As 2024 winds down and the dawn of a new year approaches, a time-honoured tradition is to make predictions for the year ahead. Economic forecasting, and its implications for capital markets, tends to be challenging even in the best of times. President-elect Donald Trump’s return to the White House introduces additional wrinkles to this year’s forecasting ritual. Implications of some Trump 2.0 policy proposals, such as reduced taxes and regulations, are easier to forecast while changes to tariffs and immigration policy have potential for unintended consequences.
While daily announcements and prognostications from the incoming administration are indeed causing ripples, we think broad market currents are being driven by the fundamental factors of interest rates, consumer sentiment, corporate profits, and valuation. When viewed in aggregate, we think fundamentals are pointing to a “soft-landing” economic scenario and supportive of further equity market gains in select regions and sectors. As noted in our September newsletter, we have been steadily adding equity exposure in recent months and are now overweight. Given the outcome of the U.S. election, our increased equity exposure is concentrated in the U.S.
Meet the new boss… same as the old boss
So far, Trump 2.0 economic priorities are unsurprisingly like those under his first term: tax cuts, deregulation, and tariffs. Other signature policies that have economic implications include immigration and isolationism. In his first term (to the beginning of the pandemic in February 2020), U.S. gross domestic product (GDP) growth accelerated, the unemployment rate dropped, and the equity market gained. With a similar playbook being deployed, markets have already started positioning for similar outcomes. Republican control of the House and Senate increases the likelihood that Trump 2.0 priorities find their way into legislation. While each policy initiative is complex, below is a summary and initial market reaction. We discuss potential impacts to inflation, interest rates, GDP growth, fiscal deficit, and currencies later in the newsletter. Unless otherwise stated, data in this newsletter is per Bloomberg as of November 29, 2024.
Tariffs – The new administration intends to use tariffs for the dual purpose of re-shoring production to the U.S. and as a broad threat to trading partners to fulfill other objectives such as controlling illegal immigration, protecting intellectual property rights, stopping drug trafficking, boosting military spending, and maintaining dollar-based international trade. Trade with the U.S. being critical to many countries, including Canada, we think the threat of tariffs could boost volatility for these markets during the Trump 2.0 administration and redirect global investment capital toward the U.S. Even though actual tariff imposition may be several months away, global markets have already started to adjust. U.S. equities have outperformed other global markets since the November 5th election, with China, Europe, and Latin America trading lower. Interestingly, the Canadian equity market (S&P/TSX Composite) has kept pace with the U.S. market as of November 29. Directionally, we think these trends should persist in the near-term.
Taxes – Trump has proposed a reduction in corporate taxes from the current 21% to as low as 15%. He also campaigned on renewing personal tax cuts enacted in his first term that are set to expire at the end of 2025. Corporate tax cuts enacted in 2017 contributed to a 26% total increase in S&P500 earnings over the 2017-2019 period, matching the 26% increase in the S&P500 Index over this two-year period. While the degree of tax reduction may be lower during Trump 2.0, markets have reacted enthusiastically to this potential earnings tailwind. However, markets continue to be complacent about potentially higher fiscal deficits that tax cuts may trigger.
Deregulation – Although not as quantifiable as tax cuts, reduced regulatory burden on businesses also has the potential to be an earnings tailwind. Amongst the most regulated industries, the U.S. financial sector has been the strongest performer since the election (+9.7% vs. +4.3% for the S&P500) on the prospect that onerous capital requirements may be relaxed. The energy and technology sectors are also expected to experience tailwinds from deregulation. Finally, the merger/acquisition environment is also expected to improve as some anti-trust hurdles are eased.
Soft-landing thesis intact, but interest rate path keeps evolving
Supply and demand drivers in the post-pandemic era have continued to normalize and inflation is approaching pre-pandemic levels in the U.S., Canada, Europe, and other developed markets. This progress on inflation, combined with a gradual cooling of the labour market, has facilitated ongoing interest rate relief. We believe the path of interest rates will remain downward sloping, but Trump 2.0 policies could affect the cadence of rate cuts.
In the U.S., where last-mile progress on inflation was already slowing due to a resilient economy, the combined impact of higher tariffs, lower taxes, and tighter immigration could prove inflationary and push the U.S. Federal Reserve to slow the pace of interest rate cuts. After cutting its short-term rate to 4.75% from a recent peak of 5.50%, market-pricing suggests the Federal Reserve may deliver another 0.75% of cuts by the end of 2025, bringing the rate to 4.00%. In mid-September, when the U.S. labour market was showing signs of distress (and Vice-President Kamala Harris was ahead in the polls), the market was pricing in a Federal Reserve rate of 3.00% by the end of 2025. So, a full percentage point of interest rate easing has already evaporated. Ultimately, this could slow economic and equity market momentum and is receiving our full attention.
