Reblogged from Brintab
This quarter the media attention and investment market impact was all focused on the new US President Donald Trump, inaugurated on January 20. Although the President did have the benefit of a supportive Senate and House, he wasted little time pursuing that path to make changes and instead focused on things he could do through executive order and the declaration of a national emergency on various fronts. Early on, certain specific tariffs were implemented, followed by plenty of signalling about the broad-based tariffs to be announced on April 2.
Markets reacted in anticipation of tariffs and other governmental actions through the quarter but the continuing decline of markets after April 2 shows that many investors were still caught off guard by just how far President Trump went. This was overlayed on top of higher interest rates over the past couple years that were already cooling off the economy.
Fortunately for us, we were already taking a fairly cautious stance with respect to investments, given the restraining effects of the US Federal reserve and the Bank of Canada. This meant we were somewhat protected against the worst of the stock market retrenchment. We had increased equity exposure after the election last November, expecting a “Trump bump” but reduced that as the winter quarter unfolded.
One would expect that various campaign promises would run up against post-election reality and we have seen that start to happen. First and most expected was the notion of ending the Russian invasion of Ukraine in 24 hours. Following that was the extreme predictions of tariff implications such as bringing jobs back to the US and raising significant government income to reduce the deficit. Many tariffs have already had to be stalled, watered down, riddled with exemptions and otherwise. I think the writing is now on the wall that they will bring few jobs back to America and the government revenue they generate will be extremely modest. As a side note with respect to deficits, I think it is evident now that all the attempted DOGE cuts in the federal government will really just be a drop in the ocean of the US deficit.
This brings me to the next point, income tax cuts promised during the campaign. Right now, there are tax cut proposals making their way through the US Congress. Investors are conveying to Congress their extreme concern about the US deficit and now that it is clear the tariff revenue is going to be a mere trickle, and since tariff revenues was to be the enabler of lowering income taxes, I believe the promised tax cuts are going to be dramatically watered down. US government bond buyers really have little appetite for the government deficit increasing and if the government attempts significant tax cuts, bond buyers will go on a US government bond hiatus, forcing government interest rates higher. This will force Congress and the President to retreat.
By the end of Q2 we will likely get a fair bit of clarity on roughly where tariffs are going to settle out and will start to see where the major US tax consequences are going to settle out.
Lastly, even once we get improved tariff clarity, this only starts to get us through the havoc that has been wreaked on the economy. For example, leading up to April 2 the flow of cargo into the US, via trucking, air freight, etc. was overwhelming, with all shippers running at full capacity. Then on April 3 nothing but crickets; everybody took the day off. If shippers were running full out, then you can expect that non-US producers were too, trying to get as much merchandise as possible into the US before the tariffs hit. Many of them will have little need for much manufacturing in the spring, while the stuffed warehouses get cleared out. Meanwhile many companies put their capital investment plans on hold, pending better clarity. All this means that even after the tariff clarity comes it will take some time to undo the chaos the tariffs have created.
Does this review sound dour? Not so fast. For the investor who has kept some dry powder ready on the side, chaos can create golden opportunities. Generally speaking, we are watching for investment opportunities that have been created by this turbulence. We hope to have more to report on that this spring and summer.
Bonds and Interest Rates
You can see from the chart below that in January the long-term US government bonds (TLT – the purple line) fell to the lowest since October 2023. This was driven by the notion that all the Trump deregulation efforts and tax reductions would jack up the US economy and be inflationary. Remember that when bonds fall, the implied interest rate is rising. That gave way to rising long bonds through the quarter as the tariff talk took centre stage and its cooling effect on the US economy came into focus. In parallel, we saw high yield corporate bonds (orange line below) declining as investors started to worry about some of the very weakest of companies possibly going bankrupt.
Fig. 1: Bonds-Med. term Cdn-blue, Corp-green, High Yield-orange, Long Term US-purple – 2 years – Yahoo Finance
With all this talk about the presidency, we should not lose sight of another key player in the bond market and the economy in general. That is Jerome Powell and the US Federal Reserve (the Fed). Some bond investors have been worried that there are still residual high inflation problems in the economy and the Fed is dropping overnight rates too fast. If short term rates are dropped too fast and inflation is stoked, then in the long run rates will have to stay higher to get inflation under control. That is why recently, the more the Fed dropped short term rates the more the bond market pushed long term rates higher. Basically, long bond investors think the Fed is wrong, being too aggressive too fast.
Personally, I disagree. Without getting too technical, money supply growth has lanquished and with a time lag of a year or two, economic growth will fall when money supply does not keep growing. Layer onto that tariff-induced problems and bond buyer worries about the US government deficit and I think it is clear that weakness is the likely path ahead for the US consumer.
