Three-quarters of the way into 2025, and the Canadian and U.S. markets are in a significantly different – yet arguably better – place than where many people expected them to be at the start of the year.
The S&P/TSX is in record territory, the S&P 500 continues its steady march higher (aside from a jarring hiccup in April), and, despite a great deal of economic uncertainty, recession fears have subsided. Those were just a few of the topics covered at the recent Market & Economic Outlook in Montreal, moderated by Mark Bayko, Head of North American Equities, BMO Private Wealth.
During the session, Brian Belski, Chief Investment Strategist for BMO Capital Markets, made the case for why Canada is a “fantastic buying opportunity.” At the same time, Robert Kavcic, BMO Capital Markets’ Director and Senior Economist, explained why he’s optimistic about 2026 and beyond.
Stuck with uncertainty
Despite the strong equity markets, conversations with businesses and survey data from the Bank of Canada (BoC) and the U.S. Federal Reserve reveal that uncertainty remains the economy’s biggest headwind. While neither country may be headed toward a recession, the unpredictability is preventing the two economies from reaching their full potential, explained Kavcic.
“A lot of firms are saying, ‘we don’t know what the rules of the game are going to be six or 12 months from now, why should we go out and hire? Why should we go out and deploy a lot of capital?’” he said. “We’re stuck in this below potential run rate for the economy.”
Although business investment may be scuffling somewhat in these conditions, Kavcic wants people to remember that uncertainty doesn’t necessarily mean there will be a negative outcome.
Heading into the new year, Kavcic expects the Canada-U.S.-Mexico Agreement (CUSMA) will be deep into negotiations. While it’s impossible to predict what the terms of that deal might look like, he remains optimistic that the countries will reach an agreement.
While he expects Canada will make some concessions, just having more certainty over trade policy will create a better outlook for 2026 and beyond, he says.
For Belski, the markets are already looking forward to conditions improving next year. “Stocks lead earnings, which lead the economy,” he said. It’s one of the reasons why BMO is sticking with the call it made in May 2024, that Canada is entering a multi-year period of outperforming the U.S.
“Canada, if we continue on this path, will be at the greatest net positive outperformance relative to the U.S. and current currency since 1990,” said Belski. “We think Canada continues to be quite bullish from a fundamental perspective with respect to valuation, earnings, operating performance and how the companies are performing.”
Shifting political environment
One of the other big takeaways for Kavcic is that the current Liberal government is not following the same economic playbook as the last one. Ottawa is likely to announce budget deficits of around $70 billion to $80 billion, but it will be due to tax relief, infrastructure spending and stimulus rather than social spending, he explained.
“We’re pretty optimistic on that front,” he said. “We’re getting a pro-growth policy shift in Canada.”
Canada is still performing below its potential, says Kavcic, but the country is not looking at a recession. Instead, BMO’s forecast calls for growth of around 1.2% or 1.3%. Against that backdrop, the BoC should continue cutting rates, slashing 50 basis points to 2% by Spring.
In the U.S., significant expansion of AI and the capital spending boom should result in around 2% growth and just under that mark next year. While inflation remains slightly elevated, ranging between 3% and 3.5%, Kavcic says that with the employment rate slowing, the Fed will likely continue cutting rates through the end of this year and into 2026. BMO’s current forecast is for the Fed rate to ease by 125 basis points to 3% by the end of 2026.
Watching valuations
If you’ve ever heard Belski speak, you know he’s all about buying stocks based on fundamentals. Against that backdrop, an audience member asked whether he was concerned that the rising U.S. tech stock valuations could be a sign of a bubble.
While Belski says he has been underweight the Magnificent Seven – Apple, Microsoft, Amazon, Alphabet, Meta, Tesla and Nvidia – he continues to see opportunities in this space.
“It’s a bubble when everyone’s making money,” he said, pointing out how, during the dot-com craze in 1999 and 2000, companies were buying each other for stock that had no value. But that doesn’t describe the market today, he said, noting that there is no major consolidation, secondary deals, or overexuberant initial public offerings.
“We are actually in the third inning of AI,” he said. The companies today have very different business models, and they have earnings, he explained. Even within the tech industry, companies are highly differentiated.
Small caps
Another audience member inquired whether falling interest rates would benefit small-cap stocks. “Small caps are my favorite child,” said Belski, noting that these companies are at a scarce level and that they usually get bought up. “There’s so many amazing little industrial and consumer companies in Canada that really define, in our view, the Canadian stock market.”
Additionally, he noted that valuations are at all-time lows, relative to large-cap companies. “I believe 10 years from now,” he said, “we’re going to be kicking ourselves that we don’t own enough small and mid-caps because of the fundamental condition of these companies.”
