2025 Market Outlook – 8 key themes to watch for this year

Announcer: You’re listening to the Scotiabank Market Points podcast. Market Points is part of the Knowledge Capital Series, designed to provide you with timely insights from Scotiabank Global Banking and Markets’ leaders and experts.

Stephen Meurice: I’m Stephen Meurice, host of Scotiabank’s weekly podcast, Perspectives. Today you’ll be hearing an episode I recorded recently for Perspectives with Hugo Ste-Marie. Hugo is the Director of Portfolio and Quantitative Strategy in Equity Research at Scotiabank. He’s also one of the authors of a recent Scotiabank report looking ahead at the markets in 2025. In it, Hugo and his co-authors outline the key themes they think will shape the investment landscape in the coming year. And he’s here to break some of those down for us. He’ll tell us where he thinks markets may head, where there may be opportunities as well as risks, potential surprises, the possible impact of a new administration in the U.S., and much more as we head into the new year. And before we begin, just a reminder to always consult your own advisor before making any investment decisions. I’m Stephen Meurice and this is Perspectives. 

Hugo, welcome back to the show. It’s always great to have you on.

Hugo Ste-Marie: Thanks for inviting me.

SM: All right. Before we begin, I just want to clarify that your job is mainly advising global institutional investors and not necessarily everyday retail investors. That said, I think your take on the broader macroeconomic outlook will be of interest to lots of people and can help give them a big picture sense of things.

HSM: Exactly.

SM: Okay. So, I think it’s probably impossible to talk about the market outlook for 2025 without first getting a little bit of the lay of the land, the broader macroeconomic situation. And I guess specifically how a second Trump administration might affect that. Maybe we can start there. How do those factors affect your outlook?

HSM: That’s a great question. Even though we have, I would call it even a rosy base case scenario, there certainly are some risks shaping up for 2025. As you alluded, one of them is the new incoming Trump administration. If Trump were to implement steep tariffs on Canada, Mexico, Europe, China, clearly world growth won’t improve as much as we are expecting right now. That could be a big risk on the earnings side. So, if growth were to disappoint or worse, growth was to contract due to tariffs, obviously you won’t get 10-12% EPS growth in 2025 and that could lead to a decent retrenchment in stock prices. So that’s a key risk. We should have more details in in the next few weeks, maybe next couple of months to see what’s happening with tariffs.

SM: Alright. And I guess there’s different forces at work. On one hand, I think many people expect that a Trump administration would be good for the business environment and growth on that side. But then with the potential downside of things like tariffs and so on.

HSM: Yeah, absolutely. That’s why the market initially rallied relatively strongly following the November 5 election. People were banking on tax cuts. I think that that should happen. But the big question mark is to know if the tariffs are just a ploy to extract the most from the U.S. trading partners or if Trump has decided to enforce tariffs on most trading partners. And again, even if we have tariffs, are they going to be quite high? Like he mentioned several times, 25% on Canadian exports. But again, if it’s not 25%, if it’s 5%, it’s more manageable than if it’s 25%. So again, there was a lot of uncertainty, not only if we’re going to have or not tariffs, but if we have tariffs, is it going to be small tariffs or massive tariffs? And are they going to be broad-based or more focused on one or two industries, which would be more, I would say, easy to swallow, if you will, from an economic standpoint, from a Canadian economic standpoint.

SM: Okay. Alright, maybe before we get into the specific themes in the report that I’ve mentioned a couple of times, maybe you can just tell us briefly what that report is, what it’s intended to do. Is it a bit of a guidebook for investors as they look ahead into 2025?

HSM: Yeah, you can call it a guidebook, if you will, where at the time of writing in early December, we put all our best efforts into this report suggesting what could happen in 2025. Obviously, a lot could change over a year. But when we when we wrote this and even as we speak today, our base-case scenario was for decent growth. And I think that’s going to be supportive of risk assets further down the road.

SM: Okay. So, let’s get into the report. And one of your first themes is about interest rates. You wrote, “It all comes down to a synchronized easing cycle.” What do you mean by that?

