Introduction
The first quarter of 2025 brought several significant macroeconomic developments. Inflation showed signs of stabilizing near central bank targets, prompting cautious shifts in interest rate policies. Meanwhile, the Bank of Canada (“BoC”) and the U.S. Federal Reserve (“Fed)” navigated a complex environment of cooling price pressures and emerging trade uncertainties. We can’t ignore what happened after the quarter ended, on April 2nd (“Trump declared Liberation Day”) the US administration announced a set of tariffs that upended the market for the following seven trading days. The Raintree Wealth Management portfolio diversification was a huge asset through this challenging trading environment to start the month.
Inflation: Slowing but Not Defeated
Inflation in both Canada and the U.S. has largely moderated toward the 2% range, which is a welcome development for policymakers. In Canada, core inflation hovered close to the BoC’s 2% target early in the quarter, indicating that the aggressive interest rate hikes of prior years have been effective. However, a surprise uptick in February (annual inflation reached ~2.6%, an eight-month high) raised some concerns. Essentially, while price growth is much lower than the peaks of recent years, it hasn’t completely settled. Central bankers are watching inflation data closely, because if prices start rising faster again, it could reduce your purchasing power and potentially lead to renewed market volatility. For now, though, the trend is generally favorable: everyday price increases have cooled considerably from the highs of 2022–2023, easing pressure on consumer budgets and investment returns.
What this means for you: A lower and more stable inflation rate is positive for your portfolio because it preserves the real value of your investment returns. For example, if your portfolio earned 5% and inflation is 2%, your real gain is roughly 3%. In high-inflation environments, that real gain would be much smaller. The recent moderation in inflation suggests that the “cost” of holding stocks and bonds (in terms of lost purchasing power) is diminishing, which is a constructive backdrop for investors. That said, we remain vigilant. Should inflation flare up unexpectedly (as the February data hinted), it could prompt central banks to adjust course – a scenario we’re prepared for through diversified holdings that can perform in various inflation conditions.
Interest Rates: BoC and Fed Policy Updates
Bank of Canada (BoC): In the first quarter, the BoC took action to support the economy by cutting its key interest rate. In fact, in March the BoC reduced its overnight rate by 0.25% to 2.75%. This marked the seventh consecutive rate cut since mid-2024, totaling a substantial 2.25% reduction over ten months. The BoC’s rationale was that with inflation trending closer to target and the Canadian economy starting 2025 on solid footing, it could afford to gently lower borrowing costs to spur growth. However, this easing stance was balanced by new uncertainties – notably, heightened trade tensions. Early in the quarter, U.S. tariff threats against Canada created a cloud of uncertainty for businesses and consumers, leading the BoC to signal a possible pause to assess the fallout. In simple terms, the BoC is trying to thread the needle: supporting the economy with lower rates without reigniting inflation. Lower interest rates generally make mortgages, loans, and business credit cheaper, which can stimulate economic activity. For your portfolio, BoC rate cuts tend to be a tailwind for bond prices and interest-sensitive assets (like real estate and utilities stocks) because yields decline and previously issued bonds at higher rates become more valuable. Indeed, we saw Canadian bond yields ease downward as markets anticipated slower growth and further policy support.
U.S. Federal Reserve (Fed): The Fed also shifted from the aggressive tightening of previous years to a more cautious stance. After implementing its first rate cuts in late 2024, the Fed held its benchmark rate steady during Q1 2025, adopting a “wait-and-see” approach. Fed officials noted that “uncertainty around the economic outlook has increased” – a reference to the mixed signals in the economy, including robust job numbers on one hand and evolving trade conflicts on the other. By keeping rates unchanged (after earlier cuts), the Fed is effectively pausing to gauge how earlier rate reductions are impacting inflation and growth. For investors, a stable Fed rate means a bit less short-term uncertainty: we’re not immediately facing higher borrowing costs in the U.S., which can calm stock and bond markets. However, the Fed’s cautious language also reminds us that they stand ready to adjust if conditions change. If U.S. inflation were to rise above comfort levels or growth were to falter significantly, the Fed might resume cuts or consider hikes – both scenarios we plan for in our risk management. The key takeaway is that interest rates are no longer in a sharp uptrend; they have leveled off and even begun to decline in Canada, which reduces a major headwind that markets faced in 2022–2023.
