Check in, look ahead with SLC Management’s podcast

Steve Guignard: Welcome to our podcast series, Checking In, Looking Ahead.
Today we're talking about the macro, market and investment themes for the second half of 2025. I'm Steve Guignard, Senior Director of Client Solutions at SLC Management. Joining me is Dec Mullarkey, Managing Director of Investment Strategy and Asset Allocation. Thanks for joining us today. Let's dive right in. Dec,
it's fair to say that we've had quite an eventful year so far, and I'm going to give you the difficult task of providing us with the Cliff’s Notes version of it for our listeners.

Dec Mullarkey: Thanks and great to catch up. And as you describe it, yes, it's been an eventful year. I guess the way I bucket it, in terms of the kind of key themes are coming across, and not that I want to observe the rule of threes, but they actually do seem to naturally fall into that. So first, there's all of the tariff noise, and you know, of course, what’s difficult about that is it’s very transactional in nature. What the approach of the White House is, is to ask for this maximalist position and then dial it back as you get feedback from, obviously, the folks you're negotiating with, but also from markets. So there been a lot of that happening throughout the entire year and it's created a lot of volatility around that. The next element that was an issue that's died down a little, was the attack on the Fed. The White House was berating Chairman Powell. They were trying to suggest that they might want to fire him. And that that's concerning to markets because any undermining of the central bank is critical to the markets because they look at this and say, “Well, how can we trust, say, the dollar? Will the Treasury market be heavily influenced by a political agenda? Will their rate cutting be heavily influenced by what's happening there?”. So that's a that's a big concern now, but that that risk has since dialed down a bit. And then the other thing that's out there, and it really has been overshadowed by tariffs, is what's happening on the budget and the fiscal deficit. And the U.S. is running obviously a big budget deficit, and that's adding a big budget shortfall. That's adding to the debt level that we have. All of those three together are really impacting markets in terms of the day-to-day volatility we're seeing in equities and across rates. It's kind of extraordinary that over different periods, if you looked at what's happened here today, you would say not much has happened. But you know within that there's been a lot of volatility. So, that's the situation that we've been in. You know, I get the question quite a lot. “Do you think that's good that we've had this kind of back-and-forth volatility? Why don't markets just calm down and see where this lands?”. Frankly, I think it's a positive, because that repricing of events has created a feedback loop for the administration. And they've reacted to it, particularly when they see any real bump in rates that has pushed them back, and they've taken that under advisement. And they've dialed back a lot of the rhetoric. So that's where we are right now: some of that has died down but we certainly have had an eventful five months at this point.

Steve Guignard: Yeah, and I do want to pick up on a point that you mentioned. One thing that is pretty surprising to me is that despite all of those events and market volatility, we're currently standing at a very similar place than at the beginning of the year in terms of rates, spreads and, in some instances, even equity returns, at least at the time of this recording. We know things can change very quickly, but given this, if you were to look at, for example, defined benefit plans’ funded status now versus the beginning of the year, in most instances they would be pretty similar. And so plan sponsors would say, “Good, my investment strategy is working as expected.” However, as you pointed out, if you look at it on a weekly basis or more granular basis, you would uncover a lot of volatility, and you know we experienced quite a ride there. And I think that this serves as an important reminder that financial conditions can change very quickly in Canada. Defined benefit pension plans’ funded statuses are, in aggregate but also on average, quite elevated at the moment. But history has shown us that those periods can be short lived. And I think a lot of investors suffer from recency bias, and pension plan sponsors don't appreciate the fact that they're facing an asymmetric risk profile going forward. Because they are well funded, they have, in a lot of instances and there's a few exceptions to this, little to gain from further upsides, but much more to lose on the downside. So, from my perspective, I think it's important that plan sponsors take a step back, re-evaluate their investment strategies in light of these new conditions to determine if some actions are necessary. Exactly what this means at the individual plan level is going to vary. But an obvious one to me is pension plans with shorter time horizons that have an angle of purchasing annuities, which is a pretty common goal for closed DB corporate pension plans, they should definitely be looking at de-risking activities and taking advantage of the beneficial market conditions of the last few years to take risk off the table if they haven't done so yet. Now turning it back to you, Dec, I think volatility is definitely one of the key themes of the year so far. And what makes this period particularly challenging for investors is that the volatility is largely driven by factors external to the market itself. Are there any historical parallels or lessons that investors can draw upon to navigate this market environment?

