As uncertainty clouds the Canadian economy, Vanguard offers an outlook

Versions of the word “uncertain” occurred four times in the Bank of Canada’s relatively short announcement of an interest rate hold yesterday, and twice in the announcement’s first paragraph. The persistent unknowns around US trade policy — including tariffs against both Canada and global trade partners — has cast a pall over this country’s economy and left some of the most well-informed decision makers in this country without a clear roadmap. In that environment, Vanguard has offered an outlook and a methodology that they believe can help investors and advisors now.

The asset management titan has offered a Canadian economic outlook for 2025 which sees growth settling to 1.25 per cent by year-end. They predict the unemployment rate will hit seven per cent, core inflation will sit at 2.5 per cent, and interest rates will be cut a further fifty basis points to 2.25 per cent. Despite a somewhat mixed outlook for the economy, they remain relatively constructive on Canadian assets, in the context of a framework that accounts for various likelihoods.

“The first principle really would be to be humble with risk, and particularly risk that's unknowable. So they could be either disruptive risks that could come without warning, or they could be other kinds of policy risks,” Says Ashish Dewan, Senior Investment Strategist at Vanguard. “The second principle is to be broadly diversified in your asset allocation. Our chief economist recently offered a view that instead of predicting one outcome, we should prepare for three different outcomes.”

Dewan explained that the three outlooks for the US and global economies offered by Vanguard should help inform Canadian advisors. The first outcome he sees is a US economy that rests around two per cent growth and inflation over the next decade. His view, however, is that there is only a 10-15 per cent chance of that occurring.

While the ongoing issues with US debt and aging demographics may be set to create that period of slower growth and higher inflation, Vanguard’s base case is that the productivity gains promised by AI — should they materialize — ought to result in a higher US growth rate, of around 3.1 per cent, with bond yields staying around their current levels and inflation coming down.

The third and final case that Vanguard sees is a risk that debt and demographics become an anchor on growth. Bond returns would come via coupon clipping rather than price changes, inflation and treasury yields would rise.

In planning for all three possible long-term outcomes, Dewan prefers a tilt towards value stocks and fixed income in portfolio allocations. Even if AI’s promises manifest fully, he expects value companies will also see those benefits in their own earnings. Within that view he holds a preference towards Canadian stocks due in large part to the value tilt in Canadian equity markets. He notes, though, that his positive view of Canadian stocks runs contrary to a more muted outlook for the Canadian economy.

With q4 GDP growth revised down and q1’s surprisingly positive GDP numbers skewed by an excess of US pre-tariff imports, Dewan highlights a more challenged picture in Canada. He notes that domestic demand contracted in q1 and the new doubling of steel and aluminium tariffs imposed by the US should exacerbate an already worsening unemployment problem. Core inflation, too, should remain somewhat elevated which may keep the Bank of Canada from further rate cuts.

In looking to reassess Vanguard’s outlooks for Canada, Dewan notes that his firm will be looking at inflation expectations. As of now those forward expectations have increased slightly but are not “terrible.” If longer-term inflation expectation numbers start to increase significantly, that may be enough for Vanguard to adjust their outlook. A more significant increase in unemployment, too, would cause a reassessment of that overall outlook.

Given that view, advisors are left with the somewhat unenviable task of presenting Canadian stocks in a more positive light while acknowledging the structural weakness in the Canadian economy. Beyond simply highlighting the fact that markets and economies are not directly correlated, Dewan suggests framing any kind of rebalancing or reallocations to Canada in a global context.

“US markets represent around 63-64 per cent of global market capitalization, that’s a substantial component and we just don’t see that US exceptionalism persisting into the future,” Dewan says. “Valuations are very elevated. PE multiples are literally twice what they should be. Going back to Canada and that value tilt, we look at a number of factors including the dividend payout ratio, which is much stronger in Canada because of the tilt towards value stocks. We’d say valuations are also going to be more attractive in Canada and we see the currency impact of a decline in the US dollar.

“The simple answer, though, is not to anchor off the last ten years because it might not be representative of what’s going to happen.”