Why markets haven’t priced in a trade war—yet

Market recap

• Equity markets rallied this week on the back of the U.S. election result and alongside a widely-expected 25 bp rate cut by the Federal Reserve.

• The S&P 500 rose a strong 4.7% and crossed the 6,000 mark for the first time on record.

• The TSX added a more modest 2.1%, but is also flirting with record territory.

U.S. stocks

U.S. markets’ post-election rally continued through Friday, with the S&P 500 and Nasdaq Composite indexes both reaching record highs.¹ Investors’ primary focus appears to be on the health of the economy and the effect it will have on their own pocketbooks, with Donald Trump’s victory—and his promised tax cuts—being perceived as a positive, especially for small-cap stocks. The precedent of Trump’s previous four years in office may be lessening investors’ uncertainty about the new administration’s ability to manage the economy, and the election’s clear-cut result has also eliminated any confusion that could have arisen had there been a contested result or prolonged legal battle. With these factors fuelling the investors’ optimism, we expect the market’s momentum to continue through to the end of the year. That said, while investors are aware of some of the potentially negative implications of Trump’s proposed trade polices, including new tariffs, we don’t think these risks are priced into markets quite yet. In our view, investors would be wise to consider ways to add defense to their portfolios, whether through options strategies or an allocation to gold. Our expectation is that markets will begin to come to grips with the potential consequences of Trump’s trade policies after his inauguration in January, when details of the policies will come into clearer view. For now, we remain bullish.

Bottom line: Uncertainty is markets’ worst enemy, and while Trump’s election has provided some short-term clarity, the effects of a potential trade war remain to be seen.

Canada

Since the U.S. election, Canadian markets have been up, but not to the same extent as their American counterparts. We view this as a product of the two countries’ unequal economic footing—the U.S. economy was in good shape and received another potentially positive catalyst, while in Canada, the economic picture is weaker and any Trump-related boost would be indirect. That said, at our Multi-Asset Solutions Team’s post-election meeting, we upgraded our regional views on both the U.S. (from slightly bullish to bullish) and Canada (from slightly underweight to neutral). This dual upgrade is a reflection of Canada’s close economic ties with its southern neighbour—we are, in essence, America’s cousin, and it would be unlikely for Canada to see an economic downturn as long as the U.S. economy is on solid footing. To return to trade: it is entirely possible that the U.S.-Canada-Mexico free trade agreement could get reworked under the Trump administration. However, we suspect that Mexico would get hit harder than Canada in any renegotiation. The potentially negative impacts of Trump’s trade policies are most likely to be felt by Europe and China, and we’ve downgraded our ratings to slightly bearish on Europe, Australasia, and the Far East (EAFE) and Emerging Markets (EM) as a result.

Bottom line: Canadian markets’ modest post-election bump can be attributed to our close economic ties to the U.S.—if the American economy continues to prosper, it’s likely the Canadian economy will as well.

Interest rates

Speaking of the Canadian economy, the trajectory for interest rate cuts from the Bank of Canada (BoC) remains largely unchanged—employment is likely to continue to be an issue, and we expect the BoC to remain aggressive. The one major worry the BoC had with respect to further rate cuts was that they could cause the Canadian dollar (CAD) to drop below the $0.70 USD mark. But with Trump returning to the White House, the expectation is that he will attempt to push the USD down in order to make the cost of American goods more competitive, which means the CAD would appreciate from a relative perspective. This effectively gives the BoC the green light to pursue its rate-cutting agenda. On the U.S. front, the latest 25-basis-point (bps) rate cut from the U.S. Federal Reserve (Fed) came as no surprise, and we anticipate another 25-bps decrease in December. 2025 is the bigger question mark. If Trump’s trade agenda leads to higher inflation, that could result in fewer rate cuts. It remains to be seen how Trump’s policies will play out, but in our view, the market may be overestimating the number of rate decreases over the course of next year. If volatility picks up or geopolitical tensions rise under Trump’s presidency, that could further affect the interest rate trajectory and prompt a flight to safe-haven investments.

Bottom line: The Bank of Canada is likely to remain aggressive on rate cuts, while the Fed’s approach in 2025 will likely depend on the impact of Trump’s policies.

Positioning

For a detailed breakdown of our portfolio positioning, check out the latest BMO GAM House View Report, titled Surprise, surprise: A U.S. job market that simply won’t quit.

For more analysis of the economic implications of the U.S. election, see the new commentary by Fred Demers, Chief Investment Strategist, BMO GAM, and Yung-Yu Man, CIO, BMO Wealth Management, U.S., titled Trump 2.0.