HSM: When we talk about equities or investments, we have to start with the global macro landscape. So how the U.S. economy, how the Canadian economy, Europe, China are expected to perform before talking about investments. So, when you look at one of the of the main themes that we see and we got in 2024 and we see continuing into 2025, it’s the global monetary easing. It’s a synchronized easing cycle. We have seen so far rate cuts in Canada and U.S., in some LatAm countries, in Europe, in Asia, including China. I think this is one of the key components explaining our bullishness for 2025. Usually when you have, I would say, a broad easing cycle around the world, it takes time, but it tends to boost world growth. The U.S. is already in good shape. When you look at the U.S. economy, I think the consensus is looking for around 2% GDP growth in 2025. I think that could be exceeded. The Fed will ease probably a couple times next year, maybe 2 to 3 times max. That’s probably less than investors were envisioning just a few months ago because the economy is probably performing better than they were expecting and inflation is a bit more sticky. But clearly easing will continue in the U.S. economy and the Fed will provide monetary stimulus. So that keeps us bullish for the U.S. economy. The consumer is in great shape. You had a huge wealth effect last year. If you looked at the increase in value for the bond market in the U.S. plus the increase in value for the equity market, that’s huge and that’s going to be supportive of consumer spending in 2025. Job market is still doing quite well. Wage growth is robust. That should be, again, supportive of consumer spending. Home prices have started to rebound. So, I think you have a decent setup where the economy should perform relatively strongly, maybe better than the consensus, as I mentioned, is expecting right now. As I said, the consensus is around 2. I wouldn’t be surprised if we see stronger GDP growth than what is currently envisioned by economists. We might have tax cuts this year with the new Trump administration, so that’s a good setup for S&P 500 earnings. The key driver and the long run driver for the equity market is how profitability is doing. Earnings will likely continue to rebound in 2025. Consensus is looking for something like 12-13% earnings growth. That’s certainly achievable if the economy performs as we speak. Valuation is on the high side. When you look at the S&P 500, clearly the S&P is trading at 22 times. But I think if we are easing, that’s probably sustainable.

SM: Okay. Next point you talk about is, “Abundant liquidity looking for a home.” By liquidity you mean there’s lots of money out there looking for places to go?

HSM: Yes, absolutely. There are a few components to this. When you look at what I call excess deposits in the financial system, banking system in the U.S., you could see that historically this is going up smoothly. Like reserves tend to move up, liquidity tends to move up, savings move up slowly. But since the pandemic, those deposits have massively increased or they are not back to what we call trend levels. They are still well above trend. And that means that businesses and consumers still have liquidity in their bank account to spend, essentially. That’s component number one. On the investment side, when you look at the U.S. money market, you have over $6 trillion in the U.S. money market. Out of those $6 plus trillion, you have almost like two and a half to three trillion belonging to retail investors. And again, with the Fed expected to trim its benchmark rate further in ‘25, the return profile of cash will diminish because it’s tied to short term rates. Short-term rates declining, cash will generate lower return, lower returns in 2025. So, with the risk, with the return profile deteriorating for cash, I would say investors could be tempted to reallocate that cash into assets with, I would say, a superior risk-return profile. And that might be supportive of equities in ‘25.

SM: Right.

HSM: In Canada we see similar stuff in the sense that we still think that retail investors have decent cash reserves that could move the needle, too.

SM: Okay. So both on the consumer side, there’s a fair amount of liquidity. So, consumer spending continues. It’s always good for the economy. And on the investor side, there’s money to be invested that’s looking for a place to go, which also helps businesses to invest in their own businesses and spend more money as well, presumably.

HSM: Correct.

SM: Okay. The next theme was, “U.S. equities uptrend extends, but diversification needed.” What do you mean by that? I’m assuming it means maybe moving a little bit away from the Magnificent Seven into some other places.

HSM: Absolutely. And when you looked at well, we discussed a bit earlier about what we were seeing for U.S. stocks. I think we have more upside coming from a strong economy or rising earnings. So, for the S&P 500, we could see further upside. That said, when you look at ‘23 and ’24, the Magnificent Seven stocks massively dominated and that was more difficult for smaller caps, mid-cap stocks. Even the S&P 500 Equal Weight Index strongly underperformed the S&P market cap weighted index. So, what we’re suggesting in ’25 is that diversification out of the Mag. Seven could be needed. One of the key reasons for this is the earnings growth divergence that was very visible in ’23-’24. The earnings growth gap could narrow between the Mag. Seven and the rest of the market. So back in 2024, Mag. Seven earnings growth was way, way stronger than the rest of the market. In ’25, the Mag. Seven stocks will continue to outgrow on the earnings front. But this gap, the earnings growth gap will be smaller than it was last year. And given valuation, I think that could help the rest of the market to do probably a bit better being a bit more competitive versus the Magnificent Seven. So yeah, that’s what we meant by, ‘Diversification is needed.’ It means that yes, you want to own U.S. equities, but within the U.S. equity market, maybe smaller cap stocks, mid-cap stocks, the S&P equal weight could do on a relative basis, probably better, or at least as well as the S&P 500 market cap weighted index.

