Trying to make investment decisions while operating in a vacuous state is like trying to win at poker with a deck that keeps reshuffling itself mid-hand. A stray comment from a central banker, a vague tweet from a billionaire President, haphazard tariff headlines and trade deals that are more about strategy than substance have sent US equity markets reeling or surging.
The latest in this fear / greed playbook was an agreement between the US and China to reduce their embargo style tariffs by 85% for ninety days so the parties could open negotiations for a comprehensive trade deal.
That was welcome news for Chinese factories and US importers. It also reset third and fourth quarter earnings expectations and spurred a massive rally in US and Chinese stocks. At the end of trading on Monday, May 12th, US equities had recovered all the losses that were triggered by President Trump’s April 2nd liberation day levels.
At the time of writing, US equity markets were still below 2024-year-end levels (see chart) but had made a remarkable recovery from the post-liberation day sell-off. Perhaps more remarkable is the year-to-date performance of the Canadian market as measured by the iShares S&P TSX 60 Index Fund, that is up 3.00% since the end of 2024.
The rationale for our “why so sad” backdrop, is the divergence between hard and soft economic data as well as the uncertainty triggered by the President’s haphazard approach to tariffs. The paradox is trying to decipher why equity markets are performing better than expected in light of the largest corporate tax hike in US history.
On a positive note, first quarter earnings have come in better than expected. However, in keeping with our uncertainty barometer, forward guidance had all but disappeared. That’s problematic for experts trying to predict outcomes across forward-looking equity markets. How can analysts assign reasonable probabilities to outcomes when corporate insiders cannot?
We believe the performance of equity markets over the next six to nine months will come down to macro-economic conditions rather than company specific events. Perhaps, given the rally on May 12th, investors have come to believe that Trump’s tariff policies will deliver the results that he has been promising. A little pain now for a better economy later.
Our view based on trading volumes and frequency of buy and sell decisions is that gyrations in the US equity markets are being propelled by long-short hedge funds and retail day traders. And while we never discount the premonitions of the retail investor collective, one must ask if we are experiencing a classic fake out boosted by misguided optimism. One thing is certain, the May 12th rally has diminished the outlook for any near-term rate cuts.
We know that the US economy did not feel the pinch of tariffs in the first quarter. There is also a view that consumers and companies attempted to front run the tariffs by stockpiling supplies and inventory. That would explain the better-than-expected profits during the first quarter.
The hard economic data provides additional support to that thesis. There is clear evidence that the US economy is declining. US GDP decreased at 0.3% in the first quarter (January through the end of March), according to the advance estimate released by the U.S. Bureau of Economic Analysis. In the fourth quarter of 2024, real US GDP increased 2.4%.
The decrease in real first-quarter GDP was driven by an increase in imports which are subtracted from the GDP calculation, and a decrease in government spending. These movements were partly offset by increases in investment, consumer spending, and exports.
Consumer spending and private investment remained steady, increasing by 3% in the first quarter, compared with 2.9% in the fourth quarter.
Private investment is a more challenging statistic. It may be the result of companies investing to onshore their production to avoid future tariffs. Or it could be projects that were underway but may not necessarily imply future expenditures.
Inflation is also sticky. The year-over-year price index for retail consumption increased 3.4% in April, compared with an increase of 2.2% at the end of the fourth quarter. The personal consumption expenditures (PCE) price index (the Fed’s favorite inflation barometer) increased by 3.6%, compared with an increase of 2.4% in the fourth quarter.
Excluding food and energy prices, the PCE price index increased 3.5%, compared with an increase of 2.6% in the fourth quarter of 2024. These numbers point to a worrying rise in prices which requires the US Federal Reserve (Fed) to question whether the inflationary impact is transitory or more deep-rooted.
Interestingly, the inflation data seems at odds with an upbeat employment report. Non-farm payroll employment surprisingly rose by 177,000 in April, roughly in line with the average monthly gain of 152,000 over the prior 12 months. Employment continued to trend up in health care, transportation and warehousing, financial activities, and social assistance. Federal government employment declined.
The total non-farm employment change for February revised down from +117,000 to +102,000, and the change for March was revised down from +228,000 to +185,000. On net, employment over these months is 58,000 lower than previously reported.
