Marc Foran, CIO

June 30, 2025

Q2 2025

US policies dominated the headlines in Q2, with the Trump administration announcing reciprocal tariffs on much of the world during early April. Surprisingly, substantive tariffs were also placed on regions long considered allies of the US, such as Canada, Europe, UK, Japan and Australia. The magnitude of the tariffs and weak rationale provided by the US government for the methodology used to determine the tariff rates triggered a rapid collapse in investor confidence and a repricing of risk across asset classes. Ultimately the Trump administration announced a 90-day pause on tariffs to facilitate negotiation, which resulted in a broad-based recovery in global markets by the end of the quarter.

MACRO

Economists generally reduced global growth targets when the reciprocal tariffs were announced by the Trump administration, saying that even if trading agreements could be reached, a permanent fracture of global trade had been triggered. The expectation was that tariffs would act as a form of flat tax that would raise prices for consumers and / or reduce margins for businesses globally and thus act as a significant drag on global growth. We note that during Q2, the impact of tariffs on US and global goods prices was rather muted due to importers stocking up on inventory prior to tariff implementation, allowing them to maintain current prices for longer. As well, consumer spending was more resilient than anticipated, which could be a sign that consumers pulled forward their purchases (particularly of larger items) prior to tariffs taking effect. We believe companies whose margins were negatively impacted by tariffs were hesitant to raise prices before tariff policies were solidified in order to avoid risking market share losses. Exacerbating the impact of tariffs was the sharp decline in the US Dollar during Q2, which decreased 5% relative to the Canadian dollar and 8% to the Euro. The US dollar’s decline was largely attributed to the passing of the “One Big Beautiful Bill,” which elevated investor concerns about unsustainable debt levels in the US and the prospects of credit deterioration. At the same time, US interest rates remained at restrictive levels (holding back growth) as the US Federal Reserve went on pause until the impact of tariffs on inflation could be determined.

Overall, our view is that the economic consequences of tariffs, should they remain for an extended period, haven’t yet been fully realized. We believe the US Federal Reserve and central banks around the world have been hesitant to materially lower interest rates until the stagflation (slow growth with high inflation) impact of tariffs is realized. Businesses also appear cautious, as revealed by the Q2 slowdown in US job creation to levels last seen during the pandemic; and consumers increasingly feel stretched, as evidenced by poor earnings reports of consumer discretionary companies and rising credit delinquencies, including among higher income household tiers.

PUBLIC EQUITIES

Following the announcement of US reciprocal tariffs, public equity investors engaged in significant and indiscriminate selling, with declines of ~11% in each of the S&P 500, MSCI ACWI, MSCI Europe and MSCI Japan indices during the first five trading days of the quarter. By mid-quarter, a relief rally in global equity markets was triggered after i) the Trump administration announced a suspension of most tariffs to facilitate negotiations; and ii) the passing of the “One Big Beautiful Bill” (OBBB) which, although widely unpopular with voters, provided clarity in terms of US policy related to tax, spending and government support programs such as Medicaid. By the end of the quarter, public equity markets were generally in positive territory, with megacap technology firms driving the bulk of returns.

US equity market valuations remained elevated, with a price-to-earnings (P/E) valuation of 26.3x for the S&P 500 at the end of Q2, though the excessive valuation is largely due to the Magnificent 7 stocks which were collectively trading at a 44.3x P/E. Excluding these companies, the balance of US markets traded at more acceptable levels of 18.3x although in the current interest rate environment this valuation would not be considered cheap. By comparison, both the MSCI Europe Index and MSCI Japan Index were trading at 15.6x at the end of Q2, making these markets appear relatively more attractive though admittedly with lower near-term growth prospects given current economic headwinds. As we noted last quarter, Europe’s largest stocks have higher exposure to geopolitical shocks and global economic growth than US or Japanese equities and we believe the region’s valuation discount to the US reflects these risks.

In the current environment we believe investors should remain cautious in their public equity exposure by remaining underweight or outright avoiding frothy areas of the market because history suggests that the long-term earnings growth required to justify these excessive valuations is unlikely to materialize. We also prefer service-oriented equities and companies with relatively price-elastic end markets that derive their sales from local markets or, conversely, diversified global markets, and ideally with limited exposure to import-export markets in the US. We remain wary of cyclical stocks and those exposed to the US consumer, given continued weakness in spending and personal credit trends.

