On the Money with Dynamic Funds

PARTICIPANTS

Mark Brisley
Managing Director & Head of Dynamic Funds

Jean-François Perrault
Chief Economist at Scotiabank

Mark Brisley: Welcome to this special edition of On the Money. I'm your host, Mark Brisley. I think it's fair to say that elections in most major democracies tend to create a degree of uncertainty for investors. With the outcome of the recent U.S. election rippling through financial markets, coupled with the results that we may just be describing as a red sweep for the Republicans, we've been watching closely as markets are reacting positively to a more aggressive policy agenda in the areas such as tax cuts, tariffs and deregulation, which on one hand may drive domestic economic growth, but as many have discussed, may also increase inflation and deficit concerns.

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.

With the stock market rallying to fresh records post-November 6^th, it's clear that investors are betting that the new administration's vow to cut taxes and loosen regulation will stimulate dealmaking, create growth in the economy, and support risk assets. However, there are many questions unanswered about how a second Trump administration will improve on what many economists call solid growth trends already in flight, as well as the ability to lower or maintain tax rates and how it will affect global supply chains with the looming potential for increased tariffs on imports to the U.S. and potentially stunted export impacts.

From a Canadian perspective, as the U.S.'s closest neighbor and largest trading partner, what are the potential impacts on our economy and our growth prospects? Where does that leave us as both investors and consumers? To help us unpack all this and more, I'm pleased to be joined by Jean-François Perrault, senior vice president and chief economist at Scotiabank. JF, thank you very much for being here.

Jean-François Perrault: Thanks, Mark.

Mark: I wanted to get your views on a more macro view of the economy, the effects of what has transpired since November 6th and how it's going to drive markets. We've been talking about short-term rate cuts, inflation impacts. Great to get your view of all of what's transpired.

Jean-François: Unfortunately, one of the consequences of the U.S. election result is it's injected a fair amount of uncertainty as to the way forward on things. To give that uncertainty some perspective, I think it's best to try to get a sense of where things were going absent the U.S. economy, because I think we were at a pretty interesting time from a market perspective and, in fact, a historical perspective. As you very well know, over the last number of years, central banks have been raising interest rates to slow inflation down. We had an inflation problem coming out of the pandemic.

It was difficult for central banks to get inflation under control. That seems to be where we stood, say, earlier this year, in that inflation had progressed significantly in many countries, including Canada and the U.S. That allowed central banks to start cutting interest rates in Canada more aggressively than the U.S., obviously. It led to what we consider to be a globally coordinated or synchronous easing in monetary conditions around the world. That is a very good thing from a growth perspective. Obviously, there are consequences of higher interest rates, slower growth at the moment, which is a necessary condition for inflation control in some extent.

That global easing in monetary conditions coming with lower inflation sets the stage for a pretty positive investment environment over the next few years. That's where we were and are at a very high level, this early stage of a hopefully prolonged return of economic activity, because, of course, central banks are cutting rates and they're very explicit. In Canada's case, they're cutting rates because they want to see stronger growth. Now, to your point, obviously, corporate tax cuts, as President Trump or soon to be President Trump has promised them, will boost profitability.

There's no question about that. Deregulation almost certainly will increase profitability in certain sectors of the economy where that occurs. Those are shorter-term considerations, definitely growth positive when they occur. The question is more, what are the inflation prospects going beyond, say, the short run? What if President Trump undertakes care of policies as he suggested that he would? What if he approaches immigration very differently than the previous administration or the Biden administration? Do those policies have the potential to create inflationary pressures?

Do they have the potential to derail the rate cuts that we see as being pretty important to sustaining the early stages of the recovery that we're in? Is there reason to rethink a little bit this thesis that we are still in the early stages of, hopefully, a reasonably long expansion in economic activity? Or do you have to rethink that a little bit? Do you look beyond, say, the sugar high of what might happen in the short run in the U.S. and counterbalance that with the potential for somewhat disruptive trade and immigration actions that might undermine that thesis?

