We took the liberty of offering you a long and short version of our semi-annual newsletter below. Please take a moment to read our comments below.

 

Quick 2024 Recap

2024 was a year of strong market returns, driven largely by AI-related tech stocks and momentum investing. While equity markets saw impressive gains, underlying risks such as high valuations, persistently high bond yields, and fiscal concerns began to emerge. As we move into 2025, market dynamics are shifting—earnings growth will need to justify current stock prices, interest rate uncertainty remains, and geopolitical factors are beginning to introduce new volatility. 

This summary highlights key takeaways from 2024 and outlines our strategic positioning for the year ahead.

2024 Highlights:

Strong Equity Market Returns: The MSCI World Index returned 27.5% ($CAD), while S&P/TSX (Canadian equity) delivered 21.65%.  The FTSE Canadian bond index had a 4.62% return and cash 4.71% (although cash in now sub 3% after the rate cuts).

 

Tech-Led Growth: AI-related stocks, particularly semiconductor companies, dominated market gains. This has resulted in one of the most concentrated markets in history as well as significant U.S. market outperformance relative to other developed markets.

Bond Yields Stay Elevated: Despite interest rate cuts in Canada and the U.S, long-term yields remained high. Higher yields make refinancing more expensive and could put pressure on equity valuations if earnings don’t accelerate in 2025.

U.S. Dollar Strength: The USD appreciated 8.5%, benefiting those with USD-denominated assets. This strength could be a headwind on earnings as we move into 2025.

Momentum Factor Outperformance: Momentum-based strategies outpaced broader markets, emphasizing price movements over valuation.  

Fiscal Deficit & Liquidity Impact: US deficit spending fueled economic growth but raised concerns about sustainability and long-term market stability.  

Valuations at Historic Highs: Stock market valuations resemble those seen in the late-1990s dot-com bubble, raising concerns about future returns.  

 

2025 Outlook & Strategy

Earnings Will Be Key: Unlike 2024, when price momentum drove stock performance, companies must now deliver strong earnings growth to sustain market gains.  

Market Volatility Likely: Economic uncertainty, geopolitical risks, and potential tariffs could trigger market swings.  

Interest Rate & Bond Market Uncertainty: A significant $7 trillion in US Treasury refinancing is set for 2025, which could impact bond yields and risk assets.  

Diversification & Risk Management:  

Equity Exposure: We are maintaining a neutral stance on our equity allocation, especially as the new administration gets to work.  We are looking at trimming some of our U.S. allocation with the idea to move it to undervalued markets. We are also sensitive to our AI allocation. 

Fixed Income & Alternative Strategies: Increased exposure to active bond managers as they offer the best yield at the moment and multi-strategy hedge funds to hedge against volatility.  

Cash Positioning: The yield on cash has fallen below 3% so we will only be holding cash to capitalize on potential market dislocations and to fund income needs over the next 12 to 18 months. 

Final Thoughts  
- High valuations & uncertainty call for caution. 
- Key risks: Rising bond yields, economic slowdown, geopolitical tensions.  
- Selective stock picking & diversified portfolios remain crucial for 2025.  

For a deeper dive into these insights, read the full newsletter below.

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More in-Depth Analysis

 

For those of you that missed our blog, here the index returns ($CAD) from our December Monthly World Markets Report:

 

•    Cash - 4.71%
•    FTSE Canadian bond universe - 4.62%
•    S&P/TSX (Canadian equity) - 21.65%
•    MSCI World - 27.50%
•    Alternative Strategy(estimate) - 9.00%

 

A Few Stocks do the Heavy Lifting

These are great returns but is sometimes important to look under the hood to see what was the source of the returns. In the U.S. and Global markets Technology, and in particular technology related to Artificial intelligence drove most of the returns. The growth of the Magnificent 7 or 8 names, led by a certain semiconductor manufacturer, ended up with very few other stocks outperforming the index and the most concentrated market in history with these seven stocks market capitalization ending the year at about 30% of the S&P 500. 

