Market optimism masks underlying fragility

While the economy remains fragile, central banks are providing strong monetary support and this should help avoid recessions in Canada, the U.S., and globally, says Leslie Alba, head of portfolio solutions, total investment solutions, CIBC Asset Management.

“Our long-term outlook on capital markets remains positive,” she said in an Oct. 10 interview. “But we do believe that the risks are more balanced to the downside because of where valuations are today, where any shock could result in an outsized impact on markets.”

Listen to the full conversation on the Advisor To Go podcast, powered by CIBC Asset Management.

A key concern is institutional stability, especially the independence of the Federal Reserve, Alba said. Any weakening could drive higher inflation expectations, a weaker U.S. dollar, and rising bond yields.

“Our central expectation is that a sudden shift in institutional stability is unlikely, but a gradual weakening is a possibility that our team continues to monitor,” she said.

Alba outlined three key themes that are driving markets through the remainder of 2025.

1. Tight credit spread

Tight credit spreads indicate strong risk appetite, she said, while elevated equity prices suggest stretched valuations. There are a few factors fueling this risk-on sentiment, including easing tariff uncertainty, and markets hitting pre-election highs, which shows investors are moving past trade concerns.

2. Stretched valuations

There have been “robust” corporate earnings, especially in innovation-driven sectors like artificial intelligence, Alba said. But she rang a note of caution about the implications of heavy investments.

“We are optimistic about the innovation theme, but maybe a bit more cautious than consensus, and that’s because it’s important to recognize that heavy capital investments in artificial intelligence will eventually lead to higher depreciation expenses,” she said. “And if revenues don’t keep up, profit margins will be under pressure.”

3. Strong investor sentiment

The VIX Index, a measure of expected equity market volatility, has historically tracked closely with the Economic Policy Uncertainty Index, Alba said. However, over the past year — aside from a brief spike around Liberation Day in early April — volatility has remained unusually low, despite continued economic uncertainty.

“While we’re seeing renewed optimism and strong market health since the beginning of April, it’s important to note that surface level strength in equities does contrast with underlying fragility.”

Alba said risk management is more crucial than ever. “Today’s valuation environment suggests the risk-versus-reward balance is less attractive than earlier in the cycle, leaving very little room for error in monetary policy or corporate earnings.”

Investment opportunities

While U.S. small-cap stocks have shown strength, there has been a shift away from U.S. market dominance, Alba said. Canadian equities are up 24% at the end of September, and emerging markets are matching that performance.  

Canadian equities stand out with compelling fundamentals, she said.

“Earnings growth forecasts are on par with the S&P 500 companies. And Canadian equity valuations are much more reasonable. Also, looking ahead, the potential for a strong economic recovery in Canada could provide a tailwind for corporate earnings.”

In Europe, Alba said, robust fiscal support and a strengthening banking sector — bolstered by the return of positive interest rates — are boosting risk appetite and may sustain economic and market momentum across the region.

However, both Canada and Europe currently trail the U.S. in digital and AI innovation, she said.

“As long as innovation remains a key driver, Canada and Europe may struggle to fully catch up to the U.S. in the near term,” she said. “But that’s not to say that they can’t lead in other sectors, or that future policy or corporate strategies won’t be aimed at closing that gap.”

Meanwhile, despite ongoing geopolitical tensions and policy risks, China’s progress in electric vehicles, AI, and renewables is transforming global investment trends, she said.

Private assets are another area that offer unique returns and have lower correlation with stocks and bonds, Alba said, helping to reduce portfolio volatility. But illiquidity remains a risk, so she recommended modest allocations that match long-term objectives and risk appetite.

“For retail investors in particular, it’s crucial to ask questions about transparency, exit options and how private assets really fit into their broader financial plan.”

Overall, Alba said, the key takeaway for investors is clear.

“Relying on a single region or sector for outsized returns is becoming less viable,” she said. “So diversification is a key strategy for managing risk and for capturing opportunity in a complex and changing global landscape.”

This article is part of the Advisor To Go program, sponsored by CIBC Asset Management. The article was written without input from the sponsor.