Hello and welcome to The Download. I'm your host, Dave Richardson, and it's always great to have one of our favorites, Sarah Riopelle who manages portfolio solutions at RBC Global Asset Management, among a million other things. You're just a big deal, is the way we describe you. I know I let my mother make up my title. I'm sure your dad came up with this one for you.

I don't know. Have you ever heard the term herding cats? I think I'm the chief cat herder.

Is that your official title now? Director and cat herding?

And cat herding, yes. I seem to spend a lot of my time organizing people and moving them towards a similar goal.

Well, it's the same kind of thing when you're putting portfolios together because you're pulling everything in and building it all together and moving it around all the time. So it would have given you good experience for cat herding.

Yep, for sure. It's all about staying organized and making lists and making sure everything's moving the way it's supposed to. And then when something happens that's unexpected, make sure that you can adjust quickly.

Oh, you mean like: war's on, war's off, war's on, war's off.

Yes, I was leading you into that question.

Were you really? So we've got another escalation, maybe? It feels like it is, but how are you reacting to that?

Yeah, well, the ceasefire that's been in place since mid-June collapsed earlier this week after Iran fired some missiles at vessels transiting the strait. This morning, though, the situation seems to be calming again with some comments from President Trump. As you can see from the events over the last few weeks and months, it's a volatile situation that seems to change quickly. Markets responded to that re-escalation earlier this week. Oil prices and government bond yields both rose because of renewed inflation concerns. With those inflation concerns, the market's now fully pricing in a rate hike in October, pulling that back from the previous expectation of December. Stock markets also reacted. They sold off, but then they settled down after Trump suggested that he doesn't think a full-scale war will restart. I don't think anybody wants that. Neither side wants an all-out war again. So the adjustment in markets that we've seen this week should be fairly short-lived, we believe. The most likely scenario is that talks are going to resume. When that happens, the potential for many of these market movements that we've seen over the last few days will probably unwind over the coming weeks, especially oil prices and bond yields.

So, the war has obviously been a big part of the story in the first half of the year. It was actually a really good half for stocks, and okay for bonds. And if I'm sitting in a balanced or conservative type portfolio, a 60/40 portfolio— 60 equity, 40 bonds— I've had a pretty good first half. I'm really running off of almost 4 years of really outstanding performance. Almost 8 years of performance in 4 years. So you still have all this stuff in the background. And again, those yields are ticking up, which directly creates issues for the bond market but ultimately creates issues in stocks. What are you seeing economically? The economy looks pretty good around the world. What are you seeing in the second half of this year?

Yeah, you're absolutely right. The economic backdrop remains surprisingly resilient. The data that's coming in is better than it was a year ago. The positive forces that are driving the economy are better growth in AI-related spending, fiscal stimulus, increased productivity. So our base case is for the US economy to continue to grow because these positive forces are offsetting that drag from the energy shock associated with the Iran war. So there's more good things happening in the economy to offset some of those negative things that we talked about. It is worth noting that oil prices have mostly normalized from their peak, even with this recent change this week. We don't have a complete resolution in the Middle East yet, so we're seeing the oil prices getting out in front of that because they're anticipating a resolution. Inflation has already started moving higher due to that rise in energy prices since March, as well as some lingering effects from tariff increases from last year. Using US CPI as an example, it hit 4.2% year over year, and that's up from 2.4% before the war. So we are seeing that impact on inflation. But for the core measure, which excludes energy prices, the movement is not as significant. It's up to about 2.9% from about 2.5%. An upward movement, yes, but not as significant when you pull energy prices out of it. Given the macro backdrop, central banks are now thinking about more rate hikes than cuts. But should inflation pressures prove to be mostly temporary, which is our expectation, those central banks may not need to hike as much as the current forecast would suggest.

So with that, the bond market, even if we go a little broader than just the government bond market, you look at spreads out to corporate and high yield, they’re fairly narrow. A good environment, but you still got some risks on the table. So how do you see fixed income playing out? I know you've played around in fixed income a little bit in your portfolios over the last month or so. So what are you seeing there in terms of actionable things for investors?

