Coming into this week’s US president inauguration, investors were understandably on tenterhooks.  Donald Trump had promised everything under the sun to his base, including hammering trade partners with blistering tariffs, slashing taxes, deporting 11 million immigrants, ramping up oil and gas production, protecting the border and setting lose those convicted of crimes during the January 6th Capital riot. Would the recovery in stocks last week sputter and would economic doomsayers have their day? Well, after two full trading sessions the barking has calmed down and there have been few bites. In fact it has been downright boring on a Trumpian relative basis.

Following the initial post-election bounce in risk assets, investors started to get cold feet when memories of tariff fiasco of Trump 1.0 started coming back. And, as I have discussed before, there was also a realization that large-scale tax cuts could push the U.S. over the edge in terms of its fiscal position, inviting a harsh response from global bond holders.  In the lead up to inauguration, the level of anxiety crept higher alongside renewed concerns that the trend decline in inflation was coming to an end. Volatility, as measured by the VIX index, was not back to the levels seen earlier in December but we came close to a break of 20 by January 10th as shown in the chart below.

Things actually started to calm down prior to this week – once again a reminder that perceptions of volatility don’t always match the actual gyrations in the market. Over the last several weeks we have reminded clients that if your weather map shows a storm coming, you don’t start spinning the steering wheel back and forth. As much as Trump 2.0 looks like a storm that requires a completely different playbook and drastic shifts in portfolio strategy, it is the investing 101 textbook that needs to be read right now. Based on what we have seen this week that is exactly what institutional money is doing.

In the case of Trump, tariff reality has not matched campaign rhetoric. Yes, the new administration just announced a 10% tariff on Chinese imports, but this is a far cry from promises of a 60% hit. Canada and Mexico remain in the crosshairs of a 25% across-the-board tariff, but the timing has been pushed out to February 1st. Even that date is suspect given that out of the other side of his mouth he has said that the Commerce and Secretary departments will undertake a study on tariff impacts over the coming three months.

Thursday’s speech by Trump to the World Economic Forum in Davos, Switzerland was, at the very least, entertaining. First, he urged global companies to manufacture their products in the United States and in return, he offered incentives such as low taxes. At the same time he warned that those choosing to produce elsewhere would face tariffs, aiming to bolster U.S. manufacturing and reduce the trade deficit. He also went after OPEC to reduce oil prices, even though (as I discussed in last week’s newsletter) we are already on course for a situation of excess supply in 2025. He went after the European Union for what he believes are unfair trade practices and threatened to hit the region with tariffs.

But my favourite was his call for an immediate reduction in interest rates in the U.S. and elsewhere. Well, if your own Federal Reserve is independent from the policy yearnings of the White House, I’m not sure how compelled other central banks feel about delivering on rate cuts.  The Bank of Japan actually raised rates Friday morning by a whopping quarter of a percent, taking the bank’s key rate to 0.5%.  As small as this sounds, it is the highest rate Japan has seen in 17 years.   And for good reason.  Inflation is up close to 3% and the Japanese yen is trading at the weakest levels against the American greenback since 1990. As you can see from the above chart, there is room for the yen to depreciate further and that would argue for a tightening in monetary policy.

So if we can steal ourselves away from Trump 2.0 banter for a bit, what does the textbook tell us to do? Well for one, we need a strategy that has a shelf life of more than a few days – the kind that you stick to when looking out over a long-term time horizon. For funds this will mean following their investment mandates and for retail investors it will mean adhering to an investment policy. That doesn’t mean we don’t make tactical changes, but without hard evidence to validate a shift, you stay the course.

Next we need to pay attention to economic and market fundamentals. Granted, there are bifurcations among nations in terms of economic activity.  The U.S. continues to deliver results that are largely better than what economists expected to start the year with and even Canada has shown some resilience in recent weeks. The major European economies continue to struggle, yet Europe’s periphery is doing well (i.e., Spain). China can’t seem to pop the clutch on growth, though authorities still predict a 5% pace of real GDP growth for 2025, yet India remains strong. From a domestic market perspective however, the fact that U.S. and Canadian economic fundamentals are still healthy helps to support the soft landing (or no landing) view. And if you can generate real GDP growth of 2-3% in 2025 with an inflation rate of 2%, then that sort of nominal growth also supports corporate revenue forecasts this year.

The resiliency in the U.S. economy has also provided a continued tail wind for corporate revenues and earnings.  This past week we saw a decent cross-section of companies that beat market consensus, including Adobe, Netflix, J&J and United Airlines.  There are two ways that we can see stocks continue their uptrend through 2025.  One would be through multiple expansions, or higher price/earnings ratios. We have seen this play a role since the election as investors factor in pro-growth policy promises like lower taxes and deregulation to higher expected earnings.  At some point, earnings have to catch up with expectations, but as long as the economic environment remains solid, and these promises are implemented then we can see stocks head higher without price/earnings ratios getting overdone.

Again, the risk to this is an aggressive delivery on tariffs. This would likely cause both revenues and earnings to be negatively impacted, with some sectors hit more than others. Depending on the time horizon with which we see this drag, the earnings drag would probably be reflected in stock valuations. We typically think of tariffs hitting the goods sectors of the economy, but we also have to bear in mind that the next stage of the artificial intelligence (AI) driven tech wave will require implementation by companies. That requires a healthy income statement, increased borrowing or reduced share buybacks – or all three. In other words, tariffs could indirectly derail the AI party.

Finally, if this already buoyant economy is stimulated by things like tax cuts and Trump pulls out a tariff pea-shooter instead of a bazooka, then this will most likely put a floor under inflation and where interest rates go. Whether or not this also coincides with a trend of higher longer-term yields will depend on if improved growth can allay concerns over debt growth. If yields push higher, as I have discussed before, then growth stocks will also likely see valuation declines.

Bottom line, we are pleased with the fact that this first week of Trump 2.0 produced little in terms of his more damaging policies, both for tariffs and immigration. This has allowed for a calmer entry to these four years than what investors may have feared, but we cannot take our eye off the road (or snowmobile trail).  There are some sectors where we have a higher degree of confidence over the near-term, including U.S. financials, natural gas pipelines and utilities.  We still like Canadian bonds over U.S. bonds and remain higher weighted towards short and medium-term corporate debt. Let’s just hope that Trump doesn’t get too bored with this calm.

On behalf of the Pyle Wealth Advisory team, have a wonderful weekend.

Andrew Pyle