 

Source: Apollo Asset Management

Rent the Winners

Another important consideration for 2024 was the factors that drove the performance. DJI/S&P publish a monthly factor analysis that shows the performance of 17 different factors (Dividend Aristocrats to High Beta). For the S&P 500 in 2024, Momentum was the best performing factor with a 46% return vs the S&P 500 with a 25% return. Inovestor, our quantitative ranking program we use to select stocks, has similar kinds of factor based model portfolios. We examined the U.S. models to find the one that had the best fit to the S&P 500 Momentum model and it was Innovest’s Price Momentum model with a 42.6% return. So what factors go into their price momentum model so that they can select the best stocks that model these characteristics? 

 

Let’s look at the Momentum factors:

 

    Factor                                                                                            Weight 
•    Price change 3 months                                                                      24%
•    Price change 6 months                                                                      24%
•    Price change 9 months                                                                      24%
•    Estimate revision current year median EPS 30 days ago              10%
•    Estimate revision current year median EPS 60 days ago                9%
•    Estimate revision current year median EPS 90 days ago                9%
                                                                                                               Source: Inovestor

 

Wow, the majority of the factor is simple price change, and the remainder is estimate revision over the past three months. There is not one valuation metric in this factor! 

 

It is no wonder that the turnover is 180% which means every stock in this 40 stock portfolio was changed almost twice during the year. The monthly standard deviation is 7.3% vs the 4.3% for the index so not only did you need to trade a lot the monthly performance was twice a 70% more volatile than the index. Tough to replicate on a consistent basis, especially if you have any valuation bias. 

Higher for Longer

Another interesting factor in 2024 was the continued elevation of bond yields, despite aggressive rate cuts in Canada and the start of rate cuts in the U.S. 

 

The Bank of Canada started cutting rates in May of 2024 and went from 5% to 3.25% in December. The 5 year Canada started to follow a similar path from 3.8% to 2.67% in September, but then ended up 2.96% despite the Bank of Canada cutting interest rates two more times. This put upward pressure on mortgage rates and made refinancing of older mortgages that much more challenging. 

 

The story was similar in the U.S. were the 10-year treasury is often used as the risk free discount rate for future cash flows. The Federal reserve started at 5.5% and did not start cutting until September but his first cut was 0.50%. He cut again in November and December and ended the year at 4.5%. The 10-year treasury started the year at 3.86%, rose in the Spring to 4.7%, fell to 3.62% and then finished the year at 4.535% which means the yield actually went up while the Fed Cut rates.

 

Doubleline, a large bond manager in the U.S. went back to 11 previous rate cutting cycles to see how the 10 year treasury performed. In 6 of those cycles the 10 year price rose for a positive return, and in 4 it fell with 2024 being the worst performer. It sure seems like higher rates are here to stay. 

Source: DoubleLine, Bloomberg

 

In 2025, the U.S. Treasury needs to refinance $7 trillion of bonds, a much larger than normal amount. Add to this potentially $1.5 - $2.0 trillion in deficit spending and you have a wall of supply coming into the market. Who is going to buy all these bonds? Trade issues with the rest of the world and a very strong dollar could further reduce global demand. Economics 101 would suggest when there is too much supply and too little demand price (yields) go up. This is bad news for risk assets, especially if the 10-year treasury breaches 5%.

 

That being said, it is awesome to be able to real yield again. At the moment our bond managers are able to generate yield of 5-6% even with corporate spreads (yield over Canada bonds) that are very low. They are perfectly positioned to take advantage of any shocks to the market that widen these spreads. In the meantime we clip a great coupon while not taking much risk.

$U.S. Tailwind in 2024

While these higher interest rates can be tough on risk assets and economies, it certainly helped our $U.S. assets as the $U.S. appreciated from 132.45 to 143.80 or 8.5% for the year. Having assets denominated in $U.S. also helps you with travel to the U.S. as you don’t need to convert as we can send you $US. In the future we will likely add U.S. stock exposure using Canadian Depository receipts as they are hedged back to $CAD instead of converting. 

Great Economy, But at What Cost
One of the reasons that bonds yields in the US remain stickily high is because of the fiscal deficit that is being run in by the government with no real end in sight. There used to be a relationship between unemployment and fiscal deficits. As unemployment fell, the need for fiscal stimulus would fall and revenues would increase as the economy increased. Starting with Trump 1.0 we saw a situation where unemployment continued to fall, but the deficit began to increase, primarily because of tax cuts. Just prior to the pandemic the unemployment rate was below 4% but the deficit, at close to 5% of GDP, was traditionally associated with unemployment rates closer to 6-7%. The pandemic created massive unemployment and massive deficits. Unfortunately the Biden administration ignored the rapidly improving economic and jobs picture and continued to borrow money to spend. When he left office the deficit was close to 7% of GDP. So let’s do the math, nominal GDP in 2024 grew by an estimate of 5.5% and the government fiscal deficit was 7% of GDP. Doesn’t seem like a very good trade!

