On the Money Podcast with Myles Zyblock, January 24, 2025

PARTICIPANTS

Myles Zyblock
Chief Investment Strategist

Mark Brisley
Managing Director and Head of Dynamic Funds

Mark Brisley: Welcome to our year ahead edition of On the Money. I'm your host, Mark Brisley. To kick off our 2025 podcast series, we continue with our tradition of having Myles Zyblock, Chief Investment Strategist here at Dynamic Funds, join us for his perspectives on the year ahead with respect to global markets, global economies, and the influences on both.

You're listening to On the Money with Dynamic Funds, the podcast series that delivers access, insights, and perspective from some of the industry's most respected active managers and thought leaders. Myles' highly regarded and followed investment insights, one of the tools of finance and psychology in order to capture major inflection points in financial markets.

He provides top-down strategic investment ideas and inputs for our portfolio managers and analysts, and his investment views are shared broadly via his research reports and regular appearances on Canadian and US financial media programs, along with his social media profile on LinkedIn. Myles and I are framing our conversation today around an outlook for 2025, with consideration also being given to the developments that we saw unfold in 2024 across markets, economies, and of course, geopolitically.

As we move into the new year, a new layer of contemplation emerges with the arrival of the Trump 2.0 administration. Cautious optimism is already flowing around pro-growth policies, lower rates, and a regulation-light era commencing in the US, but that has also been backlit by uncertainty around tough talk trade policies and the impacts on US trading partners, along with the general unpredictability of Trump himself. The questions all seem so obvious. Is it time for caution or optimism, or both? Where will the opportunities be for investors? Myles, we never have a shortage of new things to unpack every January, and we're glad to have you back to do just that.

Myles Zyblock: It's a pleasure to be on the podcast with you once again.

Mark: It's been a very busy start to the year. Maybe let's start with you giving us a quick recap of 2024 and how global markets are looking for 2025.

Myles: In 2024, we saw positive economic growth across most countries, with the US leading the way among the developed world at 2.8%, while India led emerging markets with a 7% growth rate. Also, central bankers almost everywhere were on a mission to lower their interest rates. In fact, there were 148 more central bank interest rate cuts versus interest rate increases during the year.

Part of the reason for the lower interest rates was tied to the fact that global inflation continued to recede from its peak of close to 8%, which was reached back in late 2022, down towards 2.5% as the 2024 calendar year ended. Positive economic growth and lower interest rates set the stage for a pretty good year. Global equities led the way up about 18%, with the US market finding itself near the top of the ladder with a gain of 25%.

This was the second consecutive year when the US equity market gained at least 25%. Commodities were up too, led by an impressive 27% rally in the price of gold bullion. Bonds didn't do quite as well as these other assets, but corporate bonds performed better than their government bond counterparts. The economic environment as I see it, characterized by ongoing gains in the economy and a bit softer inflation, appears supportive for financial asset prices over the coming year.

Within what seems to be a benign base case macro scenario, there is likely to be some volatility in the economic data and financial markets as well, directly traced to the pending announcements and actions from the Trump administration. President Trump appears to be able to affect change in this second term of his, given that the Republicans have control of both chambers of Congress. His more important efforts probably include tariffs, which I'm sure we'll talk about, tax cuts, the tightening of immigration policy and deregulation. These are not all pointing in the same direction for either growth or inflation.

I surely don't expect the relative calm of the past year when, for example, the largest selloff in the US equity market was about 8.5%. Looking back in time, a typical sized maximum price drawdown in a calendar year is 13%, and that, like I said, is typical or average. I think policy uncertainty will contribute to a little bit of a bumpier price path this year, but one that's still upward sloping, I think, for many assets.

Mark: You mentioned tariffs, and yes, we are going to talk about it. What are some of the impacts you think this could have on us here with respect to the Canadian economy?

Myles: Last October while on the election campaign trail, Donald Trump said that he would impose a 25% tariff on goods imported from Canada if he won the US presidential election. His view was that Canada had failed to control the flow of drugs and illegal immigrants through its border and into the US and look, he wants to see this change. On inauguration day, just a couple of days ago, President Trump provided an update saying that these tariffs might be imposed, like you say, as early as February 1st under the, let's call it the simplest scenario. This will raise the American price and lower the demand for these imported products.

However, the actual impact is much more complicated since price and demand will be influenced by the interaction of many factors, including currency moves, diversion towards non-tariff countries, importer, wholesaler and retailer margins, and the prices and availability of US substitutes and complements. To say that it's easy to assess the economic impact of tariffs, I think is a mistake. Now, the Canadian government plans to retaliate if President Trump imposes the tariffs.

News sources suggest that the government's initial list of US imports subject to a tariff represents about $38 billion. This list might be expanded to represent $150 billion or more worth of goods if the Canadian government views that a more forceful move is deemed to be appropriate. Any negative economic effects are probably going to be more visible in Canada. Canadian exports about 20% of its GDP to America, whereas the US exports only about 1% of its GDP to Canada.

Investors seem to agree as it reflected by the significant weakness seen in the value of the Canadian dollar over the past several weeks. Keep in mind that markets tend to move well in advance of the economy, suggesting that there's been a lot of potentially bad news already in the price. I don't have any more details to share at this stage. However, the situation is fluid and I'm sure we'll learn much more in coming weeks about the scale and scope and the responses by countries such as Canada that have been targeted by these trade measures.

Mark: I wanted to move into bond markets and equity markets. I'll start on the bond side because, after a tough 5 to 10 years, bond investors seem to be seeing brighter prospects on the horizon now. Would like to get your insights and thoughts on the longer term outlook for bond markets.

