Marc Foran, CIO

March 31, 2025

Q1 2025

Global markets began Q1 with measured enthusiasm, particularly in the US given the Trump administration’s stated goals to reduce taxes, deregulate, combat inflation and incentivize reshoring of key manufacturing sectors. Investor sentiment shifted in early February as Trump quickly implemented harsh and confusing tariff policies on the United States’s closest trading partners. The result was a reduction in risk appetite for investors and a reallocation towards more defensive asset classes. Within this environment, global equities ended the quarter in negative territory (after posting solid gains in January) while global investment grade bonds generally posted positive returns as yields contracted.

Macro Environment: US Policies

US policies were the big Q1 story as sentiment shifted mid-quarter from a bullish tone – particularly for sectors expected to benefit from Trump policies like deregulation and from the paring back of climate and Diversity, Equity, and Inclusion (DEI) initiatives (for example, banks) – to one of broad caution and uncertainty. At the heart of this sentiment shift were US tariffs announced in early February on Canada, Mexico and China, and discussion regarding US reciprocal tariffs on the world which were announced in early April. In particular, investors had a number of concerns regarding tariff policies driven by i) the on again-off again nature of tariff announcements, ii) unclear and often contradictory statements by the Trump administration regarding the goals, logic and rationale for tariffs (for example, implementing tariffs on Canada as a tool to halt the entry of fentanyl to the US) and iii) fear that retaliatory tariffs by affected countries would compound negative economic consequences for the global economy. As a result, business, consumer and global investor uncertainty sky-rocketed during the quarter. As we’ve previously highlighted, uncertainty could lead to reduced spending with material economic consequences and elevated levels of volatility for markets more broadly. The pace of change from confidence to uncertainty during the quarter was remarkable – the Conference Board Consumer Confidence Expectations index dropped from a robust 86.5 at the end of Q4 2024 to a dour 54.4 in March (a level last seen during the recession of 2008-09), and the University of Michigan survey of Business Conditions Expected During the Next Year recorded one of its fastest and steepest drops in history.

Public Markets: Optimism Gives Way to Uncertainty

Global public equity markets begun Q1 in positive territory following a strong Q4 2024; however, the 2025 introduction of tariffs caused a broad-based selloff, particularly in US and small- and mid-cap equities. The MSCI ACWI finished Q1 down 1.4% in Canadian dollar terms, led by a 5.7% decline in US stocks (based on the S&P 500 index) and a 3.8% decline in Japanese equities (based on the Nikkei 225 index). Bucking the trend was MSCI Europe, which rebounded 9% following a relatively weak Q4. The narrative from public companies shifted dramatically in Q1, particularly for US companies where Q4 2024’s enthusiasm was replaced by recessionary fears. We saw a common theme of “uncertainty” as companies reported Q1 earnings. Furthermore, company outlooks are increasingly mentioning the material negative impact of tariffs on earnings growth expectations.

We continue to view US equity markets as overvalued given the rich price-to-earnings valuation of 24.0x for the S&P 500 at the end of Q1. The excessive valuation continues to be driven by mega cap technology stocks; excluding these companies, US markets trade at more acceptable levels. Relative to the US, European equities appear more reasonably valued at 15.0x. However, we note that Europe’s largest stocks have higher exposure to geopolitical shocks and global economic growth than US or Japanese equities.

In the current environment we believe investors should remain cautious in their public equity exposure by remaining underweight or outright avoiding frothy areas of the market because history suggests that the long-term earnings growth required to justify these excessive valuations seems unlikely to materialize. We also prefer service-oriented equities and companies with relatively price-elastic end markets that derive their sales from local markets or, conversely, diversified global markets, and ideally with limited exposure to import-export markets in the US. We remain wary of cyclical stocks and those exposed to the US consumer, given continued weakness in spending and personal credit trends.

Global bonds experienced largely positive results in Q1, with the Bloomberg Corporate Investment Grade Bond Index finishing the quarter up 2.9%. The bulk of the quarterly returns were realised after tariffs were announced when investors, seeking to reduce portfolio risk, generally rotated out of equities and into bonds. The flight to quality was also evident in relative spreads as US high-yield credit widened 60bps relative to treasuries and 50bps relative to investment grade bonds. European corporate bonds were down 0.2% in the quarter. Going forward, US tariff policy uncertainty could create increased volatility in bond prices, particularly in longer duration and lower quality credits, as investor sentiment oscillates between fears of rising inflation and a slowing economy. Our view remains that the Trump administration is unlikely to implement inflationary policies over the long term (but is likely to do so as a negotiating tactic over the short term) given that inflation was one of the key voter concerns that resulted in Trump’s election. However, we acknowledge that, in the short term, risk and uncertainty could remain elevated.

Private Markets: Exits Remain Challenging for PE/VC; Cracks Showing in High-Leverage Private Debt

Private market participants entered Q1 optimistic that deregulation in the US and buoyant public market valuations would create a favourable backdrop for private equity and Venture capital (VC) exits. It was also anticipated that the mood seen in public markets would bode well for private equity and VC funds raising capital. This was indeed the case during January, when total private equity and VC exits increased. However, the impact of US tariff policies caused sentiment to quickly evaporate in February and activity to slow down materially, resulting in a quarterly decline in total number of global and US private equity and VC exits. The average holding time of investee companies remains elevated for PE/VC funds at six years, higher than the 5.5 years achieved during a more favourable exit market in 2022. It was a similar story for fundraising, which remained subdued in Q1, particularly for smaller and first-time fund managers. In Canada, deal value and volume trends were further hampered by US trade war angst and upcoming Canadian elections. In response, the Business Development Bank of Canada announced $500M in new funding for the Canadian Growth Venture Fund and $450M for the Growth Equity Partners fund. These investments are intended to support Canadian growth-stage technology companies experiencing fundraising challenges in the current environment.