Dec Mullarkey: Yeah, it's interesting, I guess every crisis, as you say, is different. It's got its own unique issues. You know what is critical about this, is that it’s first of all self-imposed, but for markets it's exogenous. This isn't like your typical economic cycle or credit cycle that you're in, that you can actually sketch a path forward for and say, “Okay, things are going to improve.” You could have agents that could intervene, whether it's fiscal monetary that would actually help that along. This one's a little more difficult. So, when you look at kind of shocks that have happened in our generation, let's say Brexit was one of those, all of a sudden that came out of nowhere, you'd say that wasn't expected. People knew they were going to the polls, but the outcome wasn’t expected. And the interesting thing that you have with something like that was that the shock was processed pretty quickly, was processed by currencies pretty quickly. And you see that same event if there's any altercation and maybe any risk, say geopolitical risk, of an interruption to a commodity. You'll see right away, and it usually happens within a week, that the market has done an assessment of what the bookends of risk are around this and kind of prices are toward this. What's difficult about what we have here is mainly the transactional nature of it, is that there's no clear goal as to what the objective is or maybe what the target is. It's very, very transactional. So, we start off, as I mentioned earlier, there's this maximum ask, and then it kind of keeps dialing back. That's what’s causing a lot of this volatility that companies are really struggling with. There's an interesting thing that I always assert or observe, is that when companies know the rules around anything, even if they're harsh, they immediately get back to work and start optimizing around those to, in a sense, achieve their targets. When that's not clear and you've got an ambiguous environment, they actually pull back and kind of sit on their hands. Because they're basically saying, “You know, I don't want to do anything silly here, like start a new investment, and all of a sudden things change.” And that's the risk that you run into. The one thing in a lot of environments is you can have an opinion on who you think the winners and losers are going to be. Here, that's not that clear. You could well say, “Oh, domestic manufacturers would be more favored,” but some of those have a lot of inputs. So that's the situation we're in. Again, in many respects, I appreciate the market is real time trying to price this. At least there's a view out there and there's feedback happening, but that's the situation we're in right now.

Steve Guignard: And I think in, as you mentioned, a market where you don't know who the winners and losers are going to be and that’s not necessarily driven by fundamental factors, I think the value of the diversification cannot be overstated. It's a concept we talk about a lot and it's been embraced, you know pretty much across institutional investors for the time being. But I would say that on an historical basis, a lot of effort was put into diversifying the return-seeking assets. Think of equities for example. But now what we're seeing is investors thinking long and hard about their fixed income portfolios and how the concept of diversification can be applied to that allocation as well. I'll take the example of the insurance industry. If you start with a surplus portfolio, the return seeking portion of assets, insurance companies have steadily been diversifying away from traditional equity investments and into alternatives such as real estate and infrastructure. So, that would be the diversification that most investors would be familiar with, and this is a well-documented trend. The newest trend that we're observing is the concept of diversification trickling down into the fixed income portfolio. And this is particularly relevant for insurance companies, in which assets are mostly composed of Canadian fixed income. Why? Well, you know, when viewed in a global context, Canada's fixed income market is relatively small. And it lacks diversity in terms of issuers and sectors. So, depending on where you are invested in on the curve, you're often left with concentrated and undiversified exposure. With this in mind, what form does diversification take within the fixed income portion of the portfolio and what are the trends that we're observing? In most cases it means expanding the investment universe to include what I'll broadly refer to as alternative fixed income asset classes, such as investment grade private fixed income, direct lending and U.S. corporate bonds. And the driving force behind this trend is really twofold. First, there's the current higher rate environment that makes these assets more attractive. In fact, on the higher yielding and riskier segment of alternative fixed income, some asset classes have the potential to generate equity-like returns but with a very different risk profile and, importantly for insurance companies, a fraction of the capital charges associated with equity investments. And the second force is that over time many alternative fixed income strategies have been democratized, with institutional-friendly vehicles and structures that are now available not only to the very large investors but also to small- and mid-sized players. So, I think that the combination of these two forces is what explains a lot of this trend. But exactly what it means for fixed income investors that have adopted this trend is: the potential in their fixed income portfolios to generate higher returns via varying degrees of credit risk and illiquidity or complexity premiums; a more diversified exposure because they're not limiting themselves only to the Canadian fixed income market; and finally just more options to tailor their allocation to their risk and return profiles. Let's shift gears a little bit here and look ahead. From a macro environment perspective, a question we often receive from investors is what's ahead for the rest of the year.
So Dec, we want to know what do you see in your crystal ball? But don't worry, we won’t hold you accountable for any predictions here, I promise.

