Executive Summary
In last December’s 2024 Market Outlook Plenty of Progress, Solid Foundations Laid, we discussed a continuing return to normal, an environment where investors are rewarded across the risk spectrum. After a decade of absence, normal – or normal uncertainty – has finally returned.
We see the fundamentals of economic growth, corporate earnings, inflation, bond yields and sentiment as supportive. Valuations are a mild hurdle in some markets, attractive in a few. We think valuations are manageable in U.S. markets. We see a path to further (modest) gains, but we could at any time face a growth scare, which is a normal, minor correction that occurs in bull markets.
Headwinds are abating: specifically, slow economic growth, lacklustre corporate earnings growth, high inflation, elevated interest rates and bond yields, sluggish lending, and weak consumer and business sentiment. Some tailwinds are blowing in. Markets deliver returns in waves or bunches. Inevitably, a series of strong returns is followed by punches, or pullbacks, that trim the excesses in markets through corrections and bear markets or sideways movements.
Globally, there is a powerful alignment of falling inflation and smoothsailing economies (U.S.) and economies that are doing okay (Canada, the U.K. and most of Europe).
Equity markets
The positive global macroeconomic backdrop points to solid corporate earnings growth expectations for 2025, ranging from 9% to 15% globally. We believe it’s more likely we’ll get positive earnings surprises than the opposite.
Equity market valuations (12-month forward price-to-earnings ratios) diverge across our four major markets. Valuations are above normal in some markets. Earnings growth in the teens, even on extended valuations, can deliver high-single to low-double-digit market returns. With high earnings growth and continued elevated valuations, another year of exceptional equity market returns is possible.
We are overweight equities. We believe equities can deliver mid-teens total returns. Our targets are 28,600 for the S&P/TSX Composite and 6,600 for the S&P 500.
Fixed income markets
We expect the Bank of Canada to drop the overnight rate from 3.75% to 2.5% by June 2025 and then hold. We expect the U.S. Federal Reserve to lower the fed funds rate from 4.75% to 3.5% by the end of 2025.
Canadian 2-year and 10-year bond yields are at 3.15% and 3.28%. For the U.S., yields are 4.31% and 4.44%. We think yields will fall as central banks lower benchmark rates.
Our end-of-2025 call is for the yield curve to steepen, with Canadian 2-year bond yields of 2.75% and 10-year bond yields at 3%. This should drive total return in the broad Canadian fixed income market in the 4% range.
Currency outlook
We don’t see the loonie’s fortunes turning around imminently, but given the extent of the pessimistic sentiment, we believe most of the weakness is done.
We expect the loonie to appreciate, with an exchange rate of C$1.35 or US$0.74 at the end of 2025.
Our positioning
Our portfolios remain well diversified and balanced, favouring equities over fixed income.
In our broadest representative portfolios, we are overweight Canadian and U.S. equities, neutral to international developed markets (Europe and Japan) and underweight emerging markets.
We are overweight investment-grade corporate bonds and underweight the lowest-quality borrowers in high yield.
The current yield from our well-diversified bond positions is very competitive.
The last word
We remain constructive on the investment outlook for 2025.
We conclude that the fundamentals of economic growth, corporate earnings, inflation, bond yields and sentiment remain supportive. Valuations are mixed. Therefore, we continue to rely on diversification across geographies and asset classes – stocks, bonds, cash, and alternatives – to meet our clients’ individual investing objectives.
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