The surplus liquidity from the pandemic and the fiscal stimulus counteracted the monetary tightening of the Fed which created conditions that were ripe for equity prices to go up and speculative behaviour to thrive. Just look at the number of ads you see on TV for on line betting!!

 

In 2025, the U.S. Treasury needs to refinance $7 trillion of bonds, a much larger than normal amount. Add to this potentially $1.5 - $2.0 trillion in deficit spending and you have a wall of supply coming into the market. Who is going to buy all these bonds? Trade issues with the rest of the world and a very strong dollar could further reduce global demand. Economics 101 would suggest when there is too much supply and too little demand price (yields) go up. This is bad news for risk assets, especially if the 10-year treasury breaches 5%

2025: A Whole New Ballgame!

Where do we begin as we get into the second week of the Trump reign, we mean term. Here are the things we are focused on for 2025:

 

Valuations
As we have said in the past, valuation is a terrible tool for short-term performance. We do, however, need to measure valuations for the expected long term performance of an asset class. Since equities have the greatest volatility, we tend to focus our risk management on them first. 

 

Equity valuations are some of the highest we have seen and certainly on many dimensions similar to the great dot.com bubble of the late 1990’s. There is a great website www.multpl.com that give you up to date valuation from many different perspectives. One of our favourites is price to sales as revenue can’t be manipulated like earnings. Below is the current price to sales for the S&P 500. Now it only goes back to December 2000 but you can see that it is at the highest level in 24 years. We did go back and check the values in the first quarter of 2000 and it peaked at 2.13 so we are 46% above that level. 

Source: Mulpl.com

Another less volatile measure if price to book value. Don’t worry if you are uncertain of what constitutes book value as we are only measuring the relative value over the last 25 years. Here we go:

 Source: Mulpl.com

The good news here is that we are at the same level as the peak of the dot.com bubble in March of 2000. The bad news is that we are at the same level as the peak of the dot.com bubble!

 

We could go on, dividend yield at one of the lowest levels going back to the 1880’s, earnings yield the same, but there is one long term measure that has been a very good indicator of market tops. This is the CAPE Shiller PE. CAPE stands for Cyclically Adjusted Price Earnings multiple. Robert Shiller, a Nobel prize winning Behavioural Economist determined that the best way to measure the true value of a market is to take 10 years of earning, adjust for inflation and then divide by the current value of the market. This smooths out the volatility of annual earnings and adjusts for the positive impact of inflation on earnings so it measure real earnings which are more meaningful. You may want to avert your eyes:

 

So why does this matter. Because what you pay for an investment today, impacts your ability to  earn a return over the next 10 years. It seems like common sense that if you buy something cheaply today, there is a better chance that you will be able to sell it at a higher price in the future. If the asset is expensive today, you would need to find someone to buy it at an even more expensive level in the future to make a profit. So what does history show us about future 10 year returns based on the CAPE Shiller PE ratio? 

We recognize the chart is a bit messy and a little out of date. Here is how to read it, the vertical axis the 10-year return and the horizonal axis is the current CAPE ratio. When this chart was done the CAPE was at 35, we are now at 38. At 38 you can see that there not many observations as we are rarely this expensive. It also shows that the historical 10 year returns with a CAPE of 38 are around 1% to -5%.  History would also suggest the market doesn’t just sit at this level for 10 years, we often have a significant pullback in price to bring down the return. 

 

The problem with CAPE is that on a one year basis this is no statistical significance between the value and the one year return. Therefore you need to be exposed to risk assets but with a well-diversified portfolio of style and geography (see small caps, emerging market, value).

 

So our radar is up on valuation and that is why we have been rebalancing to our bond managers and alternative strategies as they offer lower volatility or added diversification, or both. 

