- Despite potential economic headwinds, we believe the equity market will be driven by strong earnings growth expectations and supported by a reasonable valuation.
- Ongoing rate cuts by the Bank of Canada should support fixed income returns in 2025, though we expect less outperformance in credit compared with 2024.
Canadian equities
The Canadian economy should be more sluggish than the U.S. economy in 2025, in our view. Canada has experienced a dramatic slowdown in productivity relative to the U.S., as the chart on the following page shows, which constrains growth. Furthermore, the recently announced reduced immigration targets, while potentially helpful in rebalancing the housing market, could subtract nearly one percentage point in total from GDP forecasts over the next three years, according to RBC Economics. Finally, we are mindful of possible headwinds to the Canadian economy from Donald Trump’s return to the White House (e.g., blanket tariffs, renegotiation of trade agreements, and increased U.S. oil production).
After the Bank of Canada began its interest rate cutting cycle in June 2024, investor concerns about consumer spending gradually eased, leading to a rebound in Canadian bank stocks. Heading into 2025, we believe that diversification across the bank group is prudent in order to position for a range of outcomes. A pivot to a more cautious equity market backdrop could see the banks that are currently performing well continue to outperform relative to peers. Whereas if the probability of a recession continues to ease, with the ensuing relief on credit that would likely result, we could see improved relative performance by banks that have struggled in 2024.
Canada’s productivity relative to the U.S. has been falling since the 1980s
Canadian productivity and per-capita GDP relative to the U.S.
The line chart shows Canadian productivity (measured as GDP per hour worked) and per-capita GDP, both as percentages of their U.S. counterpart measures. Both were near 85% in 1970, rose slightly through the mid-1980s, and have trended downward since then, to less than 75% today.
Source - Organisation for Economic Co-operation and Development, RBC Economics; purchasing power parity (PPP) adjusted, GDP in 2015 U.S. dollars
Commodity prices should once again influence Energy sector performance. We see oil prices as potentially rangebound with geopolitical risks providing a floor, and excess capacity providing a ceiling to prices. The US$65–US$75 per barrel range provides sufficient cash generation for attractive energy stock returns, in our view. Additionally, Energy investors should have the ability to reap meaningful cash returns via share buybacks and dividends, as companies are better equipped to navigate even a challenging macro backdrop via fortified balance sheets and reasonable capital expenditure needs.
On balance, in 2025 we believe the Canadian equity market will be supported by strong earnings growth expectations and a valuation that is not terribly extended, particularly compared to the U.S. equity market.
Canadian fixed income
The Bank of Canada (BoC) cut interest rates by more than its G7 peers in 2024, but Canada’s economy continues to feel the effects of restrictive monetary policy. Since mid-2022, when the BoC accelerated its tightening cycle, Canada’s economy has consistently contracted on a per-capita basis. Meanwhile, the U.S. economy has seen strong population-adjusted GDP growth, even exceeding the rate seen in the previous decade. Economic and central bank divergence caused Canadian bond yields to decline and bond prices to rise relative to the U.S., resulting in moderate outperformance in Canadian fixed income in 2024.
Canada’s economy is contracting on a population-adjusted basis, while the U.S. economy has expanded at a healthy pace
Annual average growth in per-capita real gross domestic product (GDP)
The column chart shows average annual growth in the per-capita real (population-adjusted) gross domestic product for Canada and the United States since mid-2022 and over the previous 10 years. Canadian real GDP decreased by 1.8% since mid-2022 and increased by 0.7% over the previous 10 years. U.S. real GDP increased by 2.4% since mid-2022 and increased by 1.7% over the previous 10 years.
Source - RBC Wealth Management, Bloomberg
While the difference (spread) between U.S. and Canadian government bond yields is now wider than it has been in several decades, we see scope for further widening in 2025 as the BoC continues to cut its policy rate faster than the U.S. Federal Reserve. We believe that should keep Canadian fixed income returns from significantly lagging the U.S. in 2025 despite higher U.S. yields heading into the year. Divergence could further weigh on the Canadian dollar, which recently fell to its lowest level relative to the U.S. dollar since 2020.
Despite a challenging domestic economic backdrop, Canadian corporate bond spreads, which measure the additional yield investors receive for taking on credit risk, tightened in 2024 amid a general improvement in risk appetite. That supported excess returns in corporate bonds over government bonds of similar maturities. We see less scope for that to continue in 2025 with spreads now relatively tight and susceptible to widening if the Canadian economy deteriorates further or if risk sentiment softens.
Canada’s preferred share market performed strongly in the first half of 2024 amid a number of asset class-specific tailwinds as well as strong demand for what are typically “riskier” assets, but that rally lost momentum in the second half of the year. With valuations in preferred shares now looking much less attractive, we expect overall returns will be more moderate in 2025.