Hello, and welcome to The Download. I'm your host, Dave Richardson, and it is a special day, once a month, when we are joined by Sarah Riopelle. Oh, hello! You're going to jump in right there? We won't say your official title? I know your dad gets very upset when I don't say it perfectly because you have a pretty fancy title.

No, it's fine. I think everybody, after all this time, probably knows who I am.

Well, I would hope so. Can I even tell them how much money you manage?

You can try and guess.

Actually, that is a good point. I'm not sure I know the answer to that. I'm going to say, based on market moves, 165 billions?

Oh, very close. 170.

Oh, that's not bad. That's pretty good. And actually that five was probably just from the action today, maybe. From your extreme position of power, we are looking forward to what you have to say about markets because we always like to check in with Sarah. She's always got an eye on everything because the portfolios that Sarah manages have stocks, bonds, cash. Those stocks are all over the world. Different capitalizations, different geographies, different styles. Fixed income is in there, and all different types of fixed income, different types of credit. And some cash. Not a lot, but a little bit of cash. So it gives us a very good broad perspective on what's going on in markets relative to the economy. And of course, we have Eric Lascelles on who gives us an update on the economy. Stu Kedwell, on Stu’s days, gives us more of that Canadian equity. We've got other people who come on and talk about global equity. But Sarah covers the whole gamut and I just want to stay at the front end: we're taping just before a Fed announcement; the Federal Reserve will be out later today with an announcement on interest rates. So we've got a bit of a view and we'll talk about what the Fed is doing. But whether the Fed raises or doesn't right now is not that critically important at the end of a fairly significant rate hiking cycle, which Sarah will get into in terms of the view of how close we are to the end of that tightening cycle. But we won't talk specifically, because we won't have the answer while we're doing this taping. So again, let's step back. Let's talk more broadly about what's going on. Inflation still is really the central theme of the discussion around interest rates and the economy. We saw the US numbers out earlier this week. The overall CPI was a little bit below expected. Core was still a little high, would you say? At expectations?

Yeah, I would say probably. Generally, in line with expectations. A lot of the key factors that drove inflation to its highest level in four decades had been turning over the last several months, and we're seeing some really good progress on inflation. And so that massive amount of monetary tightening that the central banks have put into the market are really starting to work and bringing those inflation levels down. And you mentioned the Fed earlier, so yes, there is a possibility that the Fed is done. There's a possibility that the Fed does another 25 basis points. But after 500 basis points of hikes since the beginning of 2022, whether or not they do another 25 is probably not that significant an impact on markets.

Yeah. When I have dessert, if I have a third piece of cake, I've already gone way too far, once I get past one. What difference does it make, right?

Exactly. I just think that the need to continue to raise rates is going to diminish. The good thing is that central banks should now be in a position to potentially cut rates in the back half of this year, if necessary, if the economy does weaken or if there's a recession on the horizon in the back half of the year. So we don't think that interest rates are going to retreat to historic lows like we saw back a couple of years ago, or even to the average of the post financial crisis era. But we think they're near the end of their tightening cycle. And there is the potential for some rate cuts over the one-year time horizon, depending on how the economy tracks.

Yeah, I shouldn't diminish a 25-basis point rate increase if it were to occur, similar to the bank of Canada increased last week. It does have an effect if you are a borrower and you are on a floating rate loan. Your loan likely goes up in terms of cost, 25 basis points. Let's not diminish that. But as you say, in contrast to 500 basis points of increases already, another 25— and recognizing that we're getting close to the end— is not as significant as if they were going 25 basis points and we were expecting them to go another 500. That would be the beginning of a continued rapid climb in rates. And that's not what you're saying at all.

No, exactly. It reminds me of when we talk about performance, relative versus absolute performance. So it's not the absolute 25, it's the relative 25 that matters.

Perfect. Yes. Because when we went from zero to 25 basis points, that was more significant than going from 500 to 525.

Exactly.

And when you're well over 200 pounds, like I am, that third piece of cake is not doing a whole lot on a relative basis. So all of this, though, where we start to think about it from a portfolio sense, is how does this all come together around the bond market and what happens in the bond market, given all the tightening that has happened, and as they wrap up this tightening as we move towards the end of the year?

Yeah. While it's not definitive yet, I would say that we probably saw peak yields last fall because we've seen a significant improvement since then. We think that the relentless increase in bond yields from last year that we saw, because it's erased a lot of the overvaluation in the bond market, things are much better positioned in here and so the prospect for returns going forward are much better for bond investors. Our forecast for the US ten-year, taking that as an example, one year out is about 3.25% and if you take that versus the current level where we are is about 3.70% in the US. That means that yields falling, means prices higher. So we actually have some good total return prospects for bonds going forward from here. And the good news is, because we've reset yield levels to more reasonable levels, from historically low levels two years ago or so, they are in a better position to act as a ballast or a diversifier in a multi-asset portfolio, should we encounter any volatility in the equity markets, if a recession does take hold. Eric Lascelles I think has said that his forecast now is about 80% chance or probability of a recession in the back half of 2023.

Yeah. And economy slows down. Then the Fed and the bank of Canada accomplished what they were looking for in terms of slowing down the economy. Inflation coming down. And if that has a negative effect on stocks, which we'll get to in a moment, bonds are an important protection, which is why you have that diversification. And that's what you do when you're managing the portfolios that you manage. You're using or you like to be able to use the fixed income as insurance against volatility in equity markets.

