Tariff and tech bubble concerns threaten volatile 2025

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Amid Chrystia Freeland’s fiery exit as finance minister, Donald Trump’s tariff threats and a rapidly depreciating Canadian dollar, investing conditions are looking different in 2025 than they did a year ago.

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Tu Nguyen, an economist at assurance, tax and consultancy firm RSM Canada LLP, said Freeland’s exit was just the latest in a series of events adding uncertainty to Canadian markets.

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“Although the impact on the financial markets has been moderate, an event like this could contribute to Canada’s challenge to attract foreign investments in 2025, when a Trump administration comes with trade policy uncertainty with Canada,” he said in a recent note.

Volatility is the name of the game for investors in 2025, David Rosenberg, founder and president of independent research firm Rosenberg Research & Associates Inc., said.

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“We have tremendous political uncertainty when it comes to Donald Trump and his policies and what he will actually get done,” he said, adding that investors should adopt a cautious approach and play it safe until the policy clouds clear.

Rosenberg recommends investors keep more cash on hand next year than they typically would and to invest in sectors that are less likely to be hurt by the Trump administration’s policies.

James Thorne, chief market strategist at Wellington-Altus Private Wealth Inc., pointed to the possibility of 25 per cent tariffs on goods in Canada that Trump has said he would impose.

“Trump is going to implement his policies very quickly,” Thorne said. “He’s not going to get the pushback like he did in his first term, which means drill, baby, drill. And that means oil is going to US$50 a barrel next year.”

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Ashish Dewan, an investment strategist at Vanguard Group Inc., said tariffs could impact investors, as about two-thirds of Canada’s gross domestic product is dependent on trade and a significant chunk of that trade is with the U.S.

However, like others, he said what will come into force once Trump takes office is still uncertain. He and other experts believe border security and defence spending could be used as negotiating tactics against tariffs.

This is not the first time Canada has faced the threat of tariffs from its southern neighbour. During Trump’s first administration, the United States imposed tariffs on Canadian softwood lumber and later on steel and aluminum, and Canada announced its own retaliatory tariffs. The tariffs on both sides were dropped after a new trade agreement was negotiated.

Maria Wagner, an associate portfolio manager at Verecan Capital Management Inc., said investors should “cancel out the noise” and avoid making decisions based on speculation.

“Right now, we’re focusing on stocks with mid-cap and small-cap valuations, just because we think there’s a higher margin of safety with those investments,” she said, adding that her firm is underweight on the technology sector right now, given its higher valuations.

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Where should Canadian investors focus?

Stephen Johnston, a private equity manager and director at Omnigence Corp., predicted the economy will be subject to stagflation for at least the next decade, so Canadians need to pick investments that aren’t subject to poor growth dynamics.

“You’ve got a structurally weak currency, you’ve got very expensive housing, you’ve got (one of the) most indebted developed (economies) in the world,” he said.

Canada has the highest ratio of household debt to disposable income in the G7, at 185 per cent compared with an average of 125 per cent across all G7 countries, according to Statistics Canada.

Wagner said her firm is more optimistic about the global economy and has trimmed its Canadian exposure.

“Being diversified is going to help you weather many storms, and especially with policy change, you want to make sure that you are not concentrated in one stock or sector that could be adversely affected by any of these new policies,” she said.

Canadian investors allocated half their total equities to Canadian stocks, despite these accounting for just 2.6 per cent of the global equities market as of April 30, according to a June report by Vanguard Group Inc.

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The ideal home bias on the equity front should be around 30 per cent, Dewan said, in order to minimize variance and reduce volatility, especially with the Canadian economy more concentrated in certain areas (such as energy, financials and materials) and less concentrated in others.

Other experts say Canadian investors should get their money out of Canada entirely.

“I do not think there is going to be any motivation for any foreign capital to come back into Canada,” Thorne at Wellington-Altus said, adding he believes Canada will underperform the U.S. at least until the next election in Canada.

He predicted Canada will fall into a recession in 2025, with a substantial growth slowdown picking up steam in the latter half of the year.

Growth in per-capita GDP has declined for six consecutive quarters and lower immigration targets could weigh on economic growth for the coming years as well. The unemployment rate hit 6.8 per cent in November, the highest rate since January 2017 (excluding pandemic distortions), according to Statistics Canada, which Thorne said is not a soft landing.