Mark: Just thinking about the relationship between the U.S. and Canada specifically, how might changes in the U.S. trade policy with a Trump administration actually have an impact on Canada? Specifically, I think about our exporters, our competitiveness in the North American market. What are some of the impacts we need to be thinking about?

Jean-François:Maybe a point of departure here is to think of, if you will, the institutional background to the U.S.-Canada trading relationship. Go back to the first Trump election when he campaigned on essentially arguing that NAFTA at the time was the worst trade deal in the history of trade deals. We negotiated a new trade deal with the Americans along with the Mexicans, which Trump then characterized as the best trade deal in the history of the world. Those are almost verbatim his words.

We can be hopeful that as he assumes a presidency in January, that he's got a little bit of that in his memory, that he renegotiated his deal in a way that he thought benefited the Americans, but that provided a certain amount of certainty to the trading relationship. Set that against what he's been talking about in the campaign, which is he wants to tariff everything going in the United States without making a distinction between Canada or other parts of the world, countries that have a trade deal or not with the Americans. Of course, that is a little bit troubling.

Our starting point is Canada has a bit of an advantage relative to other countries, because we've got this Trump stamp of approval, if you will, on trade deal that currently manages our relations. We know that there's still some litigious points from Trump's perspective on the trading relationship. He put tariffs on steel for a little while. He was upset subsequent to the USMCA or CUSMA being signed. He talked about this once in a while on the campaign trail, not very often. American access to the Canadian dairy market. We'll see how those evolve.

We're hopeful that we get a little bit of a pass on his trade actions because of the fact that this is basically his trade deal that's governing our relations. If we don't get that, then obviously you're talking about sectoral impacts. If the idea behind Trump is, and there's a thought that folks around him will say this, that he's really only using tariff policy or a threat of tariff policy to extract concessions out of countries. He's not serious about putting tariffs on everything.

We'll see if that's true or not. If you think about that in the Canadian context, so what are those areas where he might want to extract concessions? We know softwood lumber is a perennial challenge between both countries. We know dairy access is one of those issues. He's had issues with steel and aluminum in the past. Now when he thinks about tariffs himself, he seems to think about them very much so in the context of the auto industry.

His focus has been on China and Mexico, hasn't been them on us, but it's not inconceivable that as part of his thoughts on the tariff side, that he's got a little bit of a bean in his bonnet about even Canadian auto manufacturing. There will be, if he chooses to go down the tariff path, some industries that are more a focus of attention than others. Where those are at this point in time, what they might be, it's pure conjecture. What I've just laid out are some reasonable ones, but he could think about something else entirely.

Mark: From your perspective, if he does go down the road of what he said he would do with tariffs, the impacts, from my perspective, they're not necessarily immediate, are they? This is why the inflationary pressures are a concern.

Jean-François:I guess the fundamental challenge I see with his perspective on tariffs is I don't really think he understands how they work very well. That could be for political reasons, he may know better. The reality of tariffs is that you are raising the cost of producing things. when you think about, say, a multinational operating in the U.S. who is relying on trading relationships, trading agreements between various countries to say, I'm going to purchase this good out of this country, I know what the tariff regimes are, so I have some degree of certainty over the cost structure of the things that I'm trying to produce.

If you start throwing around tariffs willy-nilly on these things, you're increasing the cost of production, obviously, which ultimately will get passed on to people, but you're also screwing up supply chains. Businesses have to rethink some elements of their supply chains, which, of course, is what Trump wants. Much of the production is repatriated into the United States, and that disturbs business plans. Tariffs are what we call a negative supply shock. Creates uncertainty. Am I going to have a tariff on my goods or not? Should I raise inventory now in anticipation of tariffs to come?

What if they don't come? You reduce growth in the short run or maybe permanently and you raise inflation. Usually, inflation and growth go in the same way. It's a particular challenge. Tariffs historically have been used to address unfair market practices and those kinds of things, and they're fine to use in those contexts. That's not the kind of application Trump has been talking about now.

