The first couple months of 2025 have likely demonstrated what we can expect for the foreseeable future: an increased level of political and economic uncertainty - and a lot of 'noise'. Investors have always needed to deal with risk and uncertainty but the opening months of the year have seen noise levels that have felt higher than normal.
This week, we are focusing on our economic update and some of the key themes that are impacting the markets and economic outlook. These include the risk of U.S. tariffs and the potential effect on the markets, the questions raised about U.S. technology investment in the face of DeepSeek, and the risk of further U.S. inflation.
Economic Update
Investors have faced a higher volume of noise and uncertainty in the past few months: the threat of tariffs, a surprise development in artificial intelligence, higher U.S. inflation, and a major shift in U.S. policy with respect to the war in Ukraine. Among other things, these are just a few of the challenges that investors have faced this year.
That said, global equity markets have been resilient in the face of these issues and are higher year-to-date. Moreover, government bond yields are close to the levels they were at to start the year. And, the beleaguered Canadian dollar, has shown signs of life of late as it has strengthened recently. We discuss this more below.
The risk of tariffs remains, but perhaps not the wide ranging ones first expected
Tariffs continue to be on everybody’s mind. Despite many threats, the U.S. government has undertaken one action so far: an additional 10% tax on Chinese imports (the U.S. had pre-existing tariffs on Chinese goods). Yet, the risk of new tariffs remains: the U.S. is expected to revisit its plans for Mexico and Canada in early March, it is planning tariffs on all steel and aluminium imports later next month, and it seems tempted to bring Europe into its crosshairs in the not-too-distant future. But, markets have thus far taken the view that the worst-case scenario has already been avoided: wide ranging tariffs that were expected to be enacted over a month ago. Instead, delays, extensions, more targeted tariffs, and exceptions have emerged as the strategy so far. Should this persist, the approach seems consistent with what was experienced during President Trump’s first term in office.
Questions raised about U.S. technology investment in the face of IA developments
On the artificial intelligence front, a Chinese company, DeepSeek, unveiled an AI model that demonstrated impressive performance relative to leading models developed in the U.S. It quickly surpassed OpenAI’s ChaptGPT as the most downloaded application on Apple’s App Store. The company suggested it was able to develop its AI model at a fraction of the cost of U.S. models. Moreover, it succeeded despite significant constraints as the U.S. government had restricted its ability (given it is a Chinese company) to access some of the world’s most powerful chips. It served as a reminder that innovation is alive and well in China. It also raised more questions around the significant amounts of capital that continue to get deployed by U.S. technology firms. That led to some volatility in the tech space. Given elevated valuations of tech stocks that reflect high expectations, and the level of concentration of the tech sector within the U.S. market, we expect developments in AI to remain very important for the U.S. market.
U.S. inflation a potential risk in the months to come
Another challenge investors had to grapple with recently was the U.S. inflation reading for the month of January. It was higher than expected and the breadth of inflationary pressures also widened, suggesting a broader range of goods and services are experiencing some pricing pressures. While it’s just one month worth of data, investors will undoubtedly be watching to see if these pressures persist over the months to come. These views were shared by members of the U.S. Federal Reserve who suggested they are reluctant to lower interest rates any more until further progress on inflation is made.
Summary
The strong performance of global equities in the face of these headlines suggests that markets are looking past the noise and continue to have confidence in the earnings growth potential over the next few years. This should not mean investors can be complacent in the wake of the market’s resilience: we continue to watch for additional signs that corroborate the market’s strength, such as rising market breadth, which would suggest that an increasing number of stocks are making new highs. Should this occur, it would help confirm that the bull market for stocks continues to be on solid footing.
Even in the face of the uncertainty we’ve experienced (and will likely continue to experience), we firmly believe the best course of action continues to be a disciplined investment strategy focused on the long-term. As always, we are constantly and proactively monitoring the markets as part of our investment strategy, and we remain confident in our portfolio management approach.
As always, we are available to connect with you personally. Please don’t hesitate to contact us at 519-822-2024 or elineskyschuett@rbc.com.