Average hourly earnings for all employees on private-sector payrolls rose by 6 cents, or 0.2% in the month of April. So far this year, average hourly earnings have increased by 3.8% which is above the prevailing inflation rate.
Clearly, the stronger-than-expected labor market was one catalyst that supported the upward momentum in equities. And that may continue if the labor market remains buoyant and the upward bias of employment income persists. Unfortunately, neither scenario is predictable.
The soft economic data paints a very different picture. Surveys taken during March 2025 showed a marked decline in sentiment. According to the US Conference Board, the Consumer Confidence Index declined by 7.2 points to 92.9, marking a 12-year low in consumer expectations for the future. This decline Is reminiscent of the fallout during the covid pandemic and reflects ongoing concerns about the economy. Consumer confidence has declined for four consecutive months. If the soft data holds, it means the future will not look anything like the recent past.
The shaded area indicates a recession. If this soft data holds and we were in a normal economic cycle, the probability of a recession within the next twelve months would seem all but certain. In fact, some economists think the US may already be in a recession.
The problem is that we are not in a normal economic cycle. The US, and by extension, the rest of the world, are suffering from a self-inflicted wound perpetrated by the Trump administration. Which means the markets will continue to respond violently to Truth Social Tweets and White House press scrums (note: the trade outline with the UK) that will alter the trajectory day to day.
Speaking of the UK trade outline (this was not the final deal but rather an outline to negotiate a binding contract), we can draw on some of the language. Notably the 10% tariff that will remain in place for much of the trade between the two countries. This tells us that a 10% tariff is likely the best outcome we can hope for in other negotiations which is where we think the USMCA will be reset. So much for the view, as opined by Louisiana Senator John Kennedy, that Trump is a free trader. Our view mirrors that of Prime Minister Mark Carney when he warned that America is no longer the anchor of global trade.
The Canadian Experience
For Canadian investors, the tariff threat remains at the epicenter of one’s investment decisions. Prime Minister Mark Carney met with President Trump on May 6th. Carney had downplayed expectations that anything concrete would come from that meeting. The idea was to reset the Canada / US relationship while setting Canada’s global trading relationships with like-minded partners. Which is to say, elimination of internal trade barriers, expansion of trade with Mexico, Asia and the European Union, while restarting discussions and removal of regulatory restrictions for an east west pipeline. Something that is long overdue!
We are also seeing some green shoots from Carney’s made in Canada approach. Canadian companies, which tended to rely on US-Canada free trade, are beginning to seek opportunities elsewhere. Most notably is a renewed interest in the trade deal between Canada and the European Union, known as the Comprehensive Economic and Trade Agreement, which was signed in 2016. A similar pact that governs trade between Canada and Britain came into force in 2021. Both agreements – which emphasize free trade and harmonized regulations – eliminate virtually all tariffs on goods and services. Not surprisingly these deals have become a welcome offset to Mr. Trump’s slapdash protectionism.
There are early signs of shifting trade patterns. Trade numbers for March showed a drop in Canadian trade with the U.S., while Canadian exports to other countries, including the Netherlands, Germany and Britain, climbed sharply offsetting most of the decline from exports into the US.
Canadian companies have also been receiving newfound support and encouragement from European leaders who are also facing a looming trade war with Mr. Trump. Two recent European trade shows have put Canada at the forefront.
“We are with you,” German Chancellor Olaf Scholz said to the Canadian contingent at the opening of the Hannover show, one of Europe’s largest trade fairs. “Canada is not someone else’s federal state. Canada is a proud, independent nation.” We couldn’t have said it better!
Some Canadian companies are in a sweet spot and stand to benefit from this change in mindset. Companies such as Canadian Pacific Kansas City Railway (Symbol CP, Listed on the TSX, recent price: $103.53) which is the only railway with a transportation network that flows from Canada to Mexico. CP shares, as with all the railways, has been damaged by the tariff threat, but longer-term, the company’s exclusive north south route should reap the rewards of increasing trade with Mexico that bypasses the elephant in the room.
BETWEEN A ROCK AND A HARD PLACE
What comes to mind when looking at President Trump’s tariff policy is the term “dynamic adaptability” or in you prefer plain English: “I have no idea what I’m doing, but let’s roll with it.”
