Why financial markets may have finally returned to a post-GFC 'normal'

Brent Joyce believes that in 2024 financial markets finally returned to normal. The trouble with a statement like that is how frequently the goalposts for ‘normal’ have moved in the past decade. Joyce, Chief Investment Strategist and Managing Director, BMO Private Investment Counsel Inc., defines normal as a return to some of the conditions we saw before the great financial crisis. He sees a return to a period before the risk-free rate was pushed to all-time lows by quantitative easing and zero or even negative interest rates. Now, as interest rates sit in the 3-4 per cent range and inflation falls to a number that starts with a two, Joyce sees a reset and a reason for some optimism among investors going into 2025.

“We had 15 plus years of this low-interest rate environment that I think is quite poisonous for society. Households make poor decisions when money is cheap. Governments waste money when it's cheap. Businesses do to, with whole notion of zombie companies. So that's at the heart of what's abnormal, because the risk-free rate was 50 basis points or 1 per cent,” Joyce says. “Now the risk-free rate is not trivially small any longer…We’ve gone through the bullwhip of the pandemic and everything else, but what we’ve landed on is that we’ve fixed the problem that predated the pandemic: low inflation and low bond yields.”

In the context of a normalizing US and Canadian economy, Joyce sees upside in US stocks within the context of an appropriately diversified portfolio. Despite expensive valuations he believes there are pockets of value in US stocks. While he argues that investors should look at diversification beyond the S&P 500, he thinks there are plenty of opportunities beyond the most highly valued names. Moreover, Joyce notes that most of these US names have earned their valuations, they’ve delivered massive earnings growth, which never comes cheap. There are also plenty of names within the S&P 500 that haven’t hit some of the multiples that the mega-caps have, which Joyce says his team of active managers have worked to identify.

While Joyce is optimistic about 2025 on markets and for the US and Canadian economies, he is cognizant of a wide range of risks. Chief among them is if we see a rise in bond yields driven by a specific set of circumstances. Joyce notes that if bond yields rise because of resurgent inflation — whether as a product of tariffs or another reason — then equities should be able to continue along, especially as inflation typically reflects GDP growth and growth in earnings.

However, if bond yields rise because of large deficits and spending in the United States then Joyce argues markets have a serious problem. That scenario is akin to what British markets did under the short-lived tenure of Prime Minister Liz Truss, when she proposed a program of tax cuts so dangerous to the UK’s balance sheet that it shot interest rates sky high.

Joyce notes, though, that we aren’t sure just how much impact Trump will have on US deficits. While he seems set to ramp up spending, there could be some controls in the form of revenue from tariffs and proposed cuts to government spending through the new so-called “department of government efficiency.” Moreover, there should be some tolerance for an uptick in yield and so long as US 10-year bond yields stay below 5 per cent the global market should continue to function.

While Joyce sees value and risk in US markets, he believes the most compelling case going into 2025 is actually in Canada. Despite the weak prospects for the Canadian economy, Joyce sees Canadian equities as the “most compelling, reasonably priced choice.” He contrasts Canadian stocks with the expensive US market, and the high volatility that can be found in Europe and China. He adds, too, that most of the stocks listed on the TSX are extremely global businesses with considerable exposure to the US economy, giving them the ability to capture US upside at Canadian valuations.

“I think many people should be saying diversify outside the US and look at Canada,” Joyce says.  “Historically, when the light goes on for Canadian equities, and they go into the sunshine and they've been in the darkness for 15 years, it doesn't take a lot of global inflows to the Canadian market to put a big juice into the TSX, and then at which point we might be having a conversation about how Canadian stocks got pretty expensive.”