Hello, and welcome to the Download. I'm your host, Dave Richardson, and I’m always excited when we have Sarah Riopelle, who is responsible for portfolio solutions at RBC Global Asset Management. Sarah, how are you doing?

I'm good, how are you?

I'm good. It's a shame that this is an audio podcast. When I'm out doing events with large groups of investors, Nancy, our producer, has put together a little slide that I can show to promote the podcast to get people to sign in. And I kind of make fun, saying how you're lucky, you don't have to look at me. You got to look at me at the event when I'm doing a speech in front of an audience, but you don't have to look at me in the podcast. It's just audio. But your hair is fabulous today. I know we talked about your hair a lot before in the podcast. Today, it's just bang on.

Right, well, I was prepping for video, audio. I want to be ready for all things that you throw at me.

All right, well, as I say, it's a shame. If people can visualize it, this is a portfolio manager with great hair. Not just super smart, but great hair. And cats causing trouble?

I have to apologize for the background noise. I have cat chaos happening here as I'm at home today.

Excellent. Well, let's get to the markets because we've actually seen that equity markets have been a little bit better over the last couple of weeks. What's driving it? What are your thoughts on it? Is this a permanent thing or is this in a recovery phase or is this a temporary, a dead cat bounce, so to speak?

Fitting with the cat reference. Yes, that's right. Looking at the S&P 500, the markets rallied from a low of 3575 or so in October, middle of October, to a close yesterday above 4000. So that's about 12.5% return over the last six weeks, which is great news. The main driver was the positive inflation ratings that we've gotten over the last two months, and that led to a fall in bond yields, 60 or so basis points over the same period. Almost all of the fluctuation in the S&P 500 so far this year can be attributed to both rising inflation and rising interest rates, and that resulting impact that we have on valuations or our P/E ratios. So moderation of both of these variables has helped to improve equity market performance. There's a variety of reasons to think that inflation may have peaked and be heading toward meaningfully lower readings from here. That includes supply chain challenges being resolved, commodity prices that have slipped a little bit, fiscal stimulus fading, and then monetary policy that has obviously kicked into aggressive tightening. So after several supersized rate hikes, the Feds rate is now about 4%, starting at about almost near zero about eight months ago. So there are signs that inflation pressures are peaking in the near term, but there's still a pretty big gap between where inflation is and where the central banks want it to be. So that means the Fed will likely remain firm on rate hikes going forward, although potentially at a slower pace than they have been doing in the past. If the inflation has peaked and that high inflation is behind us and falling, then investors’ focus is likely going to shift now to the possibility of a recession over the coming quarters and the impact that that might have on corporate earnings. I'm not going to say the worst is behind us or not, but we're a good way through this correction-type mode that we have had so far this year, but I don't think we're all the way through it yet.

We're starting to look ahead to next year. We’ll be in December, next week— hard to believe—, and before you know it, we’ll be through the holiday season into the new year. So, what do you see ahead in 2023? What are you looking for right now?

We've been talking about a number of risks so far this year and that scenario is still in place in terms of watching a variety of different risks. Russia's invasion of Ukraine, the worsening energy crisis in Europe, China's highly indebted property sector, the fact that Covid cases in China have hit new highs in recent days. These are all, in a way, on the minds of investors going forward. And then what I just mentioned, which is the economic expansion is mature, growth is slowing, and the odds of recession over the next six to nine months is elevated. That's what's going to be dominating people's thinking in the markets over the next three to six months. In the near term, both stocks and bonds could continue to be adversely affected by all of those things, as well as unacceptably high inflation. So we need to continue to monitor inflation readings. The good news is that the rising bond yields over the last few months means that, in the event that inflation doesn't come down as quickly as we expect or the economy does fall into a recession, bonds can now offer more of a cushion in a balanced portfolio because, from those higher yield levels, they have some room to adjust in the face of a risk-off environment. For stocks, the bulk of the decline in prices so far has been from valuations, as we talked about. With stocks now much more reasonably priced, the focus is going to shift to earnings and what might happen to earnings in a recessionary environment and a slowing economic growth. So earnings estimates are starting to reflect some of that expected softness ahead, but we're not fully into that process yet, so we expect earnings probably to continue to come down, especially into January as we get Q4 earnings reports starting to come out. So we use a scenario analysis methodology— bull case, bear case, base case—, and right now we have a pretty wide range of potential outcomes and we're kind of sitting right in the middle of that range right now.

So, you take all of that, and what are you doing in the portfolios that you're managing?

As always the asset mix is trying to balance the risks with the opportunities over both the short and the long term. All of these things we've already talked about, we have to consider within our asset mix. While falling valuations have improved the outlook for long-term returns, we do remain concerned in the short term based on all the risks that we've already talked about, especially the risk of recession. The jury is still out as to whether the inflation problem has been resolved. We still have to watch those numbers. So, we have a fairly cautious stance in the asset mix. Our positioning is fairly close to neutral relative to where we have been in past points in the cycle, but we're prepared to add risk as opportunities present themselves. In late September we added a little tidbit to our equity weight. That proved to be a good level for us because we added just before the market bottomed, and so that's really helped the returns. We've been reducing the underweight in bonds as those have been rising throughout the year. So we're going to continue to look for similar opportunities in the coming months. Over the long term, we do continue to expect stocks to provide superior returns relative to fixed income. So we do remain slightly overweight stocks and underweight bonds, relative to our neutral asset fix as of right now.

