Coming out of the pandemic years and the associated recovery, 2024 was a welcome breath of fresh air for investors.
With the final phase of the inflation battle largely won, central banks worldwide eased off tighter monetary policy throughout the year. With this development, coupled with moderate growth and low unemployment, 2024 delivered fairytale conditions for investors, who profited from moderate returns in bonds and strong returns in equities. For the first time in a few years, economists were no longer talking about runaway inflation and supply chain shortages; instead, the conversation turned to protecting this newfound predictability and stability.
While most of the world saw a normalization of the economy in 2024, the U.S. went one step further and enjoyed even stronger economic growth — achieving true “Goldilocks” status with earnings growth maintained in the low double-digit range. This was supported by elevated government spending, which offset the impact of higher interest rates.
Heading into the new year, the question is whether these favourable economic conditions will continue, or if investors need to prepare for potential headwinds that could threaten this “golden goose” of stable economic growth.
Protecting the golden goose
Perhaps the single most important factor shaping the economic outlook for 2025 is the result of the U.S. election. The Republicans’ decisive sweep has signalled that many of U.S. President-elect Donald Trump’s proposed policies are more likely to become a reality, which could significantly affect the U.S. and global economies.
For example, the Trump government’s proposed tariffs on imported goods could affect the cost of goods and create supply chain disruptions, potentially resulting in the resurgence of higher inflation. Trump’s promised clampdown on undocumented immigrants, which could affect more than 10 million people in the U.S., could also result in higher labour costs by creating gaps in the workforce.
In addition to these inflationary pressures, Trump’s plan to lower tax rates could mean larger deficits, which could steepen the yield curve due to an increase in bond issuance by the U.S. government. The Federal Reserve may need to reverse current policy direction and hold interest rates at current levels — or even increase rates — in response to these inflation expectations.
So, what does this all mean for the global and Canadian economies? Quite a lot.
In 2025 central banks are expected to diverge on their rate-cutting measures, with slowing economies such as Canada and the EU lowering policy rates much further than the U.S. to stimulate a rebound in domestic demand and close the output gap. This also means Canadian bond yields are more likely to decline relative to U.S. yields. And while this will put continued downward pressure on the Canadian dollar, Canadian companies that operate domestically and export globally could benefit from more favourable conversion rates on revenues. Sector examples would be Canadian resources and service-oriented sectors such as information technology. The financial services sector, particularly banks, should also benefit from lower interest rates, which support the Canadian real estate market.
Pockets of value in the U.S.
Despite unknowns related to policy changes by the Trump administration, the U.S. equity landscape is expected to remain healthy in 2025.
The concentration of the U.S. stock market in the Magnificent Seven has overshadowed the attractive value to be found in the remaining 493 S&P stocks and small and mid-cap companies. With careful stock selection, there is plenty of opportunity in U.S. equities, which are expected to continue to outperform global stocks. With the Republican congressional sweep ushering in a business-friendly setting with tax cuts, deregulation and a more favourable banking environment, corporate America should be on track to maintain its momentum in 2025.
Takeaway for advisors
In the lead-up to 2025, advisors should be prepared for potential market volatility in the months ahead as we experience the transfer of power in the world’s largest economy. A balanced and diversified portfolio that spans different asset classes, geographies and sectors will help mitigate this risk and provide a stable path forward.
Equities are expected to continue rising in 2025, driven by expectations of solid corporate earnings growth across developed markets. Despite the recent trade rhetoric, pockets of Canadian equities are positioned to perform well, benefiting from the ongoing widening market breadth that began in the latter half of 2024.
In 2025 we expect emerging markets to experience headwinds due to a stronger U.S. dollar and heightened geopolitical tensions anticipated under a second Trump administration, which will make for a challenging environment for the Chinese economy. For fixed income, the outlook is mixed because of varying global rate cuts and persistent U.S. economic strength, which could set a floor for U.S. interest rates.
Despite some uncertainty, advisors can take advantage of this more stable period of economic growth by carefully selecting stocks while considering possible inflationary pressures, geopolitical tensions and the potential for other unforeseen risks.
Lesley Marks is chief investment officer of equities with Mackenzie Investments.