 

So in 2024 much of the heavy lifting for stocks was the price based on momentum and AI optimism and less so with the 9% earnings growth. In 2025 earnings will have to come through for this market to continue to rise. Any hiccup in earnings or expectations could see a rapid price decline. Certainly the DeepSeek scare of late January was a case in point of how fragile this market, and certain stocks, can be with an unexpected surprise. 

 

Mind the Step

 

In markets like 2024, we often wonder why Tom focuses so much on portfolio construction and risk management. Is it not easier to simply stay invested and ride out the bumps along the road! The market goes up 70% of the time why worry. Aren’t you worried about missing out!

Wow, what a difference. To be fair this chart starts in 1998 so you had the dot.com bust and the Great Financial Crisis all in a matter of 10 year so it may exaggerate the experience. But you can see the power of avoiding losses, especially if the losses occur from a very high level. Let’s look at it over a longer time horizon on the next chart.

 

This chart shows the bull markets and bear markets in percentage terms. It certainly looks like the bull market reign supreme as the percentage gains are multitudes more than the bear markets.

However if we translate the percentage movement to actual stock market points movement we see a very different picture:

Let’s look at the 1982 to 2000 bull market. Over the 18 years the S&P 500 gained 2,287 points. In the bear market of 2000 to 2003, it lost 1,232 at the low. Put another way that 40% loss from above represented 46% of the total point gain over the 18 years. In fact, when combined with the GFC of 2009 the S&P 500 did not sustainably surpass the 1461 of March 2000 until January of 2013! Ouch!

 

We would argue that the current bull market started in the Spring of 2009 when the S&P 500 finally bottomed during the GFC. The pandemic threw a wrench into the system and forced central banks to lower interest rates to unseen level (negative rates in part of the world) and 2022 was simply a rebalance of the excess of the pandemic. If you agree with the premise then this bull market is entering it 16th year and with unprecedented growth. So we have a lengthy bull market and high valuations. On their own these are not conditions to predict the end of the bull market but as we have seen, much of what is gained in the later stages of bull markets is given back when we swing to a bear market. That is why it pays to be risk aware in these elevated conditions. 

The Wild Card!

So what could possibly derail the bull market. We would draw your attention to the new administration in the US. Nothing they do is conventional so it is very difficult to game out the potential impact of whatever executive order hits the President’s desk. It would also appear that the checks on his authority, namely the Congress has no appetite for a fight. We shall see if the Supreme Court is more willing to temper the Trump cadre’s enthusiasm for disruptive change at all costs. 

 

It would also appear that the tool of choice for exerting influence is tariffs starting with their most friendly trading partners. All of this posturing could result in higher inflation expectations, and higher rates. 

 

We could spend a whole newsletter on what is going on, but it will be wasted energy and paper. There is nobody in an investment chair that has truly experienced the impact of the potential tariffs that we might face. It is not only the actual financial impact, but more importantly the behaviour that the tariffs will unleash. Retaliation, disrupted supply chains, alliance breakdown, reduced consumer purchases, job anxiety, is a heady mix that will be difficult to measure right off the bat. 

 

Clearly the chaos we will experience puts an already fragile market in a more vulnerable position. 

Our Positioning for 2025

While most investors in the US are the most allocated to equities in history, we remain neutral to equity and have allocations to undervalued markets. On the margin we have been trimming some names and have not been adding back to our stock positions until earnings have been released. Even in the worst markets, some companies can thrive and we continue to sift through the market to try and find these gems.

 

We also have a significant allocation to managers that actually can benefit from increased volatility. Whether it is our active bond managers, or our Multi-strategy hedge funds, they both are waiting, and positioned, to take advantage of pricing dislocations. We also have allocations to short term cash to fund cash flow and any potential liabilities in the near term. 

Our Canadian equity allocation tends to be less economically sensitive and more yield focused so will likely not be too hurt by a potential recession in Canada and would probably benefit from a possible decline in longer term interest rates. We will continue to look at the potential impact of tariffs company by company. 

 

It is possible that the $CAD will continue to decline, which might result in a spurt of inflation. This may keep longer term interest rates anchored close to where they are now. This might have an impact on the domestic housing market as mortgage holders renew and new buyers are facing higher mortgage rates. Worth keeping an eye on this market.  

 

So it has been eventful start to 2025. Our focus is to preserve our capital and generate a decent return with the idea that the future will provide better investment opportunities.