The surprising strength of the risk-asset rally

Waiting for better valuations likely to pay off

The magnitude of the continued rally in risk assets surprised us in May. The market seemed eager to discount positive outcomes relating to tariffs, interest rates, and the global economy, rallying well through levels prior to “Liberation Day.”

While geopolitical risks are elevated from shifting trade policies and escalating conflicts both in West Asia and Eastern Europe, the market has brushed it all aside as just noise with technicals and sentiment providing the driving market forces. Ultimately, time will tell as the path of both conflicts appears to be unpredictable to us, with potential impacts on global energy markets and shipping routes. Trade policy is likely to be more impactful on consumers and the economy. The second half of 2025 should bear out whether tariffs will have a significant impact on jobs and consumers or not.

The potential for “bond vigilantes” to force fiscal austerity on the U.S. Treasury remains something of a page one story for markets. U.S. deficits are unsustainably high and likely to go higher in the near term if Trump’s “Big Beautiful Bill” becomes law. If the U.S. were any other country, the bond market likely would have forced a Liz Truss type reckoning by now.

What is more of a page 16 story, at least for U.S. markets, is the potential for foreign holders of U.S. assets to be taxed at significantly higher rates. This would be achieved through section 899 of Trump’s Big Beautiful Bill, which has been dubbed a “revenge tax” for countries with digital services taxes like Canada, the U.K., and Australia. The effect of this tax, if it goes ahead, could be to scare capital away from U.S. capital markets, resulting in higher risk premiums and lower asset values. With concerns already growing about the U.S. dollar’s safety, the timing could be quite poor, and we wouldn’t be surprised if markets forced the administration to re-think the net impact of taxing foreign investors in U.S. markets. [Note: Section 899 was in fact removed from the budget bill on June 26.]

Another area of concern for us that we believe is not priced into risk premiums is the potential for a real estate driven recession in Canada. Part of this is likely driven by the fact that Canadian real estate has looked overpriced, and Canadian consumers appeared overleveraged for over a decade. While it might take a while for a weak real estate market to filter through the broader economy, it looks to us that 2025 will see significant price declines in both Toronto and Vancouver, which has implications for consumer spending, credit, and job creation. We suspect that Canadian bank credit spreads are likely to move wider this year as the economic data deteriorates.

While the strength of the rally over the past two months was surprising to us, we believe that a disciplined approach while we wait for better valuations will ultimately pay off later this year.

Justin Jacobsen, CFA, is the Portfolio Manager of the Pender Alternative Absolute Return Fund at PenderFund Capital Management. Excerpted and updated from the Pender Alternative Absolute Return Fund Manager’s Commentary, May 2025. Used with permission.

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