Myles: Indeed, it's been a long cold winter for global bond investors. Over the past decade, the global bond benchmark has generated an annualized total return of 0.2% and -2% over, say, the past five years. It would have been worse for the benchmark over the full period had it not been for the 110 basis points of annualized out performance produced by the corporate bond market.

In the early part of the last decade or last 10 years, global bonds frequently offered yields to maturity of less than 2% and at times those yields were found sitting below 1%. For a good part of the past decade, more than $15 trillion and as high as $18.4 trillion of global bonds were trading with a negative yield to maturity. That effectively represented high odds of a loss for those investors willing to hold the negative yielding bonds to maturity.

Many bonds became these high octane vehicles trading on price rather than being bought as an investment for income. There wasn't any income. One of the most reliable predictors of the future return for a bond is its current yield to maturity. For example, the current yield to maturity for the 10-year US Treasury bond is about 4.6% today. This tells us that the annualized return over the life of that bond will be somewhere very close to 4.6%.

Now, it's not a perfect one-for-one correspondence between the current yield to maturity and future returns. Reinvestment risk from the received coupon payments is present for the bondholder over the life of the bond. Let's just say, though, that the relationship I just described has been a reliable heuristic to gauge future returns over time. That said, longer-term nominal bond returns look better than at almost any time relative to the past several years. As I said, the 10-year Treasury yield is now standing near 4.6%, and this represents a yield near the top end of its 15-year historic range.

The same can be said about the yields offered across the global bond market. It's been actually a little more than a year since any global bond has been pinned with a negative yield to maturity, and I think that's good news. All of this is good news for a patient bond investor. The share of the total return for a bond that's related to its coupon is likely to increase in future years. Higher coupons, I think, will also help to dampen the volatility of bond prices.

In other words, behavior of bond investors might shift from that trading orientation when yields were near 0% and price was the primary way of generating return to one defined by longer investment horizons. Hopefully, bonds will become a little more boring once again, much like what I remember in the earlier part of my career in the investment business.

Mark: We've seen the delivery of two years of 20% plus growth throughout the US equity market, driven largely by tech mega caps, as everyone probably is aware, but what are the chances we're going to see a three-peat of similar results in 2025?

Myles: I think there's a pretty good chance that equities will appreciate over the coming year. Central banks are likely to continue to reduce interest rates, maybe not quite as briskly as they had done last year, but a little bit lower, and global corporate earnings growth might hit 10%. Earnings growth might be even a bit better than this for the US, and especially so if the proposed Trump tax cuts take effect, and here we might see the corporate tax rate move down to 15% from 21% currently.

History suggests that positive corporate earnings growth supported by central bank interest rate cuts is usually a pretty good environment for equity market performance. Now, don't take this as a literal forecast, but we've seen equities appreciate on average by 14% annualized over periods dating back to 1948 that were characterized by higher earnings and lower interest rates.

One concern we have is valuation risk. US equity valuations are stretched, at least historically speaking, at a price-to-earnings multiple of 22 times. The S&P 500 is not only sitting at the upper end of its historical range, but it does look richly priced relative to other major markets, like Europe, where the PE is 13.5, and in Japan, the price-earnings multiple is 15.5. Most of the valuation challenges faced by the US market are due to the extended valuations of the largest of the large companies of the US equity market. Let's call them the big 10. Some people like to focus on the mag seven.

Valuation risk, I think, can be reduced by finding opportunity in the, let's call it the S&P 490, in smaller companies, in mid-caps, or in international stocks. In international stocks, like I said earlier, they do seem inexpensive. Some regional markets might be cheap for a reason. China, it's facing some important structural economic challenges, like overcapacity and population decline linked to its one-child policy, which ran from 1980 to 2016. Even so, my portfolio management colleagues are finding plenty of international investment opportunities. Focusing on the companies that deliver reliable cashflow represents just one such opportunity.

Mark: Given everything that you've talked about then so far, for our investors that are listening to this podcast, what should they be thinking about with respect to portfolio positioning in this particular climate for 2025 and beyond?

Myles: I hopefully have a very simple answer. Portfolio diversification. It's one of the best and most reliable ways for an investor to generate rewarding long-term returns subject to manageable risks. Diversification within and across asset classes not only provides a layer of protection against unforeseen changes in economic or financial conditions, but raises the odds that the investor owns a horse which wins the race.

The upcoming year won't be too different from any prior year in that there will be numerous surprises, some good and some not so good. It's better to be prepared rather than surprised, and a portfolio that is amply diversified places an investor in the ready position. With that in mind, this is the allocation that we're entering the new year with. Equities, we're at a neutral allocation. Optimism towards US mega cap stocks is running high, but a broadening earnings recovery points to, I think, broadening investment opportunity.

Japan is one of the major markets favored outside of the US. For fixed income, again, we're sitting pretty close to neutral. Bond yields at the high end of their 15-year range point to above average return potential for patient investors. Currently, there's no need. You don't even have to take excessive risk to generate an attractive return profile. We do favor investment grade segments of the fixed income universe.

Alternatives, we're marginally overweight here, and that's been adopted to provide some additional ballast to the portfolio given the volatility that might be generated on the back of strong pronouncements emanating from the Trump administration. Gold is a favored real asset, a real alternative asset. Any other asset class is diversification across different types of alternative assets and strategies is important. Finally, cash, hey, we're underweight. Risk-free, ultra short-term yield, let's call them, cash equivalent will probably continue to drift lower alongside central bank interest rate cuts. Underweight, a cash position.

Mark: Myles, we appreciate this snapshot, and no doubt we'll need to get together again to talk about things as they unfold, probably toward the middle part of this year.

Myles: Thank you, Mark. Thanks again for having me on.

Mark: Thanks to all of you for joining us today. You've been listening to another edition of On the Money with Dynamic Funds.

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