SM: I see. So, I mean, that sort of blends into your next point, which is, “Size trade: Will U.S. small caps hit a homerun or grand slam?” Basically, will investment money be slightly more evenly distributed across different sizes of companies in the U.S. as opposed to a concentration in those seven giant companies?

HSM: Correct. If you looked at the Russell 2000 or S&P 600, which are small cap benchmarks in the U.S., they really underperformed in the last few years. They underperformed the large caps and they underperformed massively the mega-cap stocks. But why small caps should do better, I think we need a couple of things. We need firmer GDP growth, strong economic activity to help small businesses because they are more sensitive to economic conditions. So, we need decent growth, strong growth in ’25. That’s condition number one for small caps to do well. Condition number two, I would say it’s on the cost of debt, if you will. We need lower interest rates. Once again, when Apple needs, or any Mag. Seven stocks need to borrow money, it’s not a problem. But if you’re a small mom and pop shop in the Russell 2000 or the S&P 600, credit conditions matter a lot. By credit conditions, I mean, is it easy to access credit? So, when you go to your bank branch, is it easy to get money? And what about the cost of money as well? So, on both fronts, if the Fed is easing its benchmark monetary policy in ’25, I think the cost of credit will come down. So, it‘s going to be less costly to borrow money. That‘s number one. And eventually, I suspect with decent growth, bankers will probably make it less difficult for small businesses to borrow. So, if we have strong growth and credit conditions were to improve at the same time, ’25 could turn out to be a great year for small cap stocks, especially that from a valuation standpoint, the discount between large cap and small cap is quite wide. The discount that we‘re seeing now, I think it happened a couple of times in the last I’d say 30 to 40 years, so small caps are trading at big discount to large caps. But you need something to close that gap, probably not fully close the gap, but at least to see a rerating. And those two conditions, as I mentioned, stronger growth and a cheaper and easy access to credit. I think if we have that, small caps will do well.

SM: I think you’ve mostly been talking about the U.S. markets in general there. So, we’ll move on to your next theme, which is Canadian equities. And what you put there in your theme was, “Banking on financials.” Maybe you can explain that.

HSM: Yeah, sure. Canada will benefit by extension from solid U.S. economic activity. When you look around the world, I think North American stocks are well-positioned to lead. So that includes both Canada and U.S. versus their global peers. Within the Canadian equity market, I suspect the TSX will end ’25 in positive territory, generating positive performance. But within the Canadian equity market, I think banks and financials could do quite well. The Bank of Canada has been much more aggressive in terms of monetary easing versus the Fed. I think that the BOC will continue to ease its monetary policy in ’25, and eventually that could help Canadian consumers to spend more. For a bank, what does that mean? It probably means that if the Canadian economy does well, the PCL will just improve. Growth will be better. It means probably stronger mortgage growth because people will be able to afford or to renew their mortgages, probably loan growth overall better, maybe some capital market activity, M&A IPOs could help Canadian banks as well. So again and the bar to beat is quite low. When you looked at the consensus earnings outlook for the banks, what Bay Street is expecting in terms of earnings growth, it’s on the low side. I think that could be exceeded. Banks are not very expensive by historical standards. So, if you have a bit of firmer growth, some positive surprise and probably some continued rerating, banks and financials could do could do quite well in 2025. And that’s the biggest sector in the TSX Composite. That’s over 30% weighting with financials, insurance, banks. So, if the banks and financials are doing well, performing well in ’25, that’s a pretty good start for the TSX Composite.

SM: Okay. And I think commodities make up a fair chunk of the TSX Composite as well.

HSM: Correct.

SM: So where do you see commodities going?

