“If I had the choice – which I do not – I would choose better political conditions and literary obscurity.”
– Margaret Atwood, Canadian novelist, poet, literary critic and inventor
Worried headlines were the order of the day during the first quarter of 2025. Words and deeds of the new U.S. administration produced many heavy hearts and unpleasant surprises (but let’s not forget one joyous 3-2 OT Four Nations hockey celebration).
Tariff pronouncements and threats are bound to continue for some time. On top of this (and because of this) there are growing fears the new U.S. administration’s trade and immigration policies (tariffs and smaller labour force), and government fiscal restraint (DOGE) might lead to a U.S. economic slowdown that could spread to the rest of the world.
Despite all this, capital markets in Q1 didn’t reflect as much doom and gloom as the general mood on the street. A Canadian investor’s representative, well-balanced, diversified portfolio is up slightly for the year. We implore clients to acknowledge this reality, double down on their efforts to separate understandably heady emotions from investment decisions, and stick to a clinical approach. The realities of what’s best for the long- term health of our investment portfolios can feel cold and unpatriotic: that is the nature of capital markets. We must focus on reality and strike emotion from our portfolios.
What do we mean by keeping reality in focus? We’re not suggesting a Pollyannish, head-in-the-sand hope that this will turn out to be a bad dream. No, we are advocating for a disciplined boycott of conjecture and rumour, along with rejection of fleeting, untrustworthy, or untrue statements slithering through all types of media. What President Donald Trump and his advisors say they are going to do is often incompatible with accomplishing their goals – and long-term prosperity. What is achievable, sustainable and congruent with the laws of supply and demand in a modern capitalist system will be revealed in the fullness of time.
It’s also possible that we might not have to wait too long for change. In under four years, we’ll see some form of shift. Special elections and the U.S. midterms in 20 months will likely bring seat flips. We could also see change sooner if one or more of the following steps up: Congress (the constitutional owners of revenue tools); the judiciary; and most important U.S. public opinion when the negative fallout from tariffs raises prices, kills jobs and batters stocks.
Tale of the tape
U.S. capital markets are a barometer for the country as a whole – and they are signalling that the MAGA movement isn’t heading in the right direction. For the first quarter, all major U.S. equity market indices (S&P 500, Dow Jones Industrial, Nasdaq and Russell 2000 small cap) are down between -4% and -11%. U.S. bond yields are down despite the inflationary pressures of tariffs. This is a sign that there’s greater fear of a slowing economy than fear of inflationary impacts. Of course, both are negatives.
In Q1, the “Great” was the great rotation to other markets at the expense of the U.S. Chinese markets topped the list (MSCI China up 15% year to date), Euro Stoxx 50 Equity Index was up 7%, FTSE U.K. 100 Equity Index up 5%. The S&P/TSX Composite eked out a 0.8% gain. This once more illustrates that diversification across equity markets and various asset classes works. We believe in and practice both, an approach that is carrying us through this period of uncertainty.
Why is this happening?
One thing that’s very frustrating: if so many people, and the weight of historical precedent, and all economic theories insist that tariffs aren’t going to achieve their objectives, why is President Trump imposing them? The answer: it appears that the U.S. administration wants to use tariffs as a universal tool to accomplish multiple goals, despite the negative consequences.
U.S. tariffs are aimed at achieving some key ambitions: geopolitical change encompassing continental security, including the Arctic; allies spending more on their own defence; competing with or containing China in key industries/national security sectors; raising revenue for the U.S.; achieving a renaissance in U.S. manufacturing; and correcting large U.S. trade imbalances.
Effecting geopolitical change is a laudable goal and is happening at a brisk pace. European equities have shot up partly because of eurozone fiscal spending announcements. Canada, too, is in this boat. Silver linings from the current situation include a positive attitude shift toward meeting our NATO commitments, beefing up border security, and shaking off our complacency about lacklustre productivity.
The ideas that tariffs will raise revenue, repatriate manufacturing and correct trade deficits should be viewed with skepticism based on sound economic theory and historical experience. Using tariffs to raise substantial revenue is a quaint concept. In practicality, tariffs are an economically inefficient tool. If this were possible, everyone would have been doing it for hundreds of years. It sounds great to say foreigners will pay the bills, but it isn’t that simple and doesn’t completely work that way.
No one country produces all (or efficiently all) of the inputs needed for everything it manufactures. Geography and economies of scale alone dictate some necessity to trade. It is estimated that 45% of U.S. imports are inputs that go into U.S. manufacturing production.
Trade wars don’t reduce trade deficits, and trade deficits aren’t correlated to manufacturing job creation. According to The Wall Street Journal, between 2000 and 2024, Germany’s trade balance flipped from a deficit of 1.5% of GDP to a 5.8% surplus, yet the share of factory jobs in the economy fell from 20% to 16%. The WSJ references a 2021 study which found that declines in manufacturing employment were similar in U.S. and German industrial hubs despite stark differences in trade balances.
