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Canadian investors seem to have gotten a breather from US President Donald Trump’s trade wars. Still, Ashish Dewan, senior investment strategist at Vanguard Canada, says investors should brace for continued volatility and focus on attractive corners of the market, such as European equities and fixed income.
Dewan sees more compelling opportunities in Europe, particularly Germany, thanks to earnings growth, a weaker US dollar, and attractive valuations. “Valuations are much more attractive outside the United States, so in our time-varying asset allocation portfolio, we advise clients to overweight ex-US,” he says.
Look Beyond the US
Although the peak tariff turmoil may have passed, Dewan says economic risks still lurk in the US. For that reason, he advises investors to “diversify outside the US.” European valuations stand out, particularly “growth stocks, which are currently priced for perfection.”
Although it’s not immune to geopolitical flare-ups and tariff tensions, Dewan argues that “Europe offers a diverse mix of industries, companies, and currencies, as well as exposure to more value-oriented stocks.” The US market, on the other hand, remains exposed to tariff risks, albeit of lower intensity, as well as Trump’s unpredictable policy moves.
Dismissing the latest Wall Street acronym, TACO (“Trump always chickens out”), Dewan says that “the Trump administration can go quite far with these tariffs. Everyone thought that if [Trump] saw the stock market decline or bond yields rise significantly, he would back off.” But he says that, contrary to public opinion, the administration is quite willing to tolerate the near-term pain of tariffs.
Dewan advises equity investors to expect the unexpected, as “truly disruptive risks might come without warning, particularly regarding the depth and breadth of [Trump’s] policy changes.”
He recommends robust portfolio diversification as a bulwark against unpredictable outcomes. Portfolios should be optimized for diverse scenarios, such as AI-driven growth, mounting debt, or demographic pressures. “When AI leads to significantly high growth in the US economy, [it] will result in good equity market returns,” Dewan explains. “[But] when debt and poor demographics dominate, it will lead to higher inflation, higher bond yields, and lower equity market returns.”
Yields and US Dollar Still Attractive
On the fixed-income side, Dewan brings attention to the yield curve steepening as uncertainty pushes up term premiums—the extra yield investors demand for holding long-term bonds. “Those higher yields will translate into more enduring fixed-income returns and less reinvestment risk,” he explains. A yield curve is a graphic representation of interest rates of bonds over various periods. The curve steepening refers to the widening of the gap between short-term and long-term bond interest rates.
Investors who can tolerate some economic forecast uncertainty should overweight fixed income, Dewan says, while emphasizing that most fixed-income returns will come from clipping the coupon—that is, the interest income—rather than price appreciation.
Dewan says there is no serious threat to the US dollar’s global supremacy. “There isn’t really a great alternative,” he argues. “The US still has the most liquid capital markets in the world and the rule of law. A lot of trade is still continually done in the US.” While the euro remains the biggest US dollar competitor, Eurozone economies don’t move in sync. Thus, in the long term, “we expect [the US dollar] to continue to be a reserve currency,” Dewan contends.
The Long-Term Case for US Stocks
Dewan acknowledges there are undeniable long-term opportunities in the US stock market. Among US stocks, he recommends a stronger “tilt toward the value sector,” especially if AI truly proves to be “a general-purpose technology.” It that happens, it would spread far beyond where it originates, benefitting companies that adopt and develop the technology.
Over the next decade, Dewan believes US equities will likely post higher earnings growth than their international peers, as the IT and communications sectors stateside see robust revenue growth.
Looking Through a Canadian Lens
Dewan is in the camp that believes Canada could avoid recession, but he acknowledges the macroeconomic headwinds currently facing the economy. “The core inflation numbers, particularly CPI trim and CPI median—which the Bank of Canada monitors—are still above 3%,” he says, citing the latest CPI report. “So there’s still a risk of inflation.”
He also points to slack in the Canadian economy and its cooling labor market, especially the tariff-hit manufacturing sector. This uncertainty has dampened business investment and could significantly impact economic growth. “Overall, not a great picture for Canada,” says Dewan, who calls the current environment “quite stagflationary.”
He believes the job market deterioration will likely persist. “Once job losses begin, with unemployment already at 6.9% and expected to increase, you’ll see lower demand, which will put downward pressure on prices.” In such a case, he forecasts the jobless rate to reach 7% by year-end. By all indications, economic uncertainty is elevated, and people are increasingly concerned about their job security. “It’s very hard to enter the workforce, so new entrants are having a tough time breaking in,” Dewan says.
Should job losses become more widespread, “the Canadian economy could really crater,” Dewan cautions. At that stage, the Bank of Canada would likely cut interest rates. However, he maintains it’s unlikely the Bank would cut below the lower bound of its neutral rate of 2.25%. “The [Bank] Governor has stated multiple times that monetary policy is a blunt tool affecting the entire economy, and a more targeted approach is needed,” he says.
Clear Dangers and Hidden Landmines
Dewan warns investors not to ignore the clear and present danger posed by Trump’s tariff policy, calling it the known unknown. “Trump and his administration can double down,” he says. “Many investors might think the worst is over, and it likely is, but you never know when more unpredictability might emerge.”
And then there are the wildcards. Geopolitical flare-ups and armed conflicts, such as the ongoing clash between Israel and Iran, can escalate without much warning. Other risks include growing tension in the South China Sea. “Those kinds of things can really impact the situation, and there could be disruptions in the supply chain. Don’t underestimate those possibilities.”
Dewan’s advice for investors: Stay disciplined and be opportunistic. “When equity markets decline, it’s a good time to reevaluate your asset allocation and perhaps buy some equities to stay within your long-term goals,” he says.
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.