Kakistocracy (noun): government by the least suitable or competent citizens of a state.
– Oxford English Dictionary
For investors, 2024 was a stellar year despite fears that politics and geopolitics would wreak havoc on the markets. What better proof that politics don’t belong in your portfolio. Seasoned investors know macroeconomic fundamentals are the main market drivers, with politics and geopolitics sometimes briefly intervening. The events of 2024 also showed us that the economy is not the stock market, and the stock market is not the economy. Equity markets worldwide are simply baskets of shares in individual companies. Their fortunes are not necessarily representative of a country’s fortunes.
Election noise
This year, elections took place in countries home to more than half of the world’s population, a recording-breaking number. U.S. elections attracted the most attention. The incoming administration’s transition turmoil, impact on Congress, cabinet appointments and international ambitions are currently dominating headlines. Global populism has been rising for many years, but the groundswell was overwhelmingly unkind to incumbents – left, centre, or right leaning. While various issues jockey for prominence in any election, from an economic standpoint the main culprit this year was a populace determined to blame inflation on the party in charge. Democracy and capitalism go hand in hand. In the year just past, the capital markets’ faith in the institutions that underpin both was tested but held.
Keep politics out of your portfolio
Yes, politics can absolutely influence individual companies and sectors, but equity markets in the aggregate are primarily moved by the fundamentals of earnings growth and interest rates.
In the U.S., the worst case of a drawn-out, contested, potentially violent transition of power did not materialize. Despite assassination attempts and the unprecedented removal of a sitting president from the ballot fewer than 100 days before Election Day, U.S. stock markets led the world in performance, with the S&P 500 clocking a total return of 25% on top of last year’s 26.3%.
As of January 1, 2025, despite ongoing political drama, Canada has not joined the election fray. When the time does come, our views about politics and portfolios will remain the same for Canada. Capital markets care about company fundamentals, not politics.
The stock market is not the economy
The performance of several global stock markets in 2024 reinforces the point that the markets are not the economy. Canadian equities were among the top performers in 2024; despite a muddling economy, the S&P/TSX delivered a solid 21.7% total return. Fears of a swing to the far right in European politics didn’t fully materialize, although the French and German governments are in flux as their economies continue to struggle. Here again, the economy is not the stock market and vice versa. The German DAX stock market index rose 19%. On the other hand, France’s CAC 40 equity index was down 2% on the year.
Below-potential economic growth and a weak employment market aided Canada’s superior progress on inflation, setting the stage for the Bank of Canada (BoC) to be the world’s most aggressive rate cutter. The BoC cut five times, including two 0.5% jumbo cuts for a total of 1.75%. For the bond market, short-term yields were down while longer-term yields were up, resulting in a 4.2% total return for the FTSE Canada Universe Bond Index. The growth, inflation and interest rate differential between Canada and the U.S. has the loonie at 20-year lows (US$0.695 or C$1.44).
The takeaway from all this confusion: the stock market is a market of stocks of individual companies, often with unique circumstances, and is not necessarily a representation of a country’s fortunes. For developed markets (like the U.S., Canada, Europe, Japan and others), democracy, the rule of law, and modern, globally interconnected financial systems allow companies to call these jurisdictions home and enable strong, globally oriented companies to shine despite a weak local economy or shaky politics.
Although it’s counterintuitive to some, a struggling domestic economy could mean that local firms’ currency and interestrate environment are favourable. Germany and Canada serve as examples. They have relatively better government balance sheets, but their weak economies are driving low interest rates and weak currencies, which are advantageous for exporters and, in turn, both countries’ stock markets.
The United States over all
Currently, the U.S. is the most welcoming place on earth to capital. The equity market’s outperformance and the U.S. market’s sheer size have been described as U.S. exceptionalism. We don’t see this as U.S. exceptionalism; we’d call it global exceptionalism, which happens to locate itself in the most favourable geography available. For all the U.S. is – and isn’t – these days, it still delivers plenty of what companies need to thrive. It grants access to the world’s deepest pool of capital (largest stock and bond markets) in the world’s most accepted currency, in the world’s mostspoken and primary business language. It offers sound physical and social infrastructure (democracy, a trusted legal system, healthcare) that supports growth, productivity and innovation. World-class higher education provides access to labour, which increasingly must be highly skilled.
It isn’t that other places aren’t good or that the U.S. is perfect – far from it. However, we shouldn’t be surprised that so many of the world’s largest companies choose to call the U.S., and the S&P 500, home.
Is there a limit to U.S. exceptionalism?
Outperformance of the U.S. equity markets is drawing comparisons to what happened in the dotcom era. As in 1999, today the market capitalization of U.S. stocks is more than twice the size of the U.S. economy. Should investors take heed? We see it differently. Many U.S. companies, certainly the largest ones, are global companies. Therefore, it isn’t just the U.S. economy that matters; we should crosscheck the value of U.S. stocks against the value of the global economy.
For example, in 1999, U.S. stocks were valued at twice the U.S. economy and were equal to the value of the global economy. Conclusion: they were overvalued, a judgment validated by the market selloff between 1999 and 2003. Contrast that to 2024. Today, U.S. stocks are equal to the value of twice the U.S. economy, but only a little more than half the value of the global economy. If there is a limit to U.S. exceptionalism (we say it’s global exceptionalism with no limit) we could be far from it.
