Looking Back and Looking Forward
If you had spent the last three months on a desert island and returned at the end of Q2, you would have thought nothing much had happened since you left. In fact, nothing could be further from the truth, as markets were extremely volatile in Q2. After a precipitous fall in April post the “Liberation Day” tariff announcement, markets staged a V-shaped recovery, largely on the walk-back or scale-back of most tariffs, and particularly those between China and the United States. Further fuelling the rally back was passage of Trump’s “big, beautiful bill” into law last week. All that said, hold on to your seats, as non-stop headlines in recent days make it clear this volatility is likely not over.
In a matter of a few days, we’ve had non-stop trade headlines coming out of the White House. On July 4, Trump stated that tariff letters would soon be sent to about a dozen countries, telling those countries their new tariff rate (which he said could range from 10-70% – even higher than April 2 tariff levels). Over the weekend, Trump and his spokespeople moved the goalposts again, suggesting the July 9 end to the 90-day tariff pause was being kicked down the road to Aug 1, and that on Aug 1 tariff rates could revert back to the April 2 levels if trading partners became “recalcitrant”. Also on the weekend, Trump threatened an additional 10% tariff on “any country aligning themselves with the anti-American policies of BRICs [countries]”. And just today, as this piece was being written, Trump announced 25% tariffs on Japan and South Korea, scheduled to start on Aug 1. Needless to say, the sudden, often conflicting, and seemingly incoherent U.S. trade policy announcements that keep hitting newswires add to the uncertainty that currently grips market participants.
With equity markets at or near highs, one clear warning sign to us is the narrowness of the recent market recovery. Yes, fiscal stimulus is coming via the big, beautiful bill. Yes, monetary stimulus is likely coming as anticipation builds that Trump will nominate a more dovish Fed chair in coming months. However, if fiscal and monetary stimulus are truly driving markets higher, then why are we seeing weak market breadth? The market has been led higher by a handful of Mag7 names and small cohort of momentum-driven names, while the average stock in the S&P 500 has simply not kept up.
In Canada, equity markets have been quite resilient, but remember that the Canadian equity market is not especially representative of the underlying Canadian economy. On the next monthly print, a 7% Canadian unemployment rate is not out of the question, and with recent Canadian inflation measures heating up, the Bank of Canada is likely to stand pat on rates until more data come in to inform their policy response.
While investors globally seem unphased by the major risks abound, we are not. We remain particularly concerned about U.S. deficits (now at 6% of GDP) and the U.S. federal debt (which just hit $37 trillion). We wouldn’t be surprised by a material rise in U.S. (and global) long-bond yields in response to the massive debt issuance that is forthcoming and/or to a politicized U.S. Federal Reserve that could make stable prices (i.e. controlling inflation) a less important consideration in future policy decisions. Rising yields, of course, could put significant pressure on the economy and risk assets.
Our Core Model Portfolios
In our core income-focused model, we further diversified our dividend-growth exposure with the addition of four new Canadian equities in the quarter. In our core capital growth models, we continued to be overweight Canadian equities and continued to hold significant equity exposure in non-U.S. markets, both of which have helped offset an underperforming U.S. stock market. Notwithstanding the Mag7, we think we could be in the early innings of a broader rotation away from U.S and toward non-U.S. assets broadly (and equities specifically).
Very early in Q2, we did reduce the equity allocation in our core capital growth models and redeployed proceeds to investment-grade short-duration bonds as well as precious metals – the latter in anticipation of heightened geopolitical and trade uncertainty and our expectation that U.S. dollar weakening would persist. The U.S. dollar was down ~11% in H1 – the biggest first-half drop since the era of free-floating currencies began in the early 1970’s. This is very noteworthy, in our opinion.
As we look ahead, we anticipate conditions will remain exciting yet challenging in global capital markets, and we embrace the opportunity to navigate such markets on behalf of our clients.