Which is putting a wall around the U.S., making sure that imports going into the U.S. are much more expensive than they are now, effectively raising either the cost of imports into the U.S., or if you're repatriating production at some point in that production is probably going to be more expensive than what you were importing anyways. Unquestionably, a higher cost environment. The only question is, do they do tariffs? How much, and when?

Mark: I guess the question that's interesting for us in Canada is how might potential changes in U.S. immigration policy actually impact our labor market, if at all? Again, to your point of if he goes as far as he said he would. I think it's really hard for us as Canadians to even understand the immigration issues they have in the U.S. Your perspectives on that would be interesting.

Jean-François:This is arguably one of his more popular platform elements and arguably one of the most damaging. There are millions and millions of illegal aliens in the U.S. A lot of these people have been in the U.S. for a very long time. A lot of these people have children who they were born in the U.S. The campaign proposal was round all these illegal aliens up and put them in camps for a while and then ship them out. The reality is probably the very significant majority of illegal aliens that are in the U.S. now are working. Because of the numbers you're talking about, whatever, 10 million, 12 million, 15 million, that is something 3%, 4%, 5%, 6% of the U.S. workforce.

They're not supposed to be working because they're illegal aliens, but they are working. It's a very disruptive policy if you go out and you round these people up, pull them out of businesses from one day to the next. It's not going to be an orderly process. You're not going to know as a business owner that I've got nine workers tomorrow who are all of a sudden going to be detained. The process would lead to very significant disruptions on the business side, has a first order impact, so lower growth in the U.S., unquestionably. In addition to that, of course, you expect businesses to replace those workers.

Maybe some of those workers are replaced by technology, so it's productivity enhancing, could be. You're almost certainly going to replace those workers with other workers, especially in fields like agriculture where roughly 15% of the workforce is illegal in nature. Then you're talking about replacing people who are cheaper than legal residents in the United States. It raises potentially very significantly the cost of labor if you're replacing illegal aliens with permanent residents. There's a significant inflationary impact on top of the disruptive impact for businesses.

From a Canadian perspective, obviously, if the American economy is much weaker, our economy is much weaker. It's not just the deportation story, it's indicated that he wants to have a much tougher immigration policy more generally. Not just with people who shouldn't be there, but even if people want to come to the countries or create an environment that is not welcoming to immigration.

The first time around, we benefited from that. Like it or not, the U.S. is the largest advanced labor market in the world. It is where people are drawn to, the land of opportunity, the American dream that applies not just to Americans, but people that want to move to the U.S. If the Americans take themselves out of the global talent market, that opens up space for other countries like ours. It might be easier for Canadian firms to attract high-skilled workers, high-skilled immigrants relative to a world where the Americans are actively in that market.

Mark: Also from a Canadian perspective on the outcome of this election, obviously in Canada, we're very focused on the energy sector. There's been a lot of discussion around renewables, implications of the shifts in energy policy in the U.S. could have on Canadian energy companies, cross-border renewable initiatives. On one hand, there's some positives around, could that be a boon for our pipeline projects? What do you think some of the impacts would be on this particular sector for Canada? Maybe you could also dispel some of the myths that were out there about, the "drill, baby drill" comments that we heard throughout the election.

Jean-François:Trump has been clear. He wants to drill, baby drill. He wants to increase U.S. oil and gas production very significantly, although U.S. oil and gas production is currently a record level. There has been a significant increase already. Part of the drive behind that appears to be some questioning about the need to decarbonize, this belief that climate change isn't necessarily all that serious, not necessarily something governments should be very active in managing. First you get a re-evaluation of the green space. Could government support as much as they used to?

Are EVs going to be as subsidized as much as they used to? Do you have to rethink the EV space? Do you have to rethink all the critical minerals that go into that stuff? Coming back down to the, well, we don't need so much green stuff. What that means, we'll see. He'll probably deregulate, make it a little bit easier to drill in the current case, maybe open up some public lands a little bit more. It's definitely a more welcoming environment for investment in that space. There's no question. That's true in the U.S., presumably true in Canada as well.