The interest rate outlook for Canada hasn’t changed materially since the U.S. election. Since June, the Bank of Canada has cut rates by an aggregate 1.25%, bringing its short-term rate to 3.75% at present. With headline inflation back to the 2% target and U.S. tariff policy potentially deterring business investment in Canada, the Bank of Canada is expected to continue cutting rates. The market is currently pricing in a further 1.00% of cuts by summer 2025. Although risks are skewed to the downside for the Canadian economy, we think proactive interest rate relief should support a soft-landing scenario.
The knee-jerk reaction to upcoming pro-U.S. policies under another Trump administration has resulted in U.S. dollar strength against most global currencies. The Canadian dollar has depreciated 1.3% against the U.S. dollar since November 5. While the Canadian dollar is subject to headline risk in the near-term, we think it is trading at the low end of the US$0.70 – US$0.80 range that has persisted for much of the last 10 years.
During Trump 1.0, the Canadian dollar initially weakened after the 2016 election but then strengthened and generally remained above the post-election low until the pandemic started in 2020. Indeed, the Canadian dollar averaged almost US$0.80 during the eight-month renegotiation of the U.S./Mexico/Canada trade agreement (USMCA) compared with US$0.74 after the 2016 election. While it is easy to paint a grim picture for the Loonie, we think much of the negative sentiment is already priced in. Case in point: the Canadian dollar initially dropped 1.3% on November 25 after Trump threatened a 25% tariff against all imports from Canada, but almost fully recovered as of November 29.
As the threat of U.S. tariffs loom over the Canadian economy, we think the U.S. will ultimately impose tariffs on a smaller range of products rather than widespread application. With the exception of oil/gas products, where Canada runs a large trade surplus, the remainder of Canada/U.S. trade is fairly balanced. In the autos/vehicle category, which is second in size to oil/gas, 2023 exports and imports to/from the U.S. were almost identical, a sign of a balanced trade relationship (based on data from tradingeconomics.com).
Based on the 2023 National Trade Estimate Report on Foreign Trade Barriers published by the U.S. Trade Representative’s office, a 466-page report of grievances against trading partners, vulnerable segments of the Canadian economy include agriculture, wine/beer/spirits, and digital media. The 2023 report had no mention of oil/gas, autos, aircraft, machinery, steel, mining, lumber etc. While all countries have to brace for protectionist policy of Trump 2.0, we think Canada is in better situation than headlines suggest.
Maintaining an overweight equity positioning, with an emphasis on U.S. exposure
Our concern that the 2022-2023 interest rate hiking cycle would tip the economy into recession had us defensively positioned during the first half of the year. As with previous economic cycles, unemployment rates in Canada and the U.S. started to respond to aggressive rate hikes and warning lights started to flash on the economic dashboard. However, declining inflation, timely interest rate cuts, a resilient consumer, and government stimulus have combined to reduce recession probabilities in recent months.
While we continue to keep a close eye on how Trump 2.0 policies could impact economic momentum and interest rate path, we have been steadily raising equity exposure across our managed portfolios and are currently in an overweight equity position. As described in the portfolio changes below, all the increase in equity exposure in recent months has been in the U.S. where we see more tailwinds than other global markets. We have trimmed our Canadian equity exposure but have maintained positions in banks, REITs, and pipelines where above average dividend yields provide a barbell approach to the growth-oriented exposure in U.S. equities.
Compared to the starting point of Trump 1.0, we are cognizant that U.S. equity market valuation is materially higher at present, suggesting that broad index gains may be limited. We have targeted increased U.S. equity exposure in small caps where we think there may be less tariff disruption, U.S. banking sector that should experience strong earnings momentum, and technology/innovation companies where growth tends to be secular rather than cyclical. We have also added wider U.S. equity exposure through the S&P500 Equal Weight Index as we expect increased breadth beyond the large cap Mag-7 technology stocks.
- We continue to expect a “soft-landing” scenario for the U.S. and Canadian economies.
- Our optimism is based on declining interest rates, consumer resilience, and healthy corporate earnings.
- U.S. policy uncertainty is a likely source of market volatility in 2025.
- We are maintaining an overweight equity positioning, with an emphasis on U.S. exposure.
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