Currency Movements: USD/CAD Stability Amid Volatility
The Canadian dollar (CAD) had a bit of a roller coaster in Q1 due to geopolitical news, but ultimately ended the quarter nearly where it began against the U.S. dollar (USD). Early in the quarter, headlines were dominated by U.S. tariff threats on Canadian exports. Such news typically weakens the CAD (because investors worry about Canada’s economy under tariffs and shift to the perceived safety of the USD). In fact, the USD/CAD exchange rate spiked to roughly 1.48 in early February (meaning 1 USD cost $1.48 CAD, a multi-year high) when those trade threats peaked. However, as the U.S. administration later signaled a pause or reconsideration on the sweeping tariffs, the panic subsided and the loonie recovered. By March 31, 2025, the exchange rate was about 1 USD = 1.439 CAD, almost the same as on January 1 (1.438. The BoC noted that the Canadian dollar was “broadly unchanged against the US dollar” by quarter-end. In the beginning of April the USD weakened against all currencies, including CAD, due to the uncertainty created by “Liberation Day”.
For investors, currency fluctuations can influence international investment returns. When the Canadian dollar strengthens (rises in value) relative to the U.S. dollar, as it did overall this quarter, U.S. investments produce lower returns in CAD terms. For example, if an American stock gained 0% in USD but the USD fell ~3% versus CAD during the period, a Canadian investor would see a ~3% loss on that holding when converted back to CAD. In Q1, the modest strengthening of the CAD acted as a headwind to our U.S. equity holdings. On the other hand, a strong CAD is beneficial when paying for imports or travel, and it reflects confidence in the Canadian economy. We manage currency risk in the portfolio by diversifying currency exposure and sometimes using hedging strategies (for instance, some international investments we hold are hedged to CAD to strip out currency effects). In Q1, despite the CAD’s swings, our globally diversified portfolios still achieved strong results, partly because the strength in overseas markets and good asset allocation outweighed the currency drag. Overall, our currency exposure has historically acted as another diversification tool, to smooth out return volatility.
Market Concentration and the “Magnificent Seven”
We have touched on the Magnificent Seven previously, but this deserves its own focus because it’s a critical theme: market concentration. The S&P 500 has become top-heavy – a few companies make up a large portion of the index’s value. As of the end of 2024, those seven tech-heavy companies accounted for over 33% of the S&P 500’s total return and an outsized share of its market capitalization. This kind of concentration is a double-edged sword. When those leaders are soaring (as they did for much of 2024), the market indexes look great. But if they stumble, the indexes can falter even if the other 493 companies in the S&P are doing okay.
In Q1 2025, we saw a hint of the vulnerability that comes with such concentration. The question in the air: “What if the Magnificent Seven falters?”. Indeed, concerns emerged that these stocks might be “running out of steam” after their huge run-up. In the first quarter, factors like stretched valuations, regulatory scrutiny, and the aforementioned trade issues led to choppiness in some of these names. For example, a couple of the Mag. Seven delivered earnings or forecasts that didn’t wow investors, leading to sell-offs. Because they are so large, those moves dragged down indices. Outside of those mega-caps, many stocks (particularly mid-caps and certain sectors) were actually doing fine or even great. This underscores how a narrowly led market can mask broader health – or conversely, cast a shadow over it.
Our stance on concentration: We have been wary of this risk for some time. It’s why, as mentioned, our portfolios do not mirror the indices in holding extremely large weights in the top seven stocks. We believe in diversification as a remedy to concentration risk. Our performance in Q1 illustrates the benefit: while the concentrated S&P 500 dipped, our Growth Fund (with a more diversified base including mid-caps, international stocks, and alternatives) was up +5.6%. We managed to outperform the concentrated index by not being concentrated. It sounds a bit paradoxical, but it makes sense – we had other return drivers. For instance, our Canadian, emerging market and international equities did a lot of heavy lifting for returns, which offset any softness in U.S. big tech. This is intentional.
Canadian Equity Market: Hanging In There
Canada’s equity market got off to a solid start in 2025, with the S&P/TSX Composite Index rising approximately 1.5% despite global uncertainties. Performance varied significantly across sectors, underscoring the benefits of diversification. Resource and defensive sectors were the strongest performers. Gold mining companies surged as investors sought safety amid geopolitical concerns, driving the materials sector sharply higher. Energy stocks also performed well, supported by steady oil prices, while utilities benefited from lower interest rates, rising about 6%. Conversely, technology and industrial sectors lagged, pressured by global growth uncertainties. Canadian financials posted only modest gains as declining interest rates and economic concerns moderated performance.
Canadian small-cap stocks, typically more sensitive to economic and financing conditions, underperformed larger peers, gaining roughly 0.9%. Higher borrowing costs and cautious investor sentiment weighed on these smaller companies.
For Canadian investors, Q1 demonstrated resilience despite external pressures. Strong returns in commodities and defensive sectors balanced weaker growth-oriented sectors, highlighting the importance of diversification. Looking ahead, maintaining a balanced approach remains crucial, allowing portfolios to capitalize on Canada’s economic strengths while navigating global risks effectively.
