Good Morning. In this newsletter, we'll delve into several key economic developments and financial concepts. To start, we’ll examine Canada’s rising inflation rate, currently at 4.0%, and its impact on household finances. Following that, we'll discuss the recent job growth slowdown in Canada, alongside the introduction of a GST rebate for families. Next, we’ll analyze the strong job growth in the U.S., with 256,000 new jobs added in December, amid rising inflation concerns. Lastly, we’ll touch on the potential consequences of President-elect Trump's proposed 25% tariff on Canadian imports and its likely impact on trade relations. Stay tuned for guidance on our financial concept of the month, risk-adjusted returns!

ECONOMIC UPDATE

CANADA, U.S, AND THE HOUSING MARKET

Inflation Increases as Challenges Continue
Canada's inflation rate increased this past month, from 3.8% to 4.0%. Food prices continue to be a large contributor to this increase, with a rise of 6.5%, while energy costs have reached 5.7%, further influencing household spending. The cost of housing is also on an upward trend, further impacting budgets that are already struggling with higher borrowing costs. With the policy rate left unchanged at 3.75%, inflationary trends will ultimately shape up the coming months for households and businesses.

Employment Trends Reflect Mixed Signals and Government Introduces a GST Rebate
The economy added only 12,800 jobs in October, which was less than the forecast of 20,000. The unemployment rate remained unchanged at 6.5%, its highest level in almost three years, suggesting that the labour market is cooling down. On a positive note, wages rose by 5.2% providing workers with some relief as costs of living rise. In order to somewhat offset the financial squeeze, the federal government has introduced a GST rebate that ranges between $245 and $482, depending on household income and family size. Although this program is a short-term reprieve, many families continue to struggle as inflation cuts down purchasing power and costs remain high.

Political Developments and Trade Tensions
Prime Minister Justin Trudeau recently announced his resignation. In the middle of growing trade tensions between the two countries, Donald Trump has promised to apply a 25% tariff to all Canadian imports. Canada would certainly retaliate with talk of export tariffs on key minerals, along with other U.S.-targeted goods, such as Florida orange juice. These developments are raising new uncertainty in Canada's economy, with several possible consequences for all sectors.

U.S Economic Update Job Growth Surpasses Expectations
In December 2024, the U.S. economy added 256,000 jobs, significantly exceeding the forecasted 153,000 and marking the largest increase since 2024. This strong performance led to a decrease in the unemployment rate to 4.1%. Particularly, the retail sector rebounded strongly by adding 43,400 jobs after a loss in November, with significant gains in clothing, shoe, and jewelry retailers.

Inflation and the Federal Reserve
Consumer prices rose by 0.4% in the U.S. in December, bringing the annual inflation rate to 2.9%, slightly above the Federal Reserve's 2% target. Energy prices were a significant factor driving this increase. The core Consumer Price Index decreased to 3.2%, which was slightly better than expected. In response to these economic indicators, the Federal Reserve cut interest rates by 0.25% in December, bringing the current rate to 4.25%-4.5%. Fed officials remain cautious, signalling the possibility of more rate cuts later in 2025 if inflation continues to slow down.

The Housing Market
The housing market continues to face challenges, with existing home sales declining by 15% year-over-year in December. High mortgage rates, which have surpassed 7.5% for the first time since 2000, are a large contributor to this slowdown. While new home construction has seen an increase due to the demand for affordable housing, elevated borrowing costs pose challenges for developers. Government programs, like tax breaks for builders, aim to support the housing market.

MARKET TREND

25% TARIFF THREATS POSES MAJOR ECONOMIC RISKS

What are Tariffs?
Customs tariffs are a duty applied to goods at the time of importation. The rate of duty is typically expressed as a percentage of the value of the good and depends on the imported good’s customs classification, value, and country of origin. Most trading nations, including Canada and the United States, use the Harmonized System (HS) as the basis for their systems of determining the customs classifications of goods.

President-elect Trump did not call out any specific sectors or goods in his social media post announcing the threatened tariff and implied it would be applicable to all goods. During the last Trump presidency, the US only targeted Canadian steel and aluminium products, imposing tariffs of 10-25%.

