Acclimatizing to new normal

The start of 2025 was a Rorschach test for investors.

Some saw the return of U.S. President Donald Trump to the White House as beneficial; others expressed concern he’d tear up trade deals, impose tariffs and spark more inflation.

The past year saw a mix of both.

The United States did unleash a storm of trade strife and inflation, while down from its 2022-23 peak, did not fade entirely.

Yet few would have guessed the TSX Composite Index would be among the top performing stock markets in the world in 2025. Canada’s equity market trailed only Hong Kong’s in 2025, and interest rates did fall modestly — though less than predicted.

Most economies, Canada’s included, logged growth.

The coming year starts with lower expectations than at the start of 2025, but also with less uncertainty at least in one crucial way, says Steve Locke, chief investment officer of fixed income and multi-asset strategies with Mackenzie Investments, based in Toronto. “It’s probably a year where we’d be a little bit less bullish than we were at the beginning of 2025.”

At the same time, investors have more certainty about the U.S. That is, ironically, to expect uncertainty from its administration, Locke says.

Last year, Mackenzie was among the asset management teams that were optimistic over the pro-business administration only to “discover it came with a lot of other risks.”

Forecasters also expected central banks would be cutting rates. Indeed, the Bank of Canada did cut because Canada’s economy was shaken by tariffs. That benefited its stock and bond markets, says Robin Marshall, director of fixed income research at FTSE Russell, based in the United Kingdom.

In contrast, the U.S. held off cuts more than expected due to concerns about inflation that arose largely from its trade policy.

“From the Canada policy rate point of view, rates are on the easy side of neutral, a level that doesn’t give the economy stimulus or restrict it,” Marshall says.

More cuts could come in 2026, but the central bank will be cautious, cutting only if the economy stumbles.

He further adds fiscal policy will more likely drive economic activity in 2026, with governments around the world generally increasing spending to stimulate growth.

Overall, many — Canada included — are spending more to expand renewable energy generation to meet demand from increased electrification of the economy and artificial intelligence. Developed economies’ governments are also dramatically increasing defence budgets as the U.S. administration becomes a less reliable ally — another major driver of economic activity next year.

AI will continue to push markets, though expectations are less in 2026 based on the performance this past year.

Despite much being made about the AI revolution powering the U.S. stock market at the start of 2025, driven by big tech/the magnificent seven, “these stocks weren’t the best performers,” says Philip Petursson, chief investment strategist at IG Wealth Management in Toronto.

Alphabet Inc. (Google) and Nvidia Corp. did have strong returns this past year. Yet Microsoft Corp., Apple Inc., Tesla Inc., Meta Platforms Inc. (Facebook) and Amazon Inc. all had positive returns, but not to the extent investors had expected.

That’s not to say AI hasn’t had an impact in 2025, and won’t this coming year.

“We are still in the AI super-cycle with hundreds of billions of dollars spent on the infrastructure to support it,” Petursson says.

Speculation and overvaluation were still present in 2025 and will likely continue to factor in the new year.

AI company Palantir Technologies Inc. is the poster stock for AI hype. Its share price grew about 160 per cent in 2025. It is likely to remain one of the most overvalued stocks on the U.S. market in 2026. As of late December, investors were willing to pay about US$450 for every US$1 of its earnings.

By comparison, Alphabet stock — up more than 60 per cent in 2025 — had a price to earnings ratio of about 31 at the end of 2025, meaning investors were willing to pay US$30 for every US$1 of earnings. While much lower than Palantir, even Alphabet is arguably overvalued.

A boost for U.S. equities — AI companies included — could be the Federal Reserve cutting rates in 2026.

Trump is expected to replace Fed chair Jerome Powell, whose term expires in May, with someone likely to favour a faster rate cut path, Petursson says.

While rates are likely to remain steady in Canada or decrease slightly, a much bigger factor in 2026 is renegotiating the free trade deal with the U.S. and Mexico.

Whether renewed (an upside for markets) or tossed aside (a downside), federal and provincial governments’ looser fiscal policies will likely play more of a role in driving economic growth regardless, Marshall says.

Another beneficial factor for investors amid market risks is the “correlation between assets is falling.”

That means we’re unlikely to see a repeat of 2022, when bonds and stocks fell together, he adds.

In turn, if choppy market conditions arise, bonds and stocks should be more de-correlated, whereby if stock values are down, bond values should increase to offset losses in portfolios.

Overall, 2026 is likely to be less affected by headlines from the U.S. administration and driven more by fundamentals: job growth, rising revenues and profits, interest rate cuts and stable, lower inflation, Petursson says.

“We believe there are more positives than negatives ahead in 2026, which should extend equity market gains made this past year.”

Joel Schlesinger is a Winnipeg-based freelance journalist

joelschles@gmail.com