Commentary

BMO ETF Portfolios’ January commentary: “Hazy Shade of Winter”

Despite blurry outlook as 2025 begins, the title was almost “I Don’t Like Mondays”, as the first day of the first full week following the holidays did not fail to disappoint.

January 16, 2025

Share

Portfolio Activity:

  • China: Stock replacement via call option: given the underperformance of China versus the rest of world and anticipating China’s stimulus announcement, we closed out our physical China holdings, replacing them with a call option on an A-shares ETF as we believe volatility will increase after Trump’s inauguration. This has worked in our favour, as China lagged since we opened the position, demonstrating the benefits of options’ asymmetrical return profile.

  • Added USD/CAD hedge: given the run-up of USD/CAD after Trump’s tariff threat, we hedged a portion of our U.S. equity overweight back to Canadian dollars. We think the tariff threat is overblown, but will increase our hedge should the loonie depreciate further, with net short positions more extreme than March 2020, the inception of the COVID pandemic.

  • Trimmed U.S. Banks: we took profit on roughly half of our holding of BMO Equal Weight US Banks ETF after a huge rally post-election. This worked in our favour as banks lagged more than the broad S&P500 Index after we took profit. We kept half of the position as we still believe in U.S. banks’ continued leadership, given expected deregulation and steeper curves throughout 2025.

  • Increased Canadian Duration Overweight: given our equity overweight, we increased our fixed income duration to balance the portfolio risks. While U.S. yields have led the way higher, Canadian rates have remained more subdued, with expectations of continued cuts much more probable than those from the U.S. Federal Reserve.

Hazy Shade of Winter”

Despite blurry outlook as 2025 begins, the title was almost “I Don’t Like Mondays”, as the first day of the first full week following the holidays did not fail to disappoint. “Trump tariffs will be lower” reported the media, followed by “No they won’t” from Mr. Trump’s social media account. Bitcoin back above 100k, and AI shares geeking out over the Consumer Electronics Show (CES) in Vegas. Canada has one more job vacancy, location: Ottawa. New Years’ resolutions for a calm and peaceful year: gone.

Looking at the board for the year ahead, here’s what’s on the watch list:

U.S. Federal Reserve (“Fed”) Cuts – markets are now pricing in between 2 and 3 over 2025, terminating in the fourth quarter at around a 4% policy rate. Further cuts will require a significant easing of inflation (good), or a sharp acceleration in unemployment (bad). With tariffs imminent, it’s hard to see inflation easing, as good deflation has been offsetting sticky service wage inflation. Musk’s Department of Government Efficiency (DOGE) efforts certainly don’t suggest a ramp up in government hiring, and more layoffs if anything, especially come March once the debt ceiling1 becomes an issue again.

Tariffs – this does not bode well for many areas of the market or economy. Exporters will face reduced demand, and importers will face higher total costs in the short term. Substitution effects will vary based on the nature of the goods…luxury/premium global brands vs commoditized staples (ie local vs imported food). For example, U.S. small caps may benefit from higher relative domestic revenue vs large-cap’s international sales. This can be extended to the negative effects of a strong U.S. Dollar on foreign revenue as well.

Earnings Growth – There is a fairly broad disparity between the earnings growth implied by current market valuations, the bottom-up consensus estimates, and the macro-implied growth rate. Add on top of that the concentrated nature of earnings contribution within the broader S&P500 Index, and indeed now the entire MSCI World Index, the question becomes will 2025 bring upside surprises that support current valuations moving even higher, or will a more sober perspective be taken on what the incoming administration will positively or negatively impact. From a bottom-up look, it seems odd that there hasn’t been much degradation of year-over-year earnings per share growth estimates for 2025, despite a significant downgrade of the third quarter of 2025 with no corresponding uptick yet to keep the full year level, placing the onus on the fourth quarter.

Bond Yields – what the Fed giveth on the front end, the bond market taketh on the long. With U.S. Treasury yields soaring through 4.50%, a breakout above the 4.75% level would probably be a sufficient trigger for a risk-off event. 5% is the next point of resistance, which may be high enough to lure in institutional buyers.

Historical market trends – market patterns are like snowflakes: no two are exactly the same, but when you’ve seen enough of them, or worse, clean up after them, they tend to look less interesting. Specifically, a lot is made recently of U.S. Presidential cycles, and the expected pullback seen on average immediately following the inauguration of a new administration, which has also historically yielded a positive year for equities. It’s fair to say that the incoming Trump administration is about as far from average as most have seen in their lifetime, so as the small print often reads, “results may vary”.

Global vs U.S. – With the effect of the Magnificent 7 stocks (Alphabet, Amazon, Apple, Meta Platforms, Microsoft, NVIDIA and Tesla) and Trump’s overtures of exceptional growth under his stewardship, the U.S. has been the epicenter of 2024’s rally. However, taking a step back from benchmark relative investing, several other markets offer reasonable growth prospects, are not priced for perfection or better, and are relatively light in their institutional positioning. Like many a fitness resolution in the new year, one has to be prepared for a period of discomfort, particularly if comparing oneself to those that are presently outperforming. Canada is a strong example, that while lagging presently, offers significant value among dividend paying stocks, in a falling rate environment with more room for upside economic surprises than our southern counterparts, particularly if a narrow congressional Republican majority isn’t fully prepared to toe the line for the next 4 years.

Let’s hope next month’s title is “Early Spring”, and not “Thin Ice.” Happy new year to all.

Insights

READ ALL INSIGHTS

Source

1The debt ceiling is the maximum amount of money the U.S. can borrow to meet it’s existing legal obligations.

Disclaimer

This communication is for information purposes only. The information contained herein is not, and should not be construed as investment, tax or legal advice to any party. Particular investments and/or trading strategies should be evaluated relative to the individual’s investment objectives and professional advice should be obtained with respect to any circumstance.

The viewpoints expressed by the Portfolio Manager represents their assessment of the markets at the time of publication. Those views are subject to change without notice at any time. The information provided herein does not constitute a solicitation of an offer to buy, or an offer to sell securities nor should the information be relied upon as investment advice. Past performance is no guarantee of future results. This communication is intended for informational purposes only.

Any statement that necessarily depends on future events may be a forward-looking statement. Forward-looking statements are not guarantees of performance. They involve risks, uncertainties and assumptions. Although such statements are based on assumptions that are believed to be reasonable, there can be no assurance that actual results will not differ materially from expectations. Investors are cautioned not to rely unduly on any forward-looking statements. In connection with any forward-looking statements, investors should carefully consider the areas of risk described in the most recent simplified prospectus.

Commissions, management fees and expenses (if applicable) all may be associated with investments in mutual funds. Trailing commissions may be associated with investments in certain series of securities of mutual funds. Please read the fund facts, ETF facts or prospectus of the relevant mutual fund before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated. Distributions are not guaranteed and are subject to change and/or elimination.

For a summary of the risks of an investment in the BMO Mutual Funds, please see the specific risks set out in the prospectus. ETF Series of the BMO Mutual Funds trade like stocks, fluctuate in market value and may trade at a discount to their net asset value, which may increase the risk of loss. Distributions are not guaranteed and are subject to change and/or elimination.

BMO Mutual Funds are managed by BMO Investments Inc., which is an investment fund manager and a separate legal entity from Bank of Montreal.

BMO Global Asset Management is a brand name under which BMO Asset Management Inc. and BMO Investments Inc. operate.

“BMO (M-bar roundel symbol)” is a registered trademark of Bank of Montreal, used under licence.