Not just a pipeline issue but encouraging more oil and gas exploration on our end because there will be more demand down south for these things because, of course, one of the consequences of the Americans maybe moving off the decarbonization path is they're going to need more oil and gas to have an energy source. Maybe the counterpoint to that is, when President Trump has been asked on the campaign trail, what is your plan to reduce inflation? What is your plan to make life more affordable for Americans? Almost always his answer is, I'm going to get lower oil prices. There is an economics issue that comes into play at some point.

Mark: One knock that Canada did get during this administration's first term was around its defense spending and its contributions to things like NATO. Do you see potential adjustments, in defense spending and resource allocation in that particular area as a result of this administration coming into power? Because that would ultimately have probably an outcome on taxes. What are your thoughts in that particular subject?

Jean-François:That seemed to be the path that we were on irrespective, whether that was Trump-related pressure or just peer pressure. There's a real question as to how achievable that is in Canada. There is this reasonable expectation as well that as you think about Trump pressure on NATO and other countries to do their share, although many countries are doing their share, that you get a significant increase in global defense spending, which of course would benefit that industry quite nicely if the Americans don't pull back themselves, which is a possibility.

There is a real question, as you indicated, can we afford to do 2% of GDP? How practical is that? How does that mesh with intentions to balance the budget over a period of time, with intention to lower taxes? How does that stuff all work together? It's not clear. To some extent, they're mutually exclusive. You can raise defense spending, cut taxes, maybe you can do both if you find a lot of other savings elsewhere in government or if you run a deficit for a longer period of time relative to maybe the plan that you've got in mind of balancing the budget over however many years.

Mark: Over history, the importance of the diplomatic relations between the U.S. and Canada, a lot of bilateral cooperation on trade and security. Are those two things put together when you think about what the future holds?

Jean-François:I hope so. Canada and the U.S. are probably the closest countries in the world in terms of economic integration and cultural, affinities. I don't expect that's going to change very much under Trump or under the conservatives. There might be more tension, more uncertainty, because that's the nature of the game. Sure, we've been a free rider on the defense side for a while.

That's been true for decades. Maybe that changes a little bit. I'm not worried that as a result of this election that we find ourselves in a world where we're in the U.S. bad books forever and this creates a huge amount of challenges for us. I think we'll respond the way we should to U.S. pressure and to maintain the strong relationship that we've got with them.

Mark: When we think about the Canadian investor landscape and market sentiment, what are your thoughts towards investor behavior in Canada and taking a view towards things like volatility ultimately benefiting for the long-term benefit of Canadian investors?

Jean-François:If we're very clinical about it, and we look at American economic performance over the last couple of years and compare that to Canada's, we don't compare favorably. The Americans grew more rapidly than we have. They've generated GDP per capita increases; they've been more productive. They've had economic conditions that warrant better market performance than ours. Part of that, though, in the U.S. is because U.S. fiscal policy has been completely irresponsible. We worry in Canada about our deficit, it's below 2% of GDP. In the U.S. they're 7% of GDP, and they've been at that level for a couple of years.

They're throwing a tremendous amount of money into the economy and getting some stuff out of that as a result. That seems to be the case going forward. Trump doesn't seem to have an inclination to consolidate fiscally, in fact, probably the opposite. That strength in economic activity that we've seen in the U.S. has come with higher interest rates, but also means that there is less pent-up demand. There is less room to rebound for the U.S. economy. In fact, as we think about Canada-US growth over the next couple of years, in Canada, we've got growth of about a percent this year, a little bit more.We're thinking a growth of about 2% next year. In the U.S., we're over 2% this year, and we're probably going to go down to something below 2% next year. A slowing in the U.S. economy, I'll talk to where things are now, whereas in Canada, we're talking about, maybe a doubling of the growth rate. Now, 2% isn't strong, but it's that picking up in the early stages of the cycle. That appeals to me. I do think there is reason to believe that the fundamentals of Canadian markets are going to improve a little bit more, equity markets, more than the U.S. side.

