We started 2024 at 4.5%, so we already have some ways that's in the rear view mirror here. But will we reach the 2.5% level that we think is likely next summer, or will we have to change our view and push this a little bit further? Big question mark, but there's going to be still some easing here.

In the US, the economic momentum remains strong. The Fed now is priced to stay on the sidelines for most of 2025. Of course, that could push the US dollar higher. There are some important implications for that. But the US economy, of course, will be carried by these policies. And what happens? What doesn't happen? You know, there's still a lot of uncertainty, also, on the faith of the US economy in 2025.

Europe is facing headwinds: lack of productivity, a rise of populism, an aging population. So, the bullish story on Europe is kind of hard to put together.

China is working through significant reforms, but the measures that they propose are still pretty timid, let's say. China needs to enact many reforms to get out of this balance sheet recession that it's in right now. If it is successful, that could be a very interesting tailwind for 2025 for the global economy. But if it doesn't, that kind of adds to the US exceptionalism story in 2025.

Now turning all of this to the markets. Well, in the US, the stocks remain expensive. The valuation of equities is not that useful in the short term. If you look at the chart and you plot the valuations and the return one year after, you find that there is not so much of a correlation. Markets can go up or down even if markets are expensive or cheap. So, it doesn't really mean anything. But in the long run, let's say if you look at the valuations and the subsequent returns over the next ten years, then you have a very solid relationship where when markets are expensive over the next ten years, returns tend to be small or even negative. And right now, with the valuations that we see in the US, the expected returns over the next ten years are close to zero or even a bit negative. What that means practically is that in the short run, you don't need to change anything. But in the long run, maybe, you know, what we've seen from the US recently, this outperformance over the last few years, maybe now it's time to take some profits there.

Make sure that you diversify in other regions, other asset classes, in 2025, 2026, 2027. Don't forget that diversification is key. And it's not because the last few years it was all about the US stock market that it's going to be the same thing for the next ten years.

The Canadian stock market is attractive based on valuation. Still big question marks about tariffs, so we need to wait it out here. Interest rates have been rising. So, if you look now at bonds or the fixed income side, you have a good opportunity to enter bonds, with the 10-year rate in the US creeping in on 5%. So now, the good news is that bonds will offer a good foundation for returns in a balanced portfolio for years to come, so there's a good opportunity there.

Now, if we look at a few contrarian trades, you know, the price of gold was very positive in 2024. We had about 25% return. Now we're taking an opposite position. We're shorting gold because the factors that pushed it higher in 2024 have reversed. Central banks were cutting in a synchronized fashion. Now it's not clear how many global central banks will keep on cutting at that pace. Maybe we'll have less geopolitical pressure, at least if President Trump follows on his promise to try to solve the Ukraine-Russia conflict. All of this could push the price of gold down.

And also, the Canadian dollar. Everyone is betting against the Canadian dollar. Everyone has left it for dead. So, you know, when we see something like this, we perk up and say, maybe it's interesting to start building a position here. So, there's a few contrarian ideas here for anyone who wants to try to take some calculated risks here in the markets.

Well, that's a very packed quarter that we're looking at here. Still lots of uncertainty. We'll keep you posted when we have more information, especially on the US trade policy. It's always a pleasure to serve you. Hope you appreciated the episode, and of course, come back again next week with another episode of the “In Your Interest!” podcast.

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