Dec Mullarkey: Alright, thanks Steve. I think it'll be easy to get off the hook on the predictions here, just with everything that's going on in the background. Broadly, I would say we are at a point, all kidding aside, where tariff risk is coming down. There's been certainly some improvement in the relationship with China, some improvement in the relationship with Europe. In terms of next steps, I think Mark Carney has established a kind of a successful bond with Trump. So, I think all of those things are actually positive. So, I do see that there'll be some convergence on where we're going to end up with tariffs. I mean some of the estimates I've seen, a lot of forecasters are thinking that Canada in particular is going to come out well in terms of where its ultimate rate will land. So, I think there's a there's a positive on that. The other thing is that this administration can move on to the next stage of their agenda, and a lot of that is much more growth oriented. Whether it is, you know, freeing up regulation and more growth support of different sectors. So, they I think that's a positive. The other thing is that you have the opportunity to get back to a normal growth cycle and that the Fed at some point can start to cut rates. Now, not to sugarcoat it too much: the growth outlook both for the U.S. and Canada is still that growth will be kind of half of their normal kind of targets. A normal target for both countries would be somewhere in the 2% range; this year it will probably come in 1% and maybe 1.5% next year in both economies, roughly. Because there will be an impact from these tariffs that will probably extend over six months. And six months is kind of the rule of thumb that we observed in COVID as well, that companies and consumers are processing what's going on. They're doing substitution, they're looking for alternatives, and that kind of takes a couple of months to phase in and for them to get comfortable. And then they kind of go back to a steady kind of balanced demand, and supply has also kind of rejigged around that. So, there could well be, even though we do not expect a recession in either economy, you certainly could have two quarters in the tail end of 2025, rolling into 2026, where you'll have close to zero growth, or some cases it could be negative. So, you will see some of that. Again, positive for the year, but that's where we would expect that to come out. The other thing is that inflation will be higher in the U.S. Inflation for the U.S. is expected to be more in the 3%–3.5% range, and for the obvious reasons. The U.S. is putting tariffs on the rest of the world. Well, if all of that starts to come through and every import has a 10% tariff, that's going to show up in increased prices. So, you'll see higher inflation in the U.S., whereas Canada will be back to target of something like 2%, which also allows Canada to cut rates quicker if it wants. Because the U.S. is going to be in this kind of awkward position for any central bank where growth is weak and inflation is high. Canada has more of, you know, a normal kind of cycle where inflation is well contained. Canada also has the opportunity to do some fiscal stimulus, while the U.S. is really up closer to its targets and has to be careful there. So that's where we kind of see the year playing out: subpar growth, inflation higher in the U.S., Canada probably in better shape in terms of fiscal support that it can provide. But both economies should do decently. And again, the general view on unemployment: it's going to bump up, but maybe no more than, you know, 50 basis points or half a percent. Which isn’t the end of the world, because again, if tariff rates settle down and everybody knows what that framework looks like, they can kind of manage the outcome to be more of a soft landing and then get to the other side and get kind of normal growth by 2027. So that's kind of what we're viewing, and what we're looking at right now, Steve. So that's kind of not exactly the shortest summary, but that's broadly what we're seeing.

