What is your outlook on the global economy?
The outlook for global growth is really shifting as we head into 2025. You know, 2023, 2024 was all about bringing down the shock of inflation and getting towards, 2%, 2.5% growth rate, something like 2%, 2.5% inflation. That's largely been accomplished as a result of that. That big headwind that had been rising short term interest rates, slowing domestic growth and money supply that seems to be behind.

About six months ago, central banks turned the corner. As inflation was settling towards a more acceptable level, rate cuts started. United States is now fully involved in that, and that becomes a bit of a tailwind. The maximum risk of recession has now passed. At one point, it was at about a 75% chance of recession. We move that all the way down to 25%. There’s always a risk of shocks, of course, within the economy.

But, the amount of interest rate relief we've seen, should be enough to stabilize growth. It’s looking for something like 2.5% growth. U.S. exceptionally is still an issue leading the rest of the world, Canada slightly below, Europe below that still. But no recession in 2025 and likely into 2026.

What are the primary threats to economic growth?
The path for inflation has been towards lower levels month by month, pretty much everywhere in the world. That's clearly still a very big risk. The surprise that we saw in 2022 and 2023 coming out of the pandemic, has really damaged credibility of central banks. They’ve worked hard to bring that back. We want to see that path down towards 2%, 2.5% continue into 2025 and beyond.

Of course, geopolitical tensions really picked up in the post-pandemic world, and the instability in the Middle East is still a big factor and a polarizing factor for the world. And more broadly, many of the benefits of the end of the Cold War slipping away, and that will have costs and concerns for investors.

And then, of course, domestically, the second Trump administration is deliberately a disruptive force, and that has implications. We don't know of what size they'll be, some of it is rhetoric, some of it is dealmaking, but it will be a different world that we're heading into in 2025 with Donald Trump as president. You know, the immigration file, trade file are clearly front and center, we'll see how far those go.

They have the chance of being having an impact on productivity, on inflation and hopefully inflation being a very short-term phenomena, and hopefully that the degree is the instability that people fear, will be lower than expected. But these are all factors that we're going to have to face as investors heading into the next 12 months.

How are central banks responding to the current economic environment?
Central banks about six months ago flip from, sole focus on inflation and bringing it down quickly, to accommodating growth going forward. With inflation slowing, without going into a recession, a soft landing appears to have happened. The economy doesn't seem to need that blunt force of higher interest rates, and so around the world we're seeing those rates come down.

Now having said that, there are enough forces that would continue to fan inflation that traders have moderated their view as to how the pace and how far down rates can fall over the year ahead. To give you an example of that in a futures market, 3-4 months ago, the expectation was that one year out short-term interest rates, the United States fed funds rate would be 2.75%.

Now, with the new administration, global instability, a variety of factors like trade, policy, immigration, etc., that outlook is no longer at 2.75%, it's 3.75%. Having said that, higher short rates don't appear to be enough to stop the economy in its tracks. We should continue to have reasonable growth around the world and inflation continuing to move towards target.

What is you outlook for fixed income?
2022 and 2023 were all about moving interest rates up to reflect two things. One, that inflation was much higher than was expected, and two, investors leaving the pandemic needed to earn a positive real interest rate. You know, during the pandemic, those real rates or after inflation rates of interest have moved to be deeply negative, and that's not sustainable in a growing world.

Investors have to be paid for saving rather than spending. So there's two really blunt forces moving against the bond market. At one point in the fall of 2023, interest rates briefly move through 5%, if we look at the U.S. bond is the reference point. But that proved to be non-sustainable for two reasons. Fears of inflation continuing to spiral upwards were unfounded, inflation came under control.

Secondly, the yield on the real interest rate on the T bond had already started moving up. That touched off a rally in bonds, taking you from 5% all the way to 3.75% by the spring of 2024. Now, at that level, there was a lot of good news buried in and of course, backed up towards the 4.5% later in the summer of 2024.

And since that time, we've kind of moved in that range 3.75% to 4.5%. Those parameters seem reasonable to us when we look at our valuation equations. If we stay in that range and we think you will over the year ahead, you're getting a proper real rate of interest. Call it 1%, 1.5%. It accommodates expected inflation.

And that's really the equilibrium value for a bond yield. In that range, you'll earn something like your coupon maybe a little more. That coupon rate now is about 4.4%. UST bonds might return slightly better than other bonds in the world, but you know, mildly positive towards bonds into 2025.

What is your outlook for equities?
Well, certainly 2024 turned out to be a fabulous year and a much better year for equities than almost any forecast, including ourselves, had expected. Having said that, much of the action has been dominated by the very largest part of the U.S. stock market and that part of the stock market, Mega-cap, which is a good exposure to the interested in artificial intelligence.

As a result of that, we see two stories. If you look at the U.S. stock market, it's very expensive. If you look at the global stock market, the Canadian stock market is quite attractively valued. Just drill right into the U.S. stock market, turns out that outside of that mega cap market, valuations there are quite attractive as well.

The sense of this being a very expensive and old bull market is really skewed by what's happened in that small group of what we call the Magnificent 7. Now the bull market can continue on this basis, although it has very high hurdles for driving it forward. The consensus right now is that we are in something like a 14% earnings growth in 2025 and maybe 12% in 2026.

You put a fairly full multiple, a high multiple on that, and you'll get single digit gains in the stock market. If you don't produce those levels of earnings, then you probably tumble into a weaker stock market, maybe even a bear market, because expectations just can't support the level of valuation. Of course, there's another pathway as well. And I think a much more attractive pathway that would essentially reload the bull market, and that would be that earnings growth finally picks up outside of those AI influenced stocks.

You know the mid-cap and the small cap market in the United States, stocks in Canada, companies in Europe and elsewhere really haven't shown much earnings growth as the Magnificent 7 has dominated performance. Kind of explains why all the focus has been on that small group of stocks.

With the economy recovering, there’s a real chance here now that we could broaden out the base of growth of earnings and that you could migrate market leadership into these much more attractively valued sectors in the United States and markets outside of the United States. That I think is the best pathway to a refreshed bull market in 2025, 2026. It also shows the great risk if earnings stall or they only remain positive in the Magnificent 7.

How are you positioning your asset mix in this environment?
Well, in fixed income, we've been much more tactical than we have been in the past. The market's been quite volatile. It's provided us with plenty of opportunities to take advantage of depressed prices and let some bonds go as those prices become more full. As stocks, we've been quite concerned about the small equity risk premium. That's the additional reward you get in terms of return, to take the risk of losing out to equities and leaving the fixed income market, or even cash.

We can see how this bull market could be sustained. However, the proof points for that bull market are rather high. In this kind of an environment where we expect to earn your coupon and fixed income, slightly above that mid-single digit, perhaps a little higher in equities, it's hard to create a compelling case for loading on one asset class versus the other.

As a result, we stuck quite close to our own long term neutral settings on asset mix, and we'd recommend that clients run minimal cash but not load much based on that neutral or away from that neutral position, whatever that neutral position is for them in both bonds and stocks.