Rhythmic Reasoning_Full Report_Final_EN - Flipbook - Page 48
THE DRUMMER'S EAR | RHYTHMIC REASONING
have also continued to lower monetary policy rates, with the Fed
joining the fray in September.
decided to keep only a modest overweight to this market with a
bias to higher quality names with pricing power.
Fig. 1: Consensus recession probabilities remain relatively low
across the major economies
Unlike the U.S., domestic markets like Canada and Mexico are
heavily weighted toward cyclical industries that are relatively more
sensitive to commodity price swings. Such companies tend to
be “price takers,” and their profitability is heavily dependent on
market and economic factors. In Canada, for instance, export
activity to the U.S. has already begun to decline. Canadian
businesses will ultimately need to choose between lowering prices
to absorb some of the tariff impact or leave prices unchanged at
the risk of losing market share to substitutes.
100%
75%
50%
25%
0%
Jan 2024
Jul 2024
U.S.
Canada
Jan 2025
Mexico
E.U.
Jul 2025
U.K.
Source: Bloomberg Finance LP, Scotia Wealth Management | Chart shows consensus
year-ahead recession probabilities
Volatility is now back to normal levels but is at risk of picking back
up depending on how trade policy evolves. Specifically, U.S.-China
trade issues, while having improved, are far from being resolved
as a trade deal has yet to be firmed up. In 2026, the USMCA
trade negotiations could fuel uncertainty further given the closeknit trading relationship between the three countries.
And, of course, the inflationary impact of tariffs is not yet known.
While tariffs have not shown up materially in the inflation data,
the latest Purchasing Managers’ Index report from S&P Global
attributed higher input costs to tariffs, adding that “weaker
demand and stiff competition reportedly limited the scope to raise
selling prices.” This suggests that corporate profit margins are
being weighed down by tariffs, underscoring the need to hold highquality companies with sustainable competitive advantages and
pricing power in investment portfolios.
This is not to say that investors should shun their domestic
markets. Canada, for instance, boasts several high quality
companies across the financials, utilities, and telecommunications
sectors. The country’s Federal government has also signalled a
shift to more proactive fiscal policy, which may provide support for
domestic growth, with more details to be revealed in the upcoming
Federal budget.
We hold a neutral allocation to international equities. Germany,
the eurozone’s largest economy, lifted its debt brake and is
spearheading a fiscal push focused on defense and infrastructure.
These initiatives should provide support to the bloc’s economy
and help to offset the political turmoil in France. In other markets,
Chinese growth is expected to slow barring another significant
policy push, while Japanese growth should remain relatively stable
as the country gains a semblance of clarity after negotiating a trade
deal with the U.S.
Economic factors aside, a look at the fundamentals shows us that
the world’s major equity markets are richly valued. The 12-month
forward price-to-earnings ratio for the S&P 500, the MSCI ACWI ex.
U.S. Index, and the S&P/TSX Composite are all above their longterm historical average. Mexican equities are an exception when
compared to the long-term historical average, but valuations there
have also run up since the start of the year (Fig. 2).
As we have discussed in previous iterations of this publication, such
high-quality companies are often found in growth-oriented sectors
like technology and healthcare and are well-represented in the U.S.
market.
Concentration risk and elevated valuations are also key
considerations that could cause performance to skew one way or
another due to handful of companies. In light of these risks, and
despite the long-term potential of several U.S. companies, we have
25
20
12-mth fwd P/E
That said, the U.S. is not without its own idiosyncratic risks. Political
risk is a big one that comes to mind, but this may diminish
somewhat as the administration tries to curry favour with the
voters in preparation for the 2026 midterm elections. As we
discussed in the U.S. section of this report, we think the midterms
will likely split up control of Congress, putting an end to the
legislative part of Donald Trump’s second term unless the two
parties engage in bipartisan cooperation. Ultimately, this reduces
the likelihood of transformative fiscal policy that could disrupt
market sentiment and risk appetite.
Fig. 2: Valuations are stretched across
many of the world’s equity markets
15
10
5
0
U.S.
International
Avg since 2010
Canada
Start of year
Mexico
Current
Source: Bloomberg Finance LP, Scotia Wealth Management
This is somewhat offset by expectations of healthy corporate profit
growth in these markets. After a strong showing on the earnings
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