Sarah, we're seeing a lot of people, a lot of investors, particularly more conservative investors, migrating towards guaranteed-type options— cash or cash equivalents—, still with the fear, on the one hand, that rates are going to continue to go higher and maybe even significantly higher. You don't want to be subject to potential capital losses if you're holding a bond, either short term or long term. But what would you say to investors who are sitting in a diversified fixed-income portfolio or looking to deploy new dollars and they want to do it in an income generating fashion? Do you like a guaranteed approach or is now the time that people should really be sticking with their current investment strategy or deploying money into a diversified fixed-income portfolio because of the opportunity for gains that are on the horizon?

There are a few answers for that. Again, it's about the risk reward. Yes, you can get a guaranteed return out of some of these instruments, but you do have to give something up in order to get that guarantee. And in most cases, it's giving up the potential upside because in an actively managed portfolio that has the ability to adjust positions as opportunities present themselves, you have the opportunity to add to returns by actively managing those portfolios, whereas when you take one of these guaranteed investments, you're locked-in for a period of time. And we're doing some work right now about how much returns you get out of the first one month, three months, six months, coming out of a bottom in a market. And if you don't participate in some of those early gains in markets, then you actually are giving up a significant portion of the eventual gains across the entire cycle. If you're locked into one of these guaranteed instruments, and even if it's only for the first six months of the new bull cycle, you could be missing out on some pretty significant returns along the way. And I really fundamentally believe in the power of active management and being able to take advantage of opportunities in the markets. A multi-strategy, multi-asset diversified approach, either if it's just only a fixed-income diversified portfolio or a multi-asset portfolio that includes stocks and bonds, I just really believe that that's going to end up with better long-term returns relative to giving up that opportunity by putting something into one of these guaranteed instruments.

And certainly, one of the distinctions you make is, as you say, long term. Most investors who would be listening here would have that long-term horizon. There are investors who are not in a position where they have a long-term horizon and that's very much where some of the more secure options come into play as really a good place to look. And of course, rates are elevated, so that's beneficial right now.

Yes, time horizon is definitely important. The other thing I would say is, if you have cash that you're trying to put to work, that's a very different decision than if you are selling a multi-asset portfolio to get into one of these guaranteed-type instruments. I just really feel strongly that now is not the time to be locking in those losses in an investment plan to move to something like this, because once you take yourself out of the market, you're locking in those losses and will not have a great ability to earn those back in the future.

Sarah, if we're looking at the fixed-income portion of the portfolios that you're running, would you characterize the positioning of those portfolios right now as being fairly conservative or more neutral in terms of the risk that's in those portfolios, given, again, there's a little bit of uncertainty about where exactly we are in the rate cycle and in the economic cycle as well?

Yes, we manage those very actively, watching credit spreads and the like. And right now, I would say we are not as risk-on as we have been in the past, but I wouldn't say that we're conservative. We do still have some allocations to invest in grade corporates and high yields because we can earn those higher yields out of those parts of the portfolios, but watching credit spreads very closely, and even though we have those allocations in the portfolios, we're being very careful to make sure that they're high quality, investment grade and high-yield securities in companies that we own. So I would say, leaning on the side of a little bit more risk-on than off, but certainly not anywhere near the level that we have been at other points in the cycle.

But you said something very important there and that is the ability to move very quickly. And you have the ability to move very quickly if you want to put risk-on within that fixed-income portfolio. Of course, that's one of the advantages that you have, doing what you do, the way you do it and the way the team would do it.

Yes, absolutely. We have access to three different fixed-income teams across the organization and a multitude of different fixed-income funds and strategies that we can access. And I talk to all the teams all the time. Plus, we are using derivatives and futures within the TAA sleeve to be able to move into and out of markets and the bond market and different strategies in particular. So huge amount of flexibility for us to quickly implement and execute as opportunities present themselves.

Yeah, and just for the listeners, TAA pool is «tactical asset allocation» pool. That's exactly where you're trying to be tactical and move quickly. Let's just make sure we're clear on that. So Sarah, that's a great overview of where we're sitting and where we may go. And then I think most importantly, what you're doing as a portfolio manager in the midst of what's been really an incredibly unusual year, particularly in fixed income, but having that year in fixed income combined with the kind of year we've had in equity, it certainly hasn't been the most fun year for diversified portfolios.

No, I totally agree. But I really do feel like there are opportunities on the horizon and that we're hoping to take advantage of.

Excellent, well, there's no one better, Sarah. Thanks as always for your time. And again, congratulations on your hair today. Always a win when your hair is looking good.

Thanks very much and happy holidays.