A trade surplus can be viewed as the U.S. being wealthy enough to buy lots of goods the rest of the world produces at a lower cost. A big part of that lower cost is wages. Are typically lower-wage jobs manufacturing cheap products with little value added really that desirable? This is sub-optimal, especially with the U.S. at full employment. It misaligns U.S. labour and capital that free markets currently allocate to more productive uses.
Zero tariffs are unlikely, and some tariffs can be imposed for the right reasons. Trade needs to be fair and free. Cheats, industrial thieves, exploiters of labour or the environment deserve to be penalized with tariffs, as do those who are using tariffs unreasonably on other countries today. Truly reciprocal tariffs could force others to lower existing tariffs, bringing about lower tariff barriers worldwide.
Increasingly freer trade that exploits competitive advantages has been the fuel of rising living standards for more than a half-century. It grows the proverbial pie for all. How that pie is divided is always a source of conflict, but a retreat from these proven practices comes at a cost to everyone – Americans included. There hasn’t been enough damage or time for these negative impacts to hit the U.S. consumer in the wallet. When they do, that fullness of time we talked about is likely to speed up.
Where do we go from here?
The logic and evidence outlined above strengthen our belief that the current policy trajectory causing turbulence in capital markets cannot last. It is only a matter of time before the economic realities set in and the American political system and public rail at the negative consequences.
The capital markets are already signalling their displeasure. It could be argued that the new administration is acting this quickly and haphazardly because it is aware of the limited time to embark on more chaotic actions. This path could be a deliberate choice aimed at shaking things up and scaring true adversaries and allies alike. Allies whose behaviour it wants to change, allies with whom it plans to negotiate, acting on the belief that this provides a position of strength at the bargaining table.
President Trump and his advisors are following through (maybe and sometimes briefly) on the more aggressive options to show they are serious. For months, capital markets and world capitals alike met their statements with a collective shrug – you can only cry wolf so many times. In fact, the relatively light reaction in capital markets may be empowering ever more bold actions. A 10% drawdown in the S&P 500 isn’t uncommon and can be quickly erased. If this is true, we may need to endure an even stronger negative signal from capital markets, coupled with political, judicial and public backlash, before we see sufficient change of heart to avoid further damage.
Things can get back on track
Absent the policy noise, the global economy and capital markets are poised for positive outcomes. The U.S. economy is expected to slow somewhat. This is a welcome development as the pace of growth has been unsustainably high, and inflation is not yet tamed.
A new U.S. administration brought the promise of lower taxes and lighter regulation. The world is in the throes of a capital spending boom on artificial intelligence and other technologies, coupled with the build-out of data centres and infrastructure to support this insatiable appetite for more technology. These are leading to – and expected to increasingly lead to – productivity gains, which is more fuel for strong capital markets. Elsewhere, especially in Canada, the powerful stimulus of lower interest rates was beginning to feed through and boost the economy. China’s ramping up of economic stimulus is another positive. All this fits with the strong stock markets of recent years; better growth and lower yields set a very positive backdrop. Clarity over U.S. trade policy can usher in the return of these animal spirits. In fact, they’re making valiant attempts to endure despite the uncertainty.
Our strategy – Balanced, still an equity bias, tilting more neutral
Our portfolios are well-balanced, and all our portfolios, including our all-equity and equity-focused portfolios, are well-diversified. We have kept our allocations to equities in check over the last two-and-a-half-year bull market run by regularly trimming stocks to buy bonds. In many portfolios, this happened as recently as mid-February.
Additionally, throughout the bull market, we rebalanced regional equity weights several times, again as recently as November and mid-February. Harvesting profits along the way ensured our U.S. equity exposure didn’t become outsized. This discipline of maintaining exposure to Canadian and particularly strong-performing international stocks served us well in Q1. Our active stock pickers continued to add value, too. Fixed income in balanced portfolios provided ballast. Given the uncertainty, we don’t currently have a mindset to be more aggressive in our asset allocations.
The last word – Keeping perspective
Thus far, we don’t see the recent capital market reaction as unusual or terribly alarming. Potential economic shocks don’t automatically mean extreme shocks to capital markets.
Remember that economic slowdowns are not unusual; they occur every few years. Economic growth slowed in 2012, 2015, and 2018-19. None of these slowdowns triggered a 25% drawdown for U.S. or Canadian stocks.
Growth scares can cause 10% to 15% drawdowns for stocks. The S&P 500, a market that was priced for perfection, has already witnessed a 10% correction and encouragingly has twice rebounded from that technically significant level.
We have seen this many times in the past 10 to15 years. Some parts of the U.S. market, particularly those areas that experienced the largest “Trump bump” at the end of 2024, were due for a cleansing.
As Margaret Atwood pointed out, we can’t change the current political conditions no matter how much we’d like to have that power. However, in a trying and unpredictable environment, response is everything. We don’t make trading decisions based on headlines. We assess and act – never overreact. In our experience, the wisest course is to navigate through, not around, volatility. While the circumstances are particular to this time and Trump moment, taking a big-picture view lends some perspective. We are well positioned to weather this whipsaw environment.
