Several Crosscurrents!
“Bulls markets are born on pessimism, grow on scepticism, mature on optimism and die of euphoria” – Sir John Templeton
After a stellar 2024, investors displayed some caution during the month of December, largely driven by the hawkish tone by the United States Federal Reserve during its meeting on December 18th, 2024. The committee delivered a 25 basis points cut, in line with market expectations, however it has dialed back on the expectations of policy easing during 2025. The Fed dots plot that shows the leaning of committee participants on a potential rate trajectory indicated that median policy rate in the United States, as at the end of 2025, is now projected to be 3.875%, up from 3.375% as projected in meeting during September (See Figure 1 and 2). In other words, the rate cut expectations were dialed back from four cuts to only two cuts during 2025. The fixed income asset class witnessed further losses as bond yields jumped higher on a more hawkish than anticipated tone of the Federal Reserve.
Figure 1: Federal Open Market Committee Dots Plot
18th December 2024
Source: Bloomberg
Figure 2: Fed Dots Median
Source: Bloomberg
On this side of the border, the Bank of Canada delivered another jumbo cut of 50 basis points on 11 December and brought the policy rates to 3.25%. Increasing unemployment put together with benign inflation readings had placed the Bank of Canada in a comfortable position to ease monetary policy. The resilience of the United States economy, even in the face of high interest rates, backs the caution in the tone of the United States Federal Reserve on forward trajectory of policy rates. On the other hand, back-to-back jumbo rate cuts by the Bank of Canada were underpinned by the anemic growth in the Canadian economy. While Bank of Canada guided for a more measured approach to rate cuts going forward, the concern around the uncertainty caused by threat of 25% tariffs on good exported from Canada to the United States was palpable.
We think the heightened caution resulted in the absence of a typical ‘Santa Claus rally’ during 2024. The Santa Claus rally refers to a seasonal advance in the North American markets during the sparsely traded last weeks of the year. Nevertheless, we think the silver lining of recent price action and market commentary is that the market sentiment can no longer be classified as euphoric, i.e., if one were to heed to the wise words of “Sir John Templeton”, the case of bull markets being over is not strong yet. We think the that markets in 2025 are set up to face several crosscurrents and investors are taking a notice. We note a few of the most importance as below
The rising bond yields even in face of the lower interest rates implies bonds markets’ concerns on potential resurgence of inflation continue to linger, therefore, Central Banks can not put this issue to bed yet.
The potential for increase in geopolitical tensions is high given the recent posturing of the incoming Trump administration on political issues around the globe.
Trade and tariffs are going to be the weapon of choice for aggression and retaliation, which bring direct but idiosyncratic risks to the capital markets.
The risk of a recession remains low; and policy rate trajectory continues to be favorable, though at a slower pace.
Lower regulations and business friendly policies from the new administration in the United States are likely to support markets.
As per Bloomberg data, the index level headline earnings growth expectations for the S&P 500 Index and S&P TSX Index are in the range in low-to-mid double digits. As long as the expected earnings growth remains robust, the case for constructive outlook on markets remains strong, in our opinion.
Overall, we think the ebb and flow of developments around the above topics will determine the direction of the markets. Layering on high valuation and healthy corporate profits, we think a choppy but still a net positive price action could be the theme for North American markets this year.
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