The Canadian Chamber of Commerce’s Business Data Lab (BDL) has released a new analysis highlighting the substantial economic risks posed by former U.S. President Donald Trump’s proposed 25% tariff on Canadian imports. The report reveals that the tariff could significantly impact both economies, with Canada’s GDP projected to decline by 2.6%, amounting to approximately CAD $78 billion.

This reduction would translate to an annual cost of $1,900 per Canadian resident. The United States would also face economic consequences, with its GDP expected to drop by 1.6%, or USD $467 billion, equating to $1,300 annually per American resident.
The Trudeau government is planning a first round of counter-tariffs that could be unveiled as soon as incoming U.S. president Donald Trump is sworn in on Monday, Radio-Canada has confirmed.

The counter-tariffs would apply to $37 billion in goods that would be less harmful to the Canadian economy.

MERGER AND ACQUISITION

A NEW GLOBAL AUTOMOTIVE POWERHOUSE

Buyer Summary
Honda motor Co. Ltd. was founded in 1948 and is headquartered in Tokyo, Japan. The company develops, manufactures and distributes primarily automobiles, motorcycles, and power equipment in Japan, North America, Europe, Asia and other geographies. The company trades on the Tokyo Stock Exchange as well as the New York Stock Exchange and has a market capitalization of approximately $ 43 billion USD, making them the 12th largest automaker in the world by market cap. The company is recognized for its commitment to technological advancements, including electric vehicle (EV) development, hydrogen fuel cell technology, and autonomous driving technologies.

Target Summary
Nissan Motor Co. Ltd. is headquartered in Yokohama, Japan and was founded in 1933. The company manufactures and sells automobiles and automotive parts across various geographies. The company operates under the Nissan, Infiniti, and Datsun brands, offering a diverse portfolio of vehicles that cater to a wide range of consumer preferences, from budget-friendly models to luxury automobiles. Nissan is the 33rd largest automaker in the world by market cap with a price of approximately $10 billion USD. The company has faced serious financial challenges in recent years primarily driven by declining sales and market share in key markets such as China and the USA. In Q3 of 2024 the company reported a net loss of $61 million USD compared to a net profit of $1.25 USD billion in Q3 of 2023.

Merger Details and Rationale
On December 23, 2024, Japanese automakers Honda and Nissan announced their plans to merge by 2026 in an effort to create the world’s third-largest automaker by sales volume. The announcement was made in tandem with the signing of a memorandum of understanding. Mitsubishi Motors, in which Nissan holds a 24% stake, has also agreed to join the integration talks. While no dollar value has been announced, the merger of Honda, Nissan, and Mitsubishi would likely create a company with a combined market cap of more than $50 billion USD based on the market capitalization of the three automakers.

The merger aims to consolidate resources to better compete with industry leaders, particularly in the EV market, such as Toyota, Volkswagen, and Tesla. In addition, the companies hope that this merger will help to mitigate the growing threat of Chinese automakers such as BYD continuing to take market share particularly in the EV category. It is planned that Honda will initially lead the new management team. A significant driver of the merger is the need to address environmental challenges, with the ultimate goal of strengthening their position in the EV industry.

There is still a significant question as to whether this deal will materialize. Honda has stated that the deal is contingent on the struggling Nissan “getting its act together”. It is no secret that the company has seen financial difficulties recently, demonstrated by their operating profits taking a 90.2% dive from about $2.3 billion to $225 million in the first half of fiscal year 2024. There are also concerns on Honda’s end regarding a 35.7% stake that French automaker Renault owns in Nissan. According to Bloomberg, Honda is worried that Nissan may be vulnerable to outside influences and has suggested that Nissan buy back this stake. It is still to be determined as to whether this stipulation will be a deal-breaker for Honda.