Yeah, well, we've certainly seen the volatility in the bond market since the war in Iran began. Investors were adjusting their outlook for fixed income. 10-year yields in the US have traded between 3.95 and 4.65 over the last several months, sitting around 4.5% right now. So we remain underweight fixed income overall within the portfolios, but we've been tactically adjusting our bond exposures during this period to take advantage of some of this volatility and that wide gap in yields. The rise in yields initially offered a more attractive risk-return profile. So we narrowed our underweight in bonds in May and moved our allocation closer to neutral at that time. Yields subsequently fell as inflation expectations eased following news that the US and Iran had reached a tentative agreement at that time to end the war. So we took some profits on that trade, sold those bonds out, and restored that previous 100 basis point underweight in fixed income. And while we're not changing our overall view of being underweight fixed income, we still tactically manage within that to take advantage of that volatility and to generate some basis points of return on behalf of our clients. So going forward, we expect…

Just to jump in there, you kind of nailed that one, didn't you?

I don't like to pat ourselves on the back but our batting average on these types of trades is fairly good, so we're quite pleased with the way that that one turned out. Still looking for more opportunities going forward. We think we're going to expect low to mid-single-digit returns for government bonds. And so in order to generate a little bit more return out of that, tactically managing the allocation is going to help with that. And then there is, as you mentioned earlier, potential for higher returns in corporate bonds. Although, as you said, the added compensation for taking risk in corporate bonds relative to government bonds is historically very small. If the macro backdrop remains supportive, those narrow spreads could remain in place for some time. And so we have fairly low allocations to corporate debt relative to history right now. But again, something that we tactically manage on an ongoing basis.

So the action continues to be in stocks. And the question I get everywhere I go— I was in Winnipeg the last couple of days and out with investors— and it's just how much longer can this go? And it's not just tech. Maybe I can get your perspective on this— and we'll have some other people on over the next week to really dig into this specifically— I got a basket of stocks that I track to see where the momentum is and where money seems to be moving, and it feels like we're seeing a little bit of that rotation that we have thought was happening about a dozen times over the last 3 years, and then the money just always ends up pouring back into tech, and particularly AI. But are we getting a sense that things are shifting and there's a broadening and maybe this just undying appetite for some of these tech names particularly focused in AI is waning, and people are starting to look at some of these stocks that almost seem boring in comparison, but generally deliver pretty solid returns over time?

As you said, stocks have surged over the past year, driven by AI optimism, also driven by easing trade policy concerns and corporate earnings upgrades. Those corporate earnings upgrades are fairly broad-based. So your comment, is the stock market performance broadening to stocks outside of the AI-driven names? I would say yes. That seems to be happening. The biggest price gains though have been in indices with the heavy exposure to technology. For example, the NASDAQ, the S&P 500, MSCI Emerging Markets are all up very strongly year to date. And that powerful rally has driven valuations higher as well. So it's actually pushing many indices into what we would deem to be expensive territory. For example, our composite of global equity markets is now 20% above fair value, and that's the highest reading we've had since late 2021. We have to watch valuations. But one of the key reasons why investors are willing to pay that higher price for stocks today is that the earnings outlook is greatly improving and being upgraded at an unusually rapid pace. For example, the consensus estimate for S&P 500 earnings has been revised higher by 20% over the past year. And that's highly unusual because usually earnings estimates are revised downward throughout the year. And the fact that we're actually getting upward revisions in earnings is quite a departure from the norm. So the main source of these earnings’ acceleration lies in the outsized spending by the AI hyperscalers. That would be Microsoft, Amazon, Google, Meta, Apple, those Mag Seven type of names. But that spending is actually finding its way into the earnings of the other companies within the index as well. Those companies that provide the ingredients for AI infrastructure, the chip companies and stuff like that. So where do the markets go from here? That's the big question. Can the rally continue? We think yes, for the time being, but the returns going forward are probably going to be more moderate because of these valuation concerns. So the current expensive starting point for stocks is consistent with low single-digit returns going forward, although we do recognize that the variety of tailwinds that are currently in place could keep stocks performing relatively well over the near term, but they would be vulnerable if the outlook were to worsen, given the lofty starting point. If we see the war continue, if we see inflation rising, those types of things that are going to have an impact on the economic outlook, given the expensive starting point of valuations for stocks right now, they are vulnerable to a sell-off. So at the moment, we're maintaining a slight overweight in equities, given our view that stocks are likely to outperform bonds over the next 12 months. We have a renewed tilt towards US markets. We had a regional bet towards Europe and away from the US earlier in the year, but we've actually adjusted that now and have more allocated towards the US market because of their technological leadership, their energy independence, and the robust earnings growth that we're seeing in the S&P 500 companies.