We're thinking a growth of about 2% next year. In the U.S., we're over 2% this year, and we're probably going to go down to something below 2% next year. A slowing in the U.S. economy, I'll talk to where things are now, whereas in Canada, we're talking about, maybe a doubling of the growth rate. Now, 2% isn't strong, but it's that picking up in the early stages of the cycle. That appeals to me. I do think there is reason to believe that the fundamentals of Canadian markets are going to improve a little bit more, equity markets, more than the U.S. side.

Now, you throw in tax changes, and unfortunately that can mess things up. If the Americans do, in fact, cut corporate tax rates to the extent that Trump is suggesting, that is an advantage on the earnings side that Canadian firms will not have. It could very well be that American markets continue to perform for a while, even though we might actually get more underlying earnings growth in Canada over the next year or so than you might see in the U.S.

Mark: There's been a saying that's been thrown around over the years, the market is not the economy. Does that still hold true from your perspective? There's been a lot of economic pain felt, post-COVID, even with markets doing as well as they have and performing quite well now, but the specter of the household balance sheet is still on everybody's mind. Your thoughts on that area.

Jean-François:That's absolutely true. Even if you look at the U.S., you take out the Magnificent Seven out of there, and it's a very different take on how markets have evolved. There is, unquestionably, disconnect between how markets have priced certain things versus the underlying economic fundamentals. That almost always happens. Maybe it's a little bit worse now than it usually is, and there's also always a disconnect between folks, individuals, and even business to some extent, form judgments on the economy based on a few very simple things, like what's going on with food prices, how high are interest rates, what's the cost of gasoline?

Those three things account for a significant portion of consumer sentiment and how retail investors think about the state of the world. Oil prices are much cheaper now and interest are coming down, but unquestionably, the cost of living now is higher than it was two years ago and three years ago, and five years ago. Then you see this, for instance, playing out across the world.

When you look at the elections that have taken place this year, particularly in advanced countries, where there has been a significant deterioration in the affordability landscape, relative to when outgoing leaders were first voted in, there's a pretty strong correlation there between what happened on the inflation side of people getting kicked out of office. Even in those cases, you had markets that were significantly more bullish on the state of the world than individuals' assessments of what the economy actually was doing for them. That's not unusual, but it's been particularly strong over the last 12, 18 months.

Mark: There was an interesting statistic I ran across that also said market performance post-election is almost always up. Another comment I heard on the heels of that statistic was history has clearly shown that politics is seldom a reason not to invest. Would you agree with that?

Jean-François:Of course. Normally, politics don't lead to dramatic changes in policy landscape. Especially in Canada. You have, whatever, you go from liberal to conservative, you're usually talking about changes at the margin. Even in the U.S., you're usually talking about changes at the margin. Trump is a disruptor, so these are not marginal changes. When there are elections, as there were in the U.S. last week, people vote.

There is a significant portion of the American population, now that Trump is president, who will think this is great news, and legitimately so, in many cases, who will reassess their perspective on the economy because he's there, become more optimistic. Things are going to be on the better path, better sense, that time to invest because the seas have parted and then we have an inspired leader there. I think that's pretty normal.

Mark: JF, this has been super insightful. I really appreciate you spending the time with us and sharing your insights. Thank you very much for your time today.

Jean-François:Thanks, Mark. It was great chatting.

Mark: We hope you found today's podcast informative. While the outcome of any major geopolitical event, like a U.S. election, can influence market dynamics and economic conditions, it should not dictate your financial plans as an investor. Staying informed about political developments is important, but focusing on your long-term investment strategy is crucial. We at Dynamic advocate for a well-diversified investment approach, utilizing the services of a qualified financial advisor. We thank you for joining On The Money, and look forward to speaking with you soon.

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