Amidst the hustle and bustle of the back-to-school season, we managed to catch up with Sarah Riopelle in her office to talk about recent market movements and how she has been positioning portfolios.

Over the summer, we have seen bond yields decline meaningfully despite some central banks starting to discuss monetary policy normalization. What’s your take on this and have you made any changes to portfolios?

Yes, we’ve seen global bond yields fall significantly over the past quarter amid slowing growth and an expectation that central banks would maintain accommodative monetary policies at least for now.  According to our models, significant valuation risk exists in the sovereign-bond market and the odds are tilted in favour of yields moving higher.

U.S. 10-year T-Bond yield

Equilibrium range

Note: As of September 1, 2021. Source: RBC GAM, RBC CM

As distortions from the pandemic fade, we think that bond yields will begin moving higher and face further upward pressure once the Fed and other central banks begin tapering their massive bond-buying programs in the coming quarters. We expect the U.S. 10-year yield to climb to 1.75% from 1.31% over our one-year forecast horizon.

Rising bond yields would weigh on total returns for fixed income, and we expect low to slightly negative returns in sovereign bonds over our one-year forecast horizon. We have made two changes over the last few months:

• In July, we trimmed our fixed-income position by 1% and moved the proceeds to cash
• In August we did the same trade again – bonds to cash – a half a percent this time.

We took advantage of the decline in yields/rise in bond prices to increase our already underweight position in fixed income.  Our recommended allocation for a global balanced investor is 64.0% equities (strategic neutral position: 60%) and 33.5% fixed income (strategic neutral position: 38%), with the balance in cash.

Recommended asset mix

Looking forward, what should investors be thinking about in light of the current environment and how are you positioning portfolios?

The intense economic rebound from last year’s deep recession is now behind us and some of the extreme dislocations that resulted from the pandemic are moderating. While the economy is slowing, growth remains robust and consumers are well positioned to support the expansion.

Balancing the risks and opportunities, our asset mix continues to maintain a bias toward risk taking. We acknowledge that the economic recovery is slowing after a strong rebound, but our assessment is that the cycle is in its early-to-mid stages and could still have several years of growth ahead. As a result, we remain overweight stocks as they offer better upside potential.

S&P 500 earnings yield

12-month trailing earnings/index level

Note: as of August 31, 2021. Source: RBC GAM, RBC CM

The S&P 500 Index climbed to an all-time high of 4500 in the past quarter, representing a doubling from its March 2020 low and a 20% gain so far this year. The rapid increase in stocks has pushed our composite of global valuations to its most expensive reading since the late 1990s technology bubble. While the degree of overvaluation has been concentrated in U.S. equities for most of the latest bull market, many indexes outside the U.S. are near or above fair value estimates.

At these valuation levels, profit gains will be critical to keeping the bull market alive and earnings have indeed been stellar so far. S&P 500 profits are on track for their best recovery on record, already surpassing the pre-pandemic high, and are expected to grow at an above-average pace for the next several years. With profits having rebounded to their long-term trend, further gains may be more difficult to come by and we should not expect the pace of gains experienced so far this cycle to be repeated.

Although valuations are elevated, we think stocks can still deliver modest returns given low interest rates, transitory inflation and strong corporate-profit growth. We look for mid-single-digit gains in North American equities, with slightly better return potential elsewhere over the year ahead.

Given your current outlook, can you share why the proceeds from your recent bond sales went into cash versus equities?

There are several risks, specifically related to the virus, China, geopolitics and U.S. taxation policy that could be sources of volatility in the near future. We want to keep a modest cash position to not only cushion against any potential volatility, but also provide funds for opportunities in the markets should they arise.