Yeah, and the US dollar has continued to be strong despite what's likely a longer-term trend of the US dollar weakening, but the war reversed that weakening that had started a couple of years ago when interest rates peaked in the US.

Agreed. We still have a view that the US dollar is in a longer-term bear cycle, but that we're in a period of strength right now because of that US market leadership and also because of the volatility around the war.

Yeah, and so you wrap that all up. I was out with a lot of investors over the last few weeks. What should we do? What's the right answer? And I said, that's why I'm getting the queen of diversification on because more so than any time I can think of in recent times, diversification is the answer right now. And I bet I'm not getting an argument from you on that point.

No, not at all. You can see the performance of the various asset classes, the various equity regions around the world. Some are doing really well; some are not doing as well. And trying to pick which one is going to do well at any given time to me is a bit of a fool's game. So why don't you just own a diversified portfolio of a variety of different investments or asset classes or strategies. Try to take advantage of volatility and opportunities in the market to tactically manage between those. But ultimately, you'll get a much smoother and more consistent return experience if you have that diversified approach to your investments over the long term.

You're going to get a little bit of the exposure to some of this high-flying tech stuff. You don't want to dismiss what's happening in that space. This is revolutionary technology. This is world-changing, life-changing technology that's in its infancy. So, there is money to be made there. Sometimes, you've got to stick your neck out and poke your nose into those areas. But at the same time, you don't want to overdo it. And the market has a way of sneaking up on you and reminding you that you've overdone it in a particular space. And this is where that diversification comes in. Hopefully, I'm hoping that we see a little bit more of that broadening that we've been talking about and that we finally see a bit more of a normal type of market as we move forward. But that diversification right now, because of what's happened in markets over the last 4 years, I think, is absolutely critical. And of course, nobody does a better job of it than you.

Thank you. I agree with you. For example, we talked about the emerging market index being one of the strongest ones and the fact that we have an allocation to EM equities within the portfolios has actually led to stronger results. I think the MSCI Emerging Market Index is up 28% year to date, and I think it's the strongest performing index globally. Just having that allocation to EM has really helped the performance of the portfolios and added to that diversification.

Yeah, and then the little tweaks and little tactical moves that you've made, like you suggested, in fixed income markets, that's where you can do little things, not extreme, but little things that add. And I'll let you use the actual quote of what you're trying to do there— but it works, right? What do you always say? I think it was an old Dan Chornous line. Scratching out the inches?

Scratching out the inches. Every basis point counts. That's another one too.

Every basis point counts. And that's really the kind of market where that seems like the right approach along with diversification.

Yeah, for sure. Dan Chornous usually uses a baseball analogy for this, and he says you don't want to go to the plate and swing for the fences every time because you're going to get that wrong or you're going to get struck out 90% of the time or more. So, we like to take small, consistent, measured bets over time to generate— using the baseball analogies— singles and doubles so that you get that more consistent result. Because if you take a big bet in a portfolio and you get it wrong, it's going to have a pretty painful impact on performance. Whereas you take small, measured bets consistently over time and get them more right than wrong, it's going to add to those basis points of relative performance for the clients.

Yeah, and I guess the baseball analogy was very effective last fall with the Blue Jays run. Blue Jays mediocre season this year, not quite as impactful. But I think everyone listening gets the idea that you can do some little things around the edges to add a little bit. And if you can do that fairly consistently and be effective in doing it, you're surprised at the end of the year how much you've been able to add on. And that's the approach that you've taken, and it's been very successful over a number of years now.

Yeah, and I would be remiss though if I didn't mention that you need to have access to the information to be able to make those tactical trades within the portfolios. So the vast amount of resources that we have behind our tactical asset allocation process in terms macroeconomic strategy, asset class expertise, so that we have the information to make informed decisions when we're making tactical changes in the portfolios is very important. I think it's challenging for individuals to be sitting at home in front of their personal computers and have that access to the information to make those trades and be successful on a consistent basis.

Yeah, watch the World Cup. Enjoy the nice weather— which isn't always around here in Canada— and let the pros take care of things. One of our favorite pros is Sarah Riopelle. Sarah, thanks for joining us again, and we'll get you on the next time you're tweaking the portfolios.

Great, thank you.