If not politics, what was it?
In 2024, the overwhelming narrative was improvement and positive surprises. The global macroeconomic backdrop ended up in better shape than expected. Economic growth outside the U.S. was better than expected (i.e., not negative). For the most part, strong economic growth wasn’t the goal because that could hamper the battle against inflation, which had yet to be tamed. However, in many countries, inflation is back to target, and growth is returning as the key goal. The U.S. remains a bastion of strength, but inflation is loitering and fears are lingering over an inflation redux.
Global equity markets were buoyed by the prospect that at least the weak growth and waning inflation would allow central banks to continue cutting interest rates (which they largely did), thus stimulating where necessary and setting the stage for nascent recoveries to continue. This is coupled with a continuation of solid U.S. growth, while U.S. inflation cooled enough that the U.S. Federal Reserve was able to deliver three cuts totalling 1%. In addition, China continued to pull levers to stoke growth in its economy. Beijing may stimulate more aggressively into 2025 since the economy remains weak and inflation hovers near zero.
The cloud of tariffs and geopolitics remains. For now, bond markets, central bank expectations, and currencies are the primary areas seeing adjustments. The movements in these shock absorbers, coupled with world leaders’ and corporate titans’ deferential attitudes toward the incoming U.S. administration, have put tariff fears on simmer for now.
Much of 2024 was a Goldilocks scenario, not-too-hot, nottoo- cold, thanks to positive surprises on inflation, economic growth, interest rates and corporate earnings. This set up a positive backdrop for global equities, leaving some areas of the global equity landscape richly valued. Valuations are a consideration, but earnings growth is the most powerful driver. We remain constructive on earnings growth and the prospect for capital markets.
Our strategy – Balanced with an equity overweight
We have maintained varying degrees of overweight exposure to equities for the last two years, including carrying an equity overweight throughout the current strong equity market rally that started in October 2023.
We remain overweight U.S. and Canadian equities, neutral to international developed markets (Europe and Japan), and underweight emerging market equities. Within fixed income, we are overweight investment-grade corporate bonds and underweight the lowest quality borrowers in high yield.
We have an appetite for letting winners run, but within reason. In portfolios where market movements pushed equity weights beyond our risk tolerance, we harvested gains in keeping with our well-balanced, disciplined process. Those trimmed positions were deployed into cash and fixed income, taking advantage of the solid income available and ensuring a level of safety should the backdrop sour for any reason.
Additionally, we maintained exposure to small- and midcap U.S. and Canadian equities, taking advantage of our high-quality, active portfolio-manager expertise in these areas and broadening our exposure, seeking to exploit less expensive areas of the market.
The last word – Do we get the politicians we deserve?
The Economist chose kakistocracy as its word of the year. One of the internet’s top lookup words in November, it’s a “snappy encapsulation of the fears of half of America and much of the world,” the magazine said. Kakistocracy is related to the idea that the electorate gets the politicians it deserves – a hotly debated sentiment. However, it’s not debatable that social media is taking on a more significant and perhaps outsized role in shaping political outcomes. Unfortunately, social media’s role and its intersection with politics isn’t universally constructive. It allows the worst elements of polarization-masquerading- as-policy to go viral.
Renowned 19th century political historian Alexis de Tocqueville once wrote, “It is easier for the world to accept a simple lie than a complex truth.” Two centuries later, social media embodies this statement. People seem crankier these days; social media contributes to the problem. Feelings of discontent naturally thrust populist politicians to the forefront. Democracy faced many tests in 2024; we can expect more in 2025. This isn’t new: history shows that democracy is fragile and requires constant nurturing and defence.
Democracy is essential to capitalism, and capitalism is essential to progress and innovation. The prospect of a fresh age of innovation is spurring positive sentiment in the equity market. Equity markets have come a long way, and we believe have more room to go. However, in the short term, equity markets may be ahead of themselves – a routine propensity. We have been writing about sentiment and bubbles for over a year in these monthly commentaries. We continue to see a backdrop where investors need to be prepared for normal, run-ofthe- mill 5% to 15% corrections. These corrections cleanse exuberance, offer opportunity, reward patient investors and set the stage for the rally to extend.
Continued political uncertainty and deliberate disruption could bring a bout of volatility. We repeat: keep politics out of your portfolio.
The last 16 years have seen a financial crisis, four different U.S. presidents (two from each party), Brexit, Crimea, broad U.S. tariff increases, NAFTA to USMCA, trade wars with China, a pandemic, wars in Ukraine and Gaza, to name a few significant developments. Volatility accompanied all of it, yet global equity markets remained an excellent place to grow wealth. From December 31, 2008, to December 31, 2024, the total return of the MSCI World Index in Canadian dollars stands at 607% or a 13% compound annual return.
For our comprehensive views on how 2025 will unfold, see our 2025 Capital Markets Outlook: Bunches and Punches.
To you, our clients, we offer heartfelt thanks for your faith and trust in us, allowing us the privilege of working on your behalf. Our responsibility to you always comes first.
Best wishes for 2025.
Please contact your Investment Counsellor if you have any questions or would like to discuss your investments.