Eventually bond investors will buy into the Fed being right and long-term interest rates should fall (and bond prices rise). The only fly in the ointment is the possible concern about US government risk and bond buyers switching their focus to other countries. We will see if that unfolds in the spring and summer.
Currencies
In the summer I talked about the CAD toying with 70 cents US and in the fall I talked about the prospect of it briefly dipping below that. This winter that is exactly what happened. Since October 2024 the USD has been strengthening against the CAD (blue line I chart) and also against a basket of currencies (green line). Although it lost its strength against the basket in the winter, the USD maintained strength against the CAD. The CAD dipped below 0.70 USD in mid-December and mostly stayed below 70 until the end of March before rebounding to above 72 cents. On the reciprocal exchange rate we could say the USD rose above $1.42 CAD in December and then at the end of March fell back through 1.42 to now (late April) trade in the $1.38 CAD ballpark.
Through the winter the Euro and Japanese Yen restrengthened against the USD but the Canadian economy was just too tied to the US economy for our currency to recover. After the end of the quarter our currency did recover as there was some modest appeasement about the worst-case scenario with respect to US tariffs on Canada.
Typically, when there is global economic fear the USD acts as a safe haven because US investors pull back from overseas investing and convert their money back to USD. That did not really happen during the tariff-induced fears this winter. The currency impact of our USD investments did not really provide a substantial tailwind. Meanwhile the Swiss Franc and the Japanese Yen did behave like safe havens as they typically do in times of trouble. This is because bond investors are increasingly worried about US government finances and are considering looking elsewhere.
One dramatic change overseas is in German government policy regarding debt. In the past, the German government has had policies severely restricting government debt. This has kept Germany in a very strong fiscal position but now the country is facing two very big issues. Firstly, sanctions on Russian oil and gas, and the resultant cost increases have put the German chemicals processing industry on the ropes. Secondly, the Trump team attack on vehicle imports is hitting the German car industry head-on. Now the German government has made an about-face not seen in decades. They have decided to increase debt far above historical norms to stimulate the economy. Since Germany is so dominant in the overall European economy, this has had the beneficial impact of boosting the economic outlook not only for Germany but more broadly for Europe as a whole.
Fig. 2: US Dollar Index (green) and USD vs CAD (blue) – 2 years – Yahoo Finance
Here in Canada we face the negative of an almost certain recession ahead against the “positive” of a more subdued US tariff environment compared to the shocking initial stance. On the currency front I see the CAD staying roughly in the 0.70-0.75 USD range, not extremely high or low, despite some pundits with extremely pessimistic outlooks. As I have said in the past, in general the CAD moves with oil prices, since that is our major export. Right now, prices are low enough that US shale oil drillers are not doing much oil exploration. This means that as shale oil production falls off (those wells have a notoriously short life) the US market will increasingly rely on stable long-term supplies from Canada, backstopping our currency somewhat.
Stock Markets
Major stock markets around the world held up well in the first part of the quarter because they were focused on President Trump’s promises of deregulation and the economic boost that would come from that. Later in the quarter, when the focus changed to his tariff drive, stock markets fell back as investors started to incorporate the risk of negative impacts from the tariffs.
In this reckoning with risk, investors were weaving into their analysis their best guess of how things would pan out in time. After the quarter ended, on April 2 (so called Liberation Day) the Trump team’s starting position on tariff negotiations was tougher than investors had baked into their analysis and so stocks fell back a bit further.
This impact hit the high-flying stocks like the high-tech industry much more dramatically than other industries like consumer staples and utilities. Hence, since our holdings have been heavily weighted in those other sectors, the impact on us was thankfully much more modest than on investors heavily exposed to the tech industry.
Fig. 3: Equities: US-purple, Can-blue, Jpn-red, UK-yellow, Germany-green – 2 yrs – Yahoo Finance
Various retailers such as Walmart are indicating that consumers are reining in their spending. In fact, we seem to be seeing a gap between strong self-restraint by the working class and continued strong spending by the rich. I feel the full effect of the economic weakness has not yet been woven into the stock prices of the market darlings (the so-called Magnificent 7) and so we should still expect to see some pullback in the prices of those stocks. With that in mind we are being patient with our capital, feeling no need to urgently rush into the market in a big way. Nonetheless, I am watching for opportunity, as I mentioned above. We may end up buying some stocks that bounce around while the clouds clear but these will be investments with great prospects, when viewed through a long-term investor’s lens.
Respectfully submitted,
Paul Fettes, CFA, CFP, Chief Executive Officer, Brintab Corp.
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