Goacher Wealth Management Blog for Friday January 17, 2025
Some thoughts on the year ahead
Happy new year to everyone. Sending positive thoughts for the best year ahead for everyone.
I recently spent three days in Toronto at the annual RBC DS equity conference listening to economists and analysts as to their thoughts on what’s ahead. No one can say for certain what might be on the horizon, especially with the incoming USA administration. However, I thought I would outline a few observations and where I think the economy and markets might be going.
Economic immune systems
RBC DS has a new Chief Investment Economist / Strategist, recruited from Manulife Financial. Frances Donald was simply awesome and I am excited to see what she brings to the table with respect to economic forecasts and the market outlook this year and beyond.
She compared the USA and Canada in the context of immune systems. The USA has a strong, insular immune system that can withstand economic shocks. It is mostly independent of the global economy. Its economy is strong, unemployment is marginal, and inflation under control. Because of this, the Federal Reserve is expected to stay on the sidelines in 2025 with only one, quarter point cut later in the year. Currently, the Federal Reserve rate is 4.5%.
Canada in contrast has a weak economic immune system. We have a weak economy that is largely dependent on the USA, unemployment is high’ish, the tax system is repressive, there is ineffective government spending, and interest rates expected to continue to decline to combat this economic weakness. Once a virus is introduced (e.g. tariffs), our system is ill equipped to respond.
Tariffs
Tariffs are the unknown. Most of the analysts during the conference expected there to be some level of tariffs imposed on Canada by Donald Trump. The unknown was how much and on which goods. No one had a unique insight or view on this and so we will have to wait to see what happens. The impact of tariffs varied according to the level of tariffs applied.
Tariffs have four stages of impact:
- Companies load up on supply and inventory in the face of potential increased prices due to tariffs. This actually creates economic growth.
- Tariffs cause a one-time increase in prices. It is not an ongoing, reoccurring event.
- Demand drops off due to higher prices and because inventories have been built up in step one above.
- On-shoring of manufacturing leads to a stronger immune system to offset short term tariff impacts.
The question on the impact of tariffs should be, “over what time?”. On-shoring does not happen quickly and therefore the full process above takes time. The short-term impact is immediate, however, over time the economy resorts back to normal.
Of note was a comment from the economist of an independent market research company. He commented that the impact of a 25% blanket tariff on all goods would lead to an immediate three-year recession for Canada and even the potential for a 60 cent dollar!
Another comment made by Frances Donald was that the weaker Canadian dollar against the US greenback should offset some of the impact of the tariffs. How much of an offset that would be was not discussed.
Tariffs will inevitably lead to a weaker Canadian economy. Forecasts for growth drop from 2 - 3% to 1 - 2% with a modest level of tariffs. The Bank of Canada most likely will have to cut rates further than expected to combat that. Current forecasts are for the bank rate to be cut to 2.5%, however, we would anticipate that rates go to 2%.
Mortgage rates
There may be a silver lining to this. Low inflation may lead to lower yields on bonds, that will ultimately lower fixed mortgage rates. Deeper and faster cuts to interest rates will mean that variable rate mortgages will also become cheaper. This is important as 50%+ of all mortgages in Canada are maturing in 2025 to 2027. The USA mortgage market is unaffected by this as consumers locked in 30 year guaranteed rates at around 3% a couple of years back. US mortgage rates are currently in the 7% range.
Exchange rate
Due to the divergence in economic growth as well as the difference in interest rates between Canada and the USA, the Canadian dollar is expected to remain under pressure. Where the exchange rate was expected to float between 75 and 80 cents on the dollar, there is potential that it trades between 70 and 75 cents, and perhaps lower. We have already seen it break the 70 cent mark this past week.
Immigration
One issue that is not being given enough consideration is immigration policy on both sides of the border. I would argue that this issue is as important as tariffs. Canada has already cut back immigration targets considerably from recent extreme highs. Donald Trump has vowed to cut immigration targets to zero and is hell bent on sending people back to their home country. This has a significant impact on growth for both countries.
In the USA, there is 40% of the population that is not working due to an aging population. There are also three people retiring for every one person working. Data shows that there are no corporate firings or hiring, with baby boomer attrition moderating employment levels. However, fewer workers supporting a large, retired population is not sustainable.
Furthermore, as immigration is cut, there are less people available and willing to do the labour that typical American workers don’t want to do. There will inevitably be a shortage of labour in many fields of work, especially in the service, food, food processing, and hospitality industries. Wages will have to increase to attract people to those jobs. This is inflationary and will cause the rate of inflation to increase to levels above that which the Federal Reserve will be comfortable with. That level remains in the 2 to 3% range.
In Canada, immigration targets have been cut from 1 million immigrants recently to 395,000 in 2025 and lower in the following years. High levels of immigration caused a number of issues such as a heightened shortage of housing, however, it also grew our economy. The cut in immigration levels will be a drag on economic growth potentially equal to, or more than, tariffs. Slower growth will keep the Bank of Canada cutting interest rates to combat this slower growth.
Market direction
There is the potential for strong growth in the markets to continue. I believe the most viable market to invest in is the USA market due to the solid footing the USA economy is on. Expectation is for the USA economy to grow at 2%+, employment to stay steady, and interest rates to hold or decline slightly. Should any of those not come to pass, market valuation is at risk. One could argue that USA growth may not meet expectations based on some of the factors noted above.
The markets have been very choppy in early 2025 trading due to the uncertainty. We saw a few down days only to be reversed with a strong couple of days due to a favourable USA inflation report that indicated inflation was moderating. This put the potential for USA interest rate cuts back on the table at least for the moment.
The USA bond market yields are indicating they anticipate higher levels of inflation. 10 year bond yields have moved up to 4.7% and 30 year bonds to 5%. This indicates a level of 3% inflation and real yields of 2% (5% bond yield – 3% inflation rate = 2% real rate of return).
As yields on bonds move higher, investors will start to invest in bonds as they provide a reasonable risk-free rate of return compared to equities.
A balanced portfolio traditional consists of 60% equities and 40% bonds. The bond component over the last decade was used as capital protection as interest rates were unbearably low. Now that we have moved into a sustained period of bond yields reverting to the normal long-term return of 5%, bonds are actually contributing to portfolio returns and not just providing capital protection.
A new view of wealth divide in Canada
An interesting comment was made by our Chief Strategist on the wealth divide in Canada. There has been some press lately that those people who own a house in Canada are ten times more wealthy than those that don’t. Our strategist, Frances Donald, commented that there is no longer an economic divide between the top 20% of Canada’s wealthiest citizens and the 80% rest of the population. Rather it is a divide between those that own real estate and those that don’t. This is a very interesting and unique view of wealth.
That’s it for this blog and outlook on the markets. We will be undertaking to review our holdings and our models, and possibly incorporate some of the news ideas that came up at the conference. I believe we already have many of the best ideas incorporated into our portfolios.
Hold on tight for next week with the inauguration of Donald. I am sure there are going to be some fire works!
Be well.
Miles…