The Administration is staring at a short timeline with US 2026 mid-term elections around the corner. Unless the US economy turns up before November 2026, we will likely witness a marked shift in the political pendulum.
Unfortunately for the adults in the room, Trump’s predilection towards structured spontaneity threatens to paint the Fed into a lose-lose corner: Navigate a recession or manage a period of stagflation.
As expected, at the May 7th Federal Open Market Committee (FOMC), the data-dependent Fed decided to remain on the sidelines by keeping their overnight lending rate unchanged. The principal concern was sticky inflation and the potential risk of stagflation for which there are no effective policy tools.
The Fed finds itself between a rock and a hard place. Trying to shift policy with so much uncertainty is the classic goalkeeper’s dilemma. Dive right to address inflation by keeping rates where they are, or dive left to counter weaker growth by cutting rates.
This is not a typical economic cycle where the Fed can draw from historical precedence. There is simply no scenario that allows for a pre-emptive rate cut which means the Fed will not cut rates based on soft economic data. It will need to see tangible hard data that definitively indicates slowing economic growth.
Economists are puzzled as to why the March employment and wage data did not square with the GDP growth trajectory. One possibility is the reluctance of companies to lay off workers during an economic cycle that is propelled by a misguided on-again-off-again tariff strategy.
If Trump decided to stand down before the onset of a major recession companies would be caught flatfooted trying to restock their labor pool in a tight labor market. For most companies, it is better to maintain their current employment levels for the next six to nine months to see how the tariff strategy unfolds.
That’s a problem and the Fed knows this. The Fed is also aware that if the employment data were to weaken they may be late to the game which could lead to a deeper recession.
Historically, Chairman Powell has epitomized patience. His seven-year track record is to wait patiently for data confirmation which prompts a rapid response. The seminal moment will be a marked shift in the US labor market or a change in consumer spending patterns.
Sometimes, the Fed sets interest rates with a focus on maximizing good outcomes. Officials did this last year when they cut rates because inflation was declining. Other times, the central bank makes decisions with a focus on minimizing the worst outcomes. That was the case in 2022-23. Back then, they hiked rates aggressively, risking a recession, to prevent high inflation from becoming entrenched.
According to the Wall Street Journal, “tariffs could force them into the latter course. Taxes on imports could push up prices in the short run while the uncertainty generated by their abrupt implementation could slow economic activity, delivering a whiff of stagflation. The risks of higher prices could make the Fed reluctant to pre-empt economic weakness by cutting rates. Instead, officials could focus initially on making sure a one-time rise in prices doesn’t fuel more-persistent increases.”
We agree with that assessment. The question is how decisively they will respond if concrete evidence of a deteriorating job market emerges. The case for cushioning the economy with lower rates would build as unemployment rises.
CFG INVESTMENT STRATEGY
While we have taken a position that trade wars are not a good thing, we must accept the fact that Trump may have a long-term plan. While not high on our list of possible outcomes, one cannot discount the fact that companies are moving production into the US market.
If the end goal is to encourage US manufacturing, we are assigning some weight to the possibility Trump may be right. To take advantage of this possibility we have a relationship with AGF and in some cases, clients hold shares in our CFG / AGF Global Select Fund which holds an overweight position in US technology and financial stocks.
The CFG / AGF Global Select Fund compliments our overweight positions in Berkshire Hathaway (symbol BRK.B) which are held in the CFG Option Writing Pool and CFG Conviction Equity Pool. The latter two pools also hold small positions in bitcoin and gold, the former being the classic risk-on trade, the latter a viable risk management strategy.
We cannot emphasize too strongly that we are experiencing a unique economic environment. One with no historical precedence which means we are applying a range of probabilities around numerous outcomes.
Recognizing that, we utilize hedging strategies that include covered call writing to generate tax-advantaged cashflow and some downside protection. That said, the portfolio strategies utilized in our various funds and models will vary i.e. some use bonds to provide ballast in portfolios. What you need to know is that whatever strategy is employed by our portfolio managers, the goal is to protect and enhance your wealth.
Richard N Croft
Chief Investment Officer