International Surprises: Asia and Europe Outshine
A key highlight in Q1 2025 was the impressive performance of several international markets, reinforcing the importance of global diversification:
- Hong Kong/China Tech Resurgence: Hong Kong’s Hang Seng surged 15.3%, driven by renewed optimism around Chinese tech companies, improving economic forecasts, and government support. After a challenging 2022- first half 2024, these factors sparked a notable rebound.
- India’s Consistent Growth: India’s markets continued their steady upward trajectory, reaching new highs with mid-to-high single-digit returns. Strong corporate earnings and favorable demographics underpinned this resilient performance.
- Japan’s Solid Quarter: Japanese equities posted solid gains (mid-single digits), particularly beneficial for investors who hedged yen exposure, enhancing returns significantly. The weaker yen, influenced by Japan’s accommodative monetary policy, boosted export-driven companies.
- Germany Leads Europe: Europe surprised positively, with Germany’s DAX rising 11.3%, driven largely by industrial and defense sectors amid increased regional spending. Optimism about moderating inflation and improved economic outlook buoyed broader European equities.
Portfolio implications: We have always advocated for international diversification, and Q1’s events validate that approach. Our portfolios include exposure to Emerging Markets and International Developed Markets, which means when places like China, India, Japan or Germany outperform, we benefit. In fact, our emerging markets exposure in our Growth portfolio benefitted from India and China’s strength, contributing nicely to our performance we even took some profits in international equities because of the strong rally. Likewise, our international developed market holdings (like a position in an EAFE ETF) gained value as Europe and Japan surprised to the upside.
Another benefit of our global approach is diversification of economic drivers. Q1 illustrated that when North America faces unique challenges (e.g., U.S. trade conflicts affecting sentiment), other regions can pick up the slack. By being globally diversified, our portfolios didn’t rely solely on North American markets to do all the work. This is one reason our funds delivered positive returns even while the S&P 500 (U.S. large-cap index) was down ~4%. We captured gains from elsewhere.
Going forward, we are optimistic about international markets and will maintain meaningful exposure to them. Of course, nothing goes up in a straight line – a big quarter like Q1 in Hong Kong might be followed by consolidation. But the key point is that there are strong economies around the world (like India’s growth story or Europe’s recovery) and we want your portfolio to have a stake in them. Our Investment Committee will keep assessing country and region allocations; if anything, Q1’s results may encourage us to further diversify geographically as opportunities arise.
Summary & Looking Ahead
In summary, Q1 2025’s macroeconomic story was one of improving stability with a backdrop of geopolitical uncertainty: inflation is down, rates have likely peaked, and economies are adjusting to a post-tightening world. Your portfolio benefited from these trends, and we have confidence that our proactive adjustments and diversified strategy will continue to serve you well. As always, we will monitor economic developments closely and make any necessary tweaks to protect your interests.
As we head into Q2 2025, our outlook remains cautious. Many of the macroeconomic uncertainties (such as the status of U.S.-Canada trade tensions or the path of inflation) should become clearer in the coming months. We anticipate that central banks will remain data-dependent – if inflation stays near target and growth slows a bit, we may see a continued pause or even additional mild rate cuts, which would further support bonds and potentially stocks. If, however, inflation surprises on the upside, policymakers could turn more hawkish, which might introduce some volatility. All-eyes are on the US Administration, one tweet or comment, can change the outlook positively or negatively at any moment. At home here in Canada, we will see what the federal election brings.
Rest assured; our portfolios are built to withstand various scenarios. We have a blend of assets that can do well in expansion (e.g., equities, small and mid-cap) and in defensive times (e.g., bonds, market-neutral funds, private alternatives). Our goal is to keep your investment journey as smooth as possible.
Pool Restructuring
We have completed the Investment Pool restructuring, turning the Raintree Wealth Management Growth and Preservation Pools into the Core Equity, Core Fixed Income, Enhanced Yield and Alternative Strategies Pools. One thing you can expect is to see varying degrees of volatility (price movements up and down) between the Equity and Fixed Income Pools, and also Enhanced Yield and Alternative Strategies, which will be valued monthly (to more closely resemble the valuation process of many of the holdings within those Pools). Finally, we are very excited about the additional diversification we have created in the Pools and our client portfolio’s overall.
Your quarterly account statements have been posted to your client portal. If you have any questions about this commentary or your portfolio, please don’t hesitate to reach out to your advisor or our team. We’re here to help, and we appreciate your trust in Raintree Wealth Management.