We go into 2025 with political and economic uncertainty as the Canadian PM steps down, and the “King of Debt” is crowned once again in the U.S. In their latest quarterly Market Observer, the team at Canso Investment Counsel Ltd., a leading Canadian institutional investment management firm, highlights the unpredictability of tariffs, inflation, and risk—while also outlining their strategy for the quarter.
Click here for the full Market Observer.
Trump returns, with “First Buddy” Musk in tow
The January Market Observer—published two days after Jan. 6, when Justin Trudeau announced his resignation (and Kamala Harris was certifying her own loss)—began by noting that 2024 saw “investors chasing returns at literally any cost or price”. Patient or risk averse investors were left behind by those willing to just “Buy In” to the market momentum. The Canso team added that the buying “euphoria” was supported by monetary easing by central banks and the election win of Donald Trump, who “seems to have met with the stock market’s approval.”
Indeed, in the U.S., the Dow Jones index was up 12.9 per cent for 2024, while AI dreaming lifted the S&P 500 by 23.3 per cent and the tech-heavy NASDAQ by 28.6 per cent. That was the S&P 500’s best two-year performance since 1997-98.
But while some things rise, others fall, and bonds were a different story in 2024. “It was up, up and away in the financial markets, except for government bonds,” the Canso team noted. “It was credit and corporate bonds that carried the day in the fixed income market, as risk premiums shrank, and credit spreads narrowed substantially.” The bond market is not as enthusiastic about Trump as the equity market, in part due to worries about the size of government deficits and continued U.S. economic strength keeping inflation higher for longer, the team pointed out.
Follow the money—into a bubble
The real question is whether the financial market enthusiasm will continue. “In our opinion, the vast amounts of money produced by central banks during their COVID-19 hysteria continues to spill over into the investment markets,” the newsletter noted, explaining that the huge increase in M2 money supply by global central banks eased the economic pain from the pandemic but created excess money supply. This move (at rates unprecedented in the U.S. and Canada) gave the Canadian and U.S. governments the money they needed to stimulate their economies by issuing bonds and spending those funds. But, as the Observer noted, it also provided the money to support inflated prices for goods and services.
“All that money created needed to go somewhere,” the Canso team wrote. Consumers have spent much of their stimulus payments and wage increases on the higher prices they are now paying for goods and services, while other, more prosperous investors have put that excess into the financial markets. “Their obvious financial success begets envy and further investment as others are drawn into the markets, and leverage amplifies the uptrend,” the newsletter noted.
Does this mean we are in a financial bubble? “We’ll really never know until it’s over, but a necessary precondition for a financial bubble is a substantial expansion of money supply and we have that in spades,” they cautioned, adding that unless we are into a very rare “It’s Different This Time” moment, economies with loose monetary and fiscal policy will probably run hotter than predicted, possibly with higher inflation.
And speaking of inflation, the Canso team also cautioned against believing that recession would bring down inflation and interest rates. Recessions have occurred during higher inflation periods from the 1970s to the 1990s. However, they also pointed out that it’s hard to find an economist or market strategist these days who believes that higher inflation is a possibility, as the consensus is that our recent high inflation was beaten for good by higher rates and tighter monetary policy and will not return. “That was also the case in the mid-1970s when the economic consensus saw inflation and monetary policy ‘getting back to normal’ after inflation fell for 2 years. Monetary ease meant that inflation reignited and ‘normal’ inflation and monetary policy didn’t happen for a very long time,” the team noted, adding: “Today’s bond market currently is imbued with a similar optimism that we’re back to the 2 per cent CPI future, and that very well might not be the case.”
What will Trump do? Watch these signs
Later this month, the U.S. will swear in their new old President, Donald Trump, who has promised to both cut taxes and the deficit, while also promising to keep up spending. Trump is the self-styled “King of Debt,” and the Market Observer warned that the continuation of the Trump tax cuts plus no taxes on social security, overtime wages and tips, coupled with his spending promises, could add as much as $15 trillion to the U.S. deficit over the next 10 years.
But Trump has a plan. He has promised to replace the lost tax revenues with his “beautiful tariffs” on imports. But who, the Canso team asked, will pay for the tariffs? And what will happen when Trump’s promises and plans run into economic reality?
“There is so much hype in Trump’s platform that it is hard to predict anything, so we won’t even bother. Nobody really knows, including Mr. Trump and his incoming administration,” the team noted, adding that the professional Wall Street and business consensus is that Trump won’t implement his more radical ideas and policies. However, there may be a lot of wishful thinking at play here.
How is the Canso team navigating these choppy waters? “We believe it depends on the reaction of the U.S. financial markets to his plans, especially the U.S. Treasury market,” they wrote. Citing the example of former British PM Liz Truss, they continued: “It’s fine in the ivory towers of conservative thinking to postulate how things work, but when actual investors rebel against your plans and sell your bonds, then things change quickly.”
This is important for investors to remember, because Donald Trump hangs on the performance of the stock market. If a policy craters either the bond or stock market, the Canso team believes he will be quick to change course.
“The Federal Reserve will be challenged to implement sound policy in the face of strident Trump exhortations to lower rates,” they wrote. “It already has felt the scourge of higher inflation, but we doubt there’s another Paul Volcker waiting to defeat another bout when Powell’s term ends in 2026. The Fed ‘muddling through’ could result in higher inflation and interest rates.”
Could Trump’s tariffs actually hit Canada?
To the Canso team, the picture in Canada is unclear. “Forget the political drama with Justin Trudeau’s ‘Long Goodbye,’ our economic housing addiction, or the inflationary impact of a lower Canadian dollar. The threatened Trump tariffs are a mortal economic threat to Canada,” they wrote, adding, “that if there’s a trade war with the U.S., Canada would inevitably lose.”
And there doesn’t seem to be much Canada can do to retaliate. “Probably the best Canada can do is to selectively hurt U.S. industries and key voters in their pocketbooks and try to outlast the chaos the tariffs cause,” the Observer pointed out.
What happens next? For now, the Canso team is concentrating on valuations, which they believe look priced for perfection.
Uncertainty raises discount rates and lowers prices, and the Market Observer pointed out that the current investment vogue is to assume higher risk to juice returns: “That makes us cautious with our client monies and, apart from some of our special situations, we think risk is currently underpriced with the current financial market enthusiasm and the many potential downsides that we see.”
The Canso team is invested, but increasingly conservatively, focusing on opportunities with better valuation metrics and avoiding higher risk situations. “If we don’t understand a risk or we’re not paid to assume it, then we would rather wait for better opportunities.”
Disclaimer: This story was created by Canadian Family Offices’ commercial content division on behalf of Canso Investment Counsel Ltd., which is a member and content provider of this publication.