PUBLIC FIXED INCOME

In Canadian dollar terms, the Bloomberg Corporate Investment Grade Bond Index finished the quarter down 1.2% due primarily to the decline of the USD (which constitutes ~45% of index constituents). Global bond markets generally sold off after the announcement of reciprocal tariffs, though much like public equities, corporate bonds rallied mid-quarter onwards. Notable this quarter were US Investment Grade Corporate bonds, which outperformed as spreads generally compressed, particularly on longer dated maturities, due to the passage of the OBBB (which made favourable corporate tax policies permanent). However, the passage of the OBBB also caused the US Treasury yield curve to steepen, with long-term treasuries widening up to 20bps due to concerns regarding rising and unsustainable government debt levels (i.e. deteriorating US federal government credit quality) while mid term government yields declined up to 20bps due to expectations of interest rate cuts by the US Federal Reserve. In Canada, government yields widened broadly across the credit curve with 2-year maturities expanding by 15bps and 20-year maturities by 35bps. The shift in credit spreads reflected investor concerns regarding potential long-term ramifications of a deteriorating trade relationship between Canada and the US, combined with anticipated increases in government spending to support the economy over a prolonged period. Meanwhile, European yields compressed slightly during the quarter as the region cut interest rates by an additional 25bps in June (total of 50bps during the quarter), the effect of which was partially offset by expectations for deteriorating credit quality as Europe issued debt to finance spending in areas such as defense (as part of pledges made to the US).

PRIVATE MARKETS

Private markets were not immune to the impact of US tariff policies, as both the number and value of North American private equity and venture capital deals declined from Q1 levels though they remained above activity in Q2 2024. Activity was particularly slow in April and May before a rebound in June took hold, largely fueled by improved trade dialogue between the US and China. In Canada, total private equity deal value declined from Q1, though levels remain above historical averages due to a handful of large transactions dominating the market (notably, the $14B Garda World Security transaction which closed in Q2). Excluding deal sizes above $1B (which accounted for just 2% of total transactions), total deal value in Canada declined, in line with US private equity trends. It was a different story for Canadian venture capital, where both the total number and value of deals rebounded modestly in Q2 though still at historically subdued levels. North American fundraising remains challenging as activity continued to slow in Q2, particularly for new and emerging fund managers. If current trends continue, 2025 would be the slowest fundraising year since the pandemic year of 2020. In terms of number of exits, Q2 marked the slowest period for North American private equity since Q2 2020 and the holding time for private equity funds remained at six years, which is above the historical average though is an improvement relative to last year. However, of note during Q2 was the pickup in venture capital exits related to AI, crypto and defense sectors, which have benefited from the support from the Trump administration.

During Q2 there were pockets of optimism within private equity / venture capital markets. In particular, there was a notable pick-up in US growth-stage investments, which accounted for over 22% of deals done, above the five-year average of 19%. We believe that the current environment is more favourable for growth equity stage deals given reduced investor appetite for high-risk deals (thereby making early stage deals relatively less attractive) and the high cost of debt financing, which reduces economics on mature stage private equity deals that tend to use high levels of leverage to enhance returns. We also saw an exacerbation of negative trends in Q2, particularly as it pertains to how private equity / venture capital funds are allocating capital across all stages of investing. Specifically, there has been a significant slowdown in the share of fund capital going to women-founded companies which year-to-date in 2025 have declined to only 5.3% of total deal activity and a miniscule 0.8% of total deal value. We believe this represents a tremendous opportunity for impact investors to profit from owning well-run companies at fair valuations while simultaneously addressing and combating systemic gender bias that exists in how private markets allocate capital.

Private credit markets continue to flash warning signs due to elevated business uncertainty, renewed fears of inflation negatively impacting corporate margins (driven by tariffs), and rising delinquencies. Of note, US business loan delinquencies have reached levels last seen during the global pandemic, which may cause lenders to tighten their credit standards. In response, investors have slowly shifted into higher quality credit opportunities, a trend that has remained intact since 2022. We expect investors will continue to seek higher quality private credit opportunities given elevated macro uncertainty and the potential for a global economic slowdown. For impact investors, we are increasingly seeing attractive investment opportunities that provide financing for high-quality projects and/or equity deserving groups. We continue to recommend a nimble approach to private debt allocations, with a keen focus on higher quality credits that can weather periods of economic stress.

OUTLOOK

While investor sentiment was relatively positive as Q2 came to a close, we believe risk remains elevated given the chaotic policies of the Trump administration and their potential to negatively impact global growth. Furthermore, we believe that the strong rebound in global markets may have emboldened the Trump administration to reintroduce punitive tariffs.

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