Steve Guignard: So I've heard some positive, some negative, but I think one thing that's clear is that the economy seems to be in a period of recalibration and rebalancing a little bit. And I think in such instances, the distribution of returns and the range of outcomes is very wide this time around – some might argue even skewed to the downside just given where we are in the market cycle. So, diversification as we discussed I think is good tool to deal with this environment, but another one is active management. So, having the ability to in such a market environment be selective on the risk that you're taking and not to buy the whole market is valuable. And on an historical basis, volatile times are also periods where active management proved to be the most beneficial. I think one additional aspect that investors need to account for is the fact that traditional asset allocation models often fall short in accounting for tail risk in volatile markets. And we know that volatility and correlation assumptions that are built into these models are not static over time and that in periods of market stress, they have a tendency to increase to the point where the diversification you had hoped for might not materialize in the moment that you need it the most. Because of that, I think it's critical to conduct scenario analysis and stress testing to understand as an investor how your portfolio might perform under various conditions and be comfortable with the risk that might be currently hidden in the portfolio. And you mentioned it briefly earlier: from my perspective one data point that I'm really looking closely at is inflation, just because I look at market expectations in Canada through breakeven inflation levels, and they appear relatively low to me. So, I think there's a lot of risk to the upside here, and there's many factors I could point to. But we discussed a lot about the tariffs here. I mean, tariffs are inflationary in nature. And I think it's unclear how that will flow through market prices and ultimately inflation. If I was an investor, I would definitely be looking at scenario analysis and stress testing to understand how inflation risk affects both my asset portfolio but also my liabilities, and make sure that I'm comfortable with any tail risk scenario that could be envisioned here. So that’s my data point, Dec, but if you had to pick one data point you know which one would it be? What are you focused on now and why?

Dec Mullarkey: So, one thing I'm really paying attention to is a lot of people say that 10-year rate is the most important and for the most part I agree on that. The 30-year is what I'm paying a lot of attention to, and that's across the G7 because it's very, very sensitive to fiscal deficits and where debt loads are going. And that's something that's been ignored by markets for some time because rates were pretty low even though countries were adding a lot of debt to their balance sheets and doing stimulus, and nobody seemed to care. But they're starting to care now. And you see in the U.S., the 30-year is beyond 5%, it's up a little bit in Canada, but certainly up across the U.K. Japan is kind of at historic levels for them. So, investors are basically paying a lot of attention. “Okay, we're getting concerned about, you know, lack of discipline. We'd like to see a little more austerity.” That's the kind of the message they're sending. And even recently in Japan – and Japan has the highest debt load in the world – when you take their debt-to-GDP, it's like 250%. There, they're having trouble selling 30-year bonds and they're also, you know, trying to sell some 40s where they just weren't getting the demand they're expecting and have to dial back their expectations. So, it's an interesting environment that we're in. That for the first time in a long time, what people call the “bond vigilantes,” bondholders, are basically sending a message to policymakers to say, “We want you to try and improve your fiscal responsibility here.” So that's one big thing I'm watching. And not to be too greedy, the other thing that I'm actually paying a lot of attention to is just capital flows into the U.S. There's this view that you could see a lot of investors globally allocate away from the U.S. for obvious reasons and certainly Europe has been the beneficiary of some of that. But if you look at ETF flows, because they're kind of quick to get your hands on, you'll see that this year both on equity and fixed income there's been still sizable flows into the U.S. So again, that's something we're watching here as we go as well. Is there going to be this tilt away? It's kind of interesting, the points you were making earlier about pension plans. That's one issue that often comes up is, will there be more pressure on pension plans within different locations in the world to do more domestic investing and, in a sense, allocate away from the U.S.? It's an interesting topic, I think, that's getting discussed out there, just in that that was something to keep an eye on. Anyway, I cheated a little bit there, Steve. But anyway that's my take on that front.

Steve Guignard: Yeah, as a fixed income nerd, I really like your first set of data points. So, the 10- and 30-year long rates, I think it's going to be very interesting to watch those evolve over the next few months. So, with that, thank you Dec for joining us today. That's all the time we have for this episode of Checking In, Looking Ahead. For more information, visit slcmanagement.com Thanks for listening and have a great day.

Sources: Bloomberg, Financial Times, 2025. Content was recorded on May 29, 2025, and reflects views of the participants as of that date.

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