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He said interest rates could fall below two per cent in 2026 (the key rate is currently at 3.25 per cent, following the latest rate cut).

“My argument has always been it’s going to be easier to achieve your economic goals by investing in the United States,” he said, highlighting Canada’s lack of “innovative companies” and Big Tech-type stocks.

Thorne said investors who don’t want to pull out of Canada entirely should consider structuring their portfolio more like the S&P 500 and less like the S&P/TSX composite index. He said he prefers secular growth, meaning companies or sectors whose growth is not reliant on GDP growth.

“I think the Canadian investor has to look in the mirror and be honest with themselves about the fact that with per-capita GDP about to fall below the (Organization for Economic Co-operation and Development) average, with productivity negative, the structural adjustment process that we have to go through will be long and painful.”

However, the historically high valuations of stocks in the U.S. market are making many nervous.

Rosenberg said earnings growth estimates in the U.S. are too lofty, whereas the Canadian market could benefit from a shift from growth to value.

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“In the land of the blind, the one-eyed man is king,” he said. “And if you have to be fully invested in the stock market, I’d sooner be in Canada right now than in the United States.”

Is the U.S. in bubble territory?

“I am not dissuaded from the fact that there’s going to be a bubble, because bubbles are natural,” Thorne said, but he doesn’t expect the bubble to burst until early next decade.

However, Rosenberg is staying cautious.

“Looking at a century’s worth of data, we have ascertained that the U.S. stock market is priced for 20 per cent average annual earnings growth for the next five years, which isn’t impossible, but historically, it’s a one in 20 event,” he said. “If you believe that AI will deliver the productivity and cost reductions that will generate a five-year period of average 20 per cent profit growth, then this market is for you.”

But Rosenberg is more skeptical and believes the equity risk premium is above zero.

“If it’s not a bubble, it’s a giant-sized sun,” he said.

Comparing the current optimism in artificial intelligence to the internet craze of the 1990s, Rosenberg said it wasn’t just dot-com companies that were impacted by the bubble, but giants such as Microsoft Corp., Intel Corp., Dell Technologies Inc., International Business Machines Corp. and Cisco Systems Inc.

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“This bubble is less intense than that bubble was, and these businesses that are out today do have real models and real profits, but we’re not talking about businesses,” he said. “We’re talking about stock prices, and I believe that at this stage, there’s a little too much speculation behind where the valuations are.”

Robert Janson, co-chief executive and chief investment officer at Westcourt Capital Corp., pointed to a note from Goldman Sachs Group Inc. that forecasted the S&P 500 would deliver an annualized return of three per cent over the next decade, compared with the 13 per cent annualized return yielded over the past 10 years.

“You’re not buying anything on sale; you’re literally buying everything at its richest valuation,” he said.

‘A tug of war’

Janson said investors should consider other asset classes in the alternative and private-equity space, such as farmland, self-storage and infrastructure — which refers to automation and digitization — to add to their portfolios.

Until fairly recently, you had to be an accredited investor with a higher net worth and income level in order to get in on private investments. But a 2019 rule change means the average retail investor can bridge the gap to liquid alternative mutual funds.

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Still, Omnigence’s Johnston cautioned against traditional private-equity strategies, such as investing in real estate, which he believes is overpriced in Canada right now.

Falling interest rates should be positive for bonds and dividend-paying stocks, Rosenberg said. Lower interest rates could also boost the stock market, with financials, utilities, pipelines and telecom services particularly benefiting, while a weaker Canadian dollar could be better for Canada’s tourism and hotel sectors.

Dewan is more optimistic about U.S. fixed income as opposed to U.S. equities for the coming year, and said Vanguard’s research indicates Canadian equities will perform better over the decade.

He pointed to higher yields, positive real returns and the potential for U.S. fixed income to provide investors shelter from higher rates.

Dewan also prefers value stocks over growth stocks, adding that Vanguard is staying cautious when it comes to the U.S. tech sector’s high valuations. Instead, he said investors should look to other sectors that could still benefit from technology and AI, such as health care or financials.

“It’s a tug of war between valuations and momentum, because momentum could win again next year, technology could still win,” he said. “But we see that as really longer term.”

• Email: slouis@postmedia.com

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