Market uncertainty often leads to heightened volatility, where markets rise and fall quickly. This can impact investor behaviour in ways that can be detrimental to their long-term investment success. More specifically, it often scares investors away from markets, or into trying to time them. Given recent volatility and the wide range of potential near-term outcomes for the economy and markets, Sarah Riopelle shares her views on the current environment and how to navigate the path forward from here.

We’ve seen a lot of volatility in the markets this year. How have you managed portfolios through this uncertainty? Has it provided more opportunity to actively manage the asset mix?

One of the main benefits of investing in a multi-asset solution like RBC Select Portfolios is the ongoing active management. We have been particularly active with adjusting the portfolios so far this year as market volatility has provided opportunities to do so. Since January, we’ve made 11 of these tactical shifts in our asset mix. This is slightly higher than usual, but not surprising given the volatility we’ve seen in markets.

Within RBC Select Portfolios, we also express our views through what we call a tactical sleeve. The tactical sleeve provides the flexibility to make small, more frequent trades to take advantage of opportunities in the markets. Within the tactical sleeve, we’ve executed 15 shifts so far this year. These have been mostly within fixed income - either increasing and decreasing our exposure, or making adjustments to duration.

Coming into the year, we felt that the biggest risk was in bonds. As such, we were underweight fixed income in our asset mix.  Since then, bonds have endured their largest sell-off in 40 years. As yields have risen, we have been buying bonds to reduce the degree of our underweight. At today’s higher yield levels, bonds should offer a much better ballast for stocks in the event of an economic downturn.

The rise of 10-year government bond yields

As of October 12, 2022. Source: Bloomberg, RBC GAM

The shift in global stock markets

As of October 11, 2022. Equity market indexes relative to equilibrium. Source: RBC GAM

We have also been reducing our equity weight as the risk of recession has increased. However, we recently added back 50 basis points. This is to recognize that there are a variety of positive scenarios for stocks should inflation calm rapidly and economies avoid recession.

That said, our equity overweight is much lower than it has been in recent years, reflecting our cautious view in the near term. Balancing the risks and opportunities, as well as the near-term versus longer-term view, we remain close to neutral in our positioning.

What are some of the risks on the horizon? Has your outlook changed in the past couple of weeks?

The broader economic outlook is murky given the combination of slowing growth, rising interest rates, and unacceptably high inflation. Adding to the list of challenges are the pandemic, the war in Ukraine and an energy crisis in Europe. Markets are extremely volatile and things are changing quickly.

A few months ago, we had thought that the worst was behind us in the bond market. However, the inflation figures released a few weeks ago disappointed the market.

Additionally, the Fed’s most recent comments about rates staying higher for longer led to another repricing for bonds. Historically, central banks have stepped in to help in the face of recession. This time around it is possible that they aren’t going to be able to provide that support as their focus is on inflation, not economic growth. We believe that central banks can effectively manage inflation down to more sustainable levels, but it may take longer than many originally expected.

Implied fed funds rate

12-month futures contracts as of October 12, 2022. Source: Bloomberg, U.S. Federal Reserve, RBC GAM

On the equity side, while valuations have seen significant adjustments, we are now focused on earnings.  If the economy is headed for recession, earnings will be vulnerable to significant downgrades. This could lead to further downside for equity markets in the near term.

What can investors expect going forward?

The one thing we know for sure is that market uncertainty never goes away. The key to investment success is not to try and predict the future. Rather, it’s about building well-diversified and resilient portfolios that can weather the storm no matter what market environment we are in.

“One thing we know for sure is that market uncertainty never goes away” - Sarah Riopelle

While I don’t want to dismiss the pain that market volatility can cause, especially for our more conservative investors, the silver lining of bear markets is that they can ultimately boost longer-term return potential. Given the lower starting point for both stocks and bonds, our expected annualized return over the next decade has risen significantly since the start of the year. Accordingly, investors with a long time horizon are presented with a much better entry point today than they were only nine months ago.