Broadly speaking, signs of stress are being seen in private credit markets due to tightening liquidity, elevated business uncertainty, renewed fears of inflation (driven by tariffs) and rising borrowing costs/spreads for lower quality credit issuers. As a reminder, approximately 51% of the private debt market is in leveraged buyout deals by private equity managers. Conversely, impact private debt tends to focus on a mix of project financing, community lending and SME financing. We believe that all else being equal, non-impact highly levered private debt tends to outperform impact private debt opportunities during favourable economic environments (that is, periods of growth, normalized inflation and high business and consumer confidence); but during economic downturns, highly levered private debt experiences a more severe decline in credit quality (and thus more downside risk). Given that the global economy is slowing and that according to Bloomberg over 40% of private debt borrowers have negative cash flow (vs. 25% in 2021) we expect increasing stress for the private debt asset class. However, we also are seeing select impact private debt opportunities, particularly those financing high-quality projects and/or equity-deserving groups, that are relatively more attractive from a credit quality standpoint. We therefore recommend that investors remain nimble in their approach to private debt allocations, with a keen focus on higher quality credits that can weather a period of economic stress.

Outlook: Volatility is Likely to Remain Elevated

Market volatility is likely to remain elevated given the high level of uncertainty regarding US trade policies and the potential for a material slowdown in the global economy. However, we also acknowledge that a pullback in tariff policies, potentially as deals are negotiated, could rapidly improve the outlook for the economy and result in a quick runup in security prices as markets recover lost value. This makes navigating current market conditions particularly challenging. Thus, we suggest that investors take a measured and diversified approach to their portfolios that is focused on the long term rather than short-term asset price fluctuations.

Within public markets we prefer global equities of companies that have i) diversified global businesses, ii) limited reliance on exporting to or from the US, iii) businesses that are less sensitive to economic cycles and iv) companies with compelling valuations. We also favour high-dividend-paying stocks that have a consistent history of growing the dividend over time. Frothy areas of public equities (for example, mega-cap AI technology), companies with excessive debt/leverage and companies with negative free cash flow should be avoided, although we note that these stocks are likely to outperform as the market recovers and underperform during periods of market declines. We also suggest reviewing if an overweighting in i) medium duration (4-10 year maturity) investment grade US corporate public bonds and ii) low-correlation private real assets that provide inflation protection alongside favourable returns/yields are appropriate for your portfolio.

Public Equities – We see heightened risk of a global economic downturn as trade wars and negative policies intensify. In general, we believe investors should remain opportunistic given expectations for rising volatility. Our overall outlook is as follows:

Positive Outlook:

• Health services and growth technology stocks that help health providers improve efficiency, lower costs and enhance value-based care
• Defensive sectors (such as utilities) and high-dividend-paying companies
• Companies that address infrastructure deficiencies or labour shortages and that enhance productivity of critical industries like agriculture and health care
• Clean energy and energy efficiency companies with commercially viable solutions and limited dependence on government regulation

Negative Outlook:

• Consumer discretionary companies
• Areas of the market trading at lofty valuations (for example, mega cap. tech)
• Cyclical sectors of the economy
• Companies with environmental and climate solutions that require government policy/subsidies to remain viable

Public Debt – Bond markets are likely to remain volatile given the high degree of uncertainty regarding Trump’s policy effects on inflation and ultimately interest rates. We recommend a nimble approach seeking to add long-duration investment grade corporate, green and social bonds to portfolios during market pull backs.

Positive Outlook:

• Fixed medium term bonds (4-10 year maturity)
• Global, developed market, investment-grade government and corporate bonds
• Canadian investment-grade government and corporate bonds

Negative Outlook:

• Cyclically sensitive areas of the economy such as global high-yield bonds, emerging market bonds and mortgage- and asset-backed securities

Real Assets – We continue to favour assets associated with natural capital, such as farmland, given that the demand for agricultural goods tends to be stable even during poor economic times. We continue to like (non-office) REITs in non-cyclical sectors, such as health care and to a lesser extent communications. We also believe that investments related to forest management or restoration and clean water scarcity are attractive for long-term investors given the need to mitigate the impacts of climate change. Notwithstanding specific portfolio targets or impact areas, we would limit exposure to housing-related opportunities although we note that affordable apartments tend to be less cyclical than market-rate apartments.

Alternative Assets – We continue to favour market-agnostic investments that have low correlations to other asset classes, thereby reducing portfolio volatility. As an example, we believe that impact litigation funds which provide marginalized individuals and communities access to the justice system, should produce returns that are independent of prevailing economic conditions (based on the performance of non-impact litigation funds which have similar dynamics, although support different litigation case types).

PE/VC – We believe that investors under-allocated to private equity and venture capital will find the 2025 vintage of new funds entering the market to be particularly well positioned to deploy capital towards impact opportunities with less competition for deals and potentially lower valuations relative to vintages of 3-5 years ago when competition between funds for deals was significantly higher. We also believe that the poor exit environment for VC/PE funds provides an opportunity for investors to acquire LP units on secondary markets and often at material discounts.

Private Debt – For impact investors willing to accept below-market rates of return, we recommend longer duration impact credits with fixed coupon payments, particularly in Canada, where spreads to traditional debt markets have narrowed. For investors seeking market rates of return, we see a limited number of deals in Canada but have identified several impact opportunities out of the US and more globally.

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