HSM: On the commodity front, the shine is kind of fading in the sense that oil was well into the 80s, has started to moderate. We’re probably closer to the mid-seventies as we speak today. I think that’s going to be an okay year, but WTI is probably stuck in the range, but that should still lead to decent profit growth next year for energy companies. Overall, we’re more neutral on the space because we see the WTI price as being more sideways. When you look at the global supply and demand picture for oil, we still expect decent growth that should support demand. But on the supply side, Trump wants to pump even more oil in U.S., Canada oil output should grow. You have a lot of OPEC spare capacity, especially in Saudi Arabia. So, I think you have a picture where oil could be a very high sixties, maybe the low to mid-seventies. So stuck in a range. We’re not negative on the space, but I think it’s going to be more a sideways environment. On the precious metals front, the spike in the in the U.S. dollar could certainly put some pressure on gold, not necessarily a lot. But as we’ve seen recently, gold is off the highs; could be kind of rangebound as well in 26 maybe 2,700 or so. That’s still good news for the companies. You should be able to make money at those levels for sure. But again, in a sideways environment you’ll probably be more neutral on the space. So that’s why in our outlook we mentioned that for commodities, the shine is kind of a bit fading, if you will.

SM: Right. So no big spikes, but not necessarily any big dips either.

HSM: Exactly.

SM: Okay. And you did say that both Canada and the United States, potentially looking better from an equities perspective than some of our international peers. On the international front, you describe it as, “a land of broken dreams.”

HSM: [laughs] Yeah. Every year we have clients, institutional clients, asking about international equities or saying that international equities are cheap, way cheaper than the U.S. and it’s time to add to position there. But in the last few years, that has been extremely disappointing. International equities underperformed when you looked at EAFE, especially EM, they all underperform the U.S. S&P 500. And quite frankly I don’t think that’s going to change that much in 2025. When we refer to EAFE, we’re talking about Europe, Australia and Far East. When we talk about EM, we’re talking about emerging markets. So that would include – it depends on the definition – but that would include markets like LatAm, markets like China, for instance, some European countries would be included as well under emerging.

SM: Right.

HSM: So that’s, as I’ve been saying earlier, we would prefer to stay closer to North America in terms of regional equity allocation and be probably underweight EAFE and kind of market neutral on EM. On the EAFE side, as I mentioned, like all international stocks look cheap versus the U.S. What matters more is the earnings momentum. When you compare the U.S. earnings to, I would say, international stocks or the rest of the world versus the U.S., U.S. earnings are rising way faster than the rest of the world. And this is driving, explaining why we’re still bull U.S. equities versus the rest of world. And that explains also why U.S. stocks have massively outperformed international stocks over the last, I would say, more than a decade ago.

SM: Alright, I’ll just ask you one last question, that is about bond markets, which have, like everything else, seen some fluctuation. Where do you see that going this year?

HSM: Yeah, if you looked at ’24, bond indices Canada and U.S. generated very low performance, low single digit performance on a total return basis and quite frankly, we’re not super optimistic for ’25 as well. I think that’s going to be positive performance. But once again, the performance will be mildly positive because we think bond yields—U.S. ten-year yield and U.S. bond yields—will stay on the high side in 2025. Within the bond market, we would prefer corporate over treasuries or corporate bonds over a government bonds, if you will. On the corporate side, strong earnings, strong economy and risk appetite should keep corporate spreads very tight. And on the government bond side, I think the higher bond yields and probably some fiscal concern if treasuries, or government yields, were to rise a bit more, could put some pressure on government bonds.

SM: Okay. Just to finish off here, your report was quite long and detailed and had lots of graphs in it and all this. So, it is perhaps unfair to ask you to summarize it, but I’m going to do that anyway. [laughs] What are the main takeaways that you think people should have from your report? And I guess part of it is your order of priorities I think in declining order, is equities, bonds, cash? Maybe is that one of the bigger takeaways?

HSM: Yes. Base case, solid growth is expected, solid economic growth due to monetary easing, that should continue. The main risk on the outlook as we speak are the tariffs. If we have a lot of tariffs, that could strongly derail our scenario. But the base case is some tariffs plus monetary easing, tax cuts will support the economy, support earnings growth. That should continue to push equity prices higher in ’25. We prefer equities over bonds, as mentioned. We see lower returns for bonds within the equity markets. In terms of regional location, I would say stay closer to North America. This is where you have best growth, maybe more positive GDP revisions versus Europe, versus Asia as well. Even though North American and U.S. equities are expensive, they are expensive for a reason. So, we prefer North America over rest of world, maybe small caps have a decent year this year, so keep an eye on that. And I think that’s pretty much it.

SM: Hugo, thank you so much for joining us. Really appreciate it. Always great to have you on the show.

HSM: It was my pleasure.

SM: I’ve been speaking with Hugo Ste-Marie. He is Director of Portfolio and Quantitative Strategy in Equity Research at Scotiabank. 

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