Broader Market Implications
This Merger could act as a catalyst for further consolidation in the automotive sector. As brands like Chinese owned BYD and US owned Tesla continue to take large amounts of market share, one of the only ways that traditional and smaller automakers will be able to compete is to consolidate their operations to grow market share and create efficiencies. This merger may also accelerate the push toward the growing EV and autonomous vehicle transition. Brands like Tesla and BYD are already pushing this technology but with a potential newly efficient competitor in the space that is actively pursuing market share in these categories, other automobile manufacturers will feel more pressure to shift their offerings to electric and invest in autonomous driving technologies to keep up with the changing industry.

QUFN FINANCE CONCEPT SPOTLIGHT

UNDERSTANDING RISK-ADJUSTED RETURN

What Is It?
Risk-adjusted return is a financial metric that often measures the profitability of an investment relative to the amount of risk taken to achieve a certain amount of return. It is most useful when investors need to compare investments with varying levels of risk, providing a basis to understand the trade-off between risk and reward.

Why Does it Matter?
Typically, higher returns = higher risk. Yet when using the risk-adjusted return, investors are able to evaluate whether they receive accurate compensation for the risks they assume. This can be useful when comparing financial instruments like stocks, bonds and alternative assets

Common Metric for Risk-Adjusted Returns – Sharpe Ratio

The Sharpe ratio measures the excess return (return above the risk-free rate) per unit of total risk. Typically, a higher Sharpe ratio indicates better risk-adjusted performance.

APPLICATION
Portfolio A: Portfolio return = 12%, Risk-free Rate = 3%, Standard Deviation of Portfolio Returns = 15%
Portfolio B: Portfolio return = 10%, Risk-free Rate = 3%, Standard Deviation of Portfolio Returns = 8%

Therefore, the second portfolio offers a better risk-adjusted return making it more attractive for risk-averse investors.

RECRUITING QUESTIONS

RISK-ADJUSTED RETURNs

When Do We Use This?
1.    Portfolio Optimization: Investors will use this concept to identify assets with best trade-off between risk and return to achieve higher earnings potential within their portfolio.
2.    Performance Benchmarking: Fund managers will typically use risk-adjusted returns to evaluate their investment strategies relative to indices.
3.    Asset Allocation: Risk-adjusted return metrics can also be used to diversify the portfolio ensuring balanced risk exposure across the different asset classes.
Recruiting Questions – Risk-Adjusted Return

CONCEPTUAL QUESTIONS
1. What is the Sharpe Ratio, and why is it an important metric for evaluating risk-adjusted returns?
The Sharpe Ratio measures the excess return (investment return above the risk-free rate) per unit of risk (volatility) taken by the portfolio. It is crucial because it allows investors to compare portfolios with varying levels of risk to determine which provides better compensation for that risk. A higher SR indicates better risk-adjusted performance - making it especially useful to compare investments across different asset classes, strategies, or markets.

2. Why might Portfolio A, with a higher return, have a lower Sharpe Ratio than Portfolio B? What does this indicate for risk-averse investors?
Portfolio A could have a lower Sharpe Ratio than Portfolio B because its higher return comes with significantly greater volatility (higher standard deviation). This means A is taking on more risk to achieve its returns, whereas B offers more efficient returns relative to the risk taken. For risk-averse investors, B is more attractive because it balances risk and return more effectively. While A may provide greater returns in favorable conditions, it is also likely to suffer larger losses in market downturns.

APPLICATION-BASED QUESTION
3. Portfolio X has an expected return of 14%, a risk-free rate of 3%, and a standard deviation of 20%. Portfolio Y has an expected return of 10%, a risk-free rate of 3%, and a standard deviation of 8%. Calculate the Sharpe Ratios for both portfolios, and determine which portfolio offers the better risk-adjusted return.

Use the Sharpe Ratio formula to calculate:
Sharpe Ratio for Portfolio X = (14% - 3%)/20% = 0.55
Sharpe Ratio for Portfolio Y = (10% - 3%)/8% = 0.875

Portfolio Y has a higher Sharpe Ratio (0.875) compared to Portfolio X (0.55), which indicates that Y delivers more return per unit of risk. Even though X has a higher absolute return, it comes with higher risk, making Y the better option for those seeking a superior risk-return trade-off.