Yeah, exactly. And so, we will tactically manage between the equity and cash and bond weight as the opportunities in the market present themselves. And if we see some equity market volatility on the horizon then we can shift money into the insurance side of the portfolio as you mentioned, which is fixed income and/or cash.

Yeah. And now as we've been talking about with Stu, we've had a fairly decent rally from the lows in October. It's been a little bit narrow; it’s broadened out a little bit over the last week. But you're starting to hit some levels where you're getting to a 20-times multiple on the S&P. So what are your thoughts on equities? Can this rally continue or is this where you expect a bit of a breather?

Yeah, well, the rally off of the lows was pretty broad-based initially, but the returns in recent months have been more concentrated on a pretty narrow set of US mega-cap technology stocks. When you actually look beneath the surface and beyond that US large cap market, you're actually seeing a little bit more modest performance. For example, the overall S&P 500 is up about 9% in the first five months of 2023. But if you look at an equal weighted version of the S&P 500, which kind of normalizes for that weight of those large cap tech stocks, the index is actually down 1.4%. So those tech stocks which are really being driven by a lot of enthusiasm and excitement around artificial intelligence, it's masking the performance of the underlying index. So not a lot of breadth in the market. We're keeping a very close eye on that. I think the bigger threat to equity markets right now is the sustainability of corporate profits. They have been struggling as of the last few months and they are vulnerable if the economy falls into recession. And as I mentioned a moment ago, we placed about 80% odds of a recession developing over the next few quarters. And in that type of environment, you're going to see corporate profits and earnings likely come down and that's going to put some pressure on equity markets over the next six months.

So you pull that all together— and this is why we love to have you on—, the bottom line is then how do you position your portfolio given your expectations around central banks, bond market, stock market and where we're sitting right now?

Yeah, well, the asset mix is a balance of risks and opportunities. And actually, right now the risks and the opportunities that are facing us in the market are exactly that, balanced, meaning that we're actually neutral on the asset mix for the first time in quite some time. So we're bang on our strategic neutral positions across all of the portfolios. How we got there was we began 2022 with an overweight in equities and an underweight in bonds. And over the last 18 months or so we have been moderating those positions by buying bonds as yields rose and by selling stocks as risks increase in the equity market. And so, our next move: we're monitoring things very closely, we're going to adjust as necessary some of the things that we're looking at in order to add back to our equity exposure because as you know, we generally have an overweight in equities because we want to capture the risk premium of equities over bonds over the long term. The things we need to look at in order to add back to our equity position would be an easing in financial conditions, an improvement in leading indicators in the economy, expanding market breadth beyond just the US large cap tech stocks driving performance in the market. So a number of things that we're looking at to potentially add to our equity weight over the next six months.

Any areas in particular you're favoring or unfavoring, overweight underweight, when you get into specific regions or biases towards value or growth?

We don't particularly focus on value and growth within the portfolios. We try to build fairly balanced portfolios from a style and factor perspective. From a regional perspective, we have a preference for Europe and Asia within the portfolio. So we're slightly overweight those regions at the expense of North America and emerging market equities.

Okay, so that's a good synopsis of where we are and what you're thinking about. For the listeners, when you say you're on a neutral weighting— let's just take the most common investor, a balanced investor— what would that mean in terms of your asset mix for balance? What is that target for the way you think of a balanced portfolio?

It's 60% equities, 38% bonds and 2% cash.

Excellent. So that's right where you're sitting and taking a look at how things play out. And you seem pretty calm, but I know you worry about a lot. What's keeping you up at night around these markets? As we talk to everyone there seems to creep in a little bit more uncertainty around what's going to happen over the next six to twelve months.

Yeah, I think I could probably answer that in two ways. One focused on markets and one focused on how clients react to that volatility that you just mentioned. So for markets, as I mentioned, we neutralized the tactical asset mix because we're expecting further volatility in equity markets over the next few quarters, as that recession comes into view. It's always possible that the market doesn't price in a recession, or the markets don't adjust, in which case we’d derisk the portfolios too early. So that's something we're keeping a very close eye on markets, and we will adjust our view and our positioning as needed if the outlook does change. In terms of the client side, I think the thing that really keeps me up at night is how clients are reacting to this volatility in market. They've become very nervous about the future prospects for markets, and this led many of them to deviate from their long-term investment plans, instead choosing to remain in cash or just to sell some of their investments and move to cash. I think that's an appropriate strategy for some clients, but probably not all clients, because those that have long-term time horizons or the need for higher returns to meet their retirement and their investment goals might be putting themselves into a position where they're not going to be able to meet their goals. So I really find myself reminding people often that they need to focus on where markets are going, not on where they've been, and to reflect on the significant change we've had in markets over the last 18 months. But I'll then also focus on their long-term goals, not what's going to happen in the next day or month or quarter. What they need to achieve in terms of performance and returns over the 12-, 15-, 20-year time horizons that most of our clients have in front of them. So it's really about controlling your emotions and sticking to those long-term investment plans that they've put together with their advisors.

Yeah. And just one more time, if we go back to October— what are we talking about, nine months?— last eight, nine months have been an example of that, where there was really nothing that would have suggested that October was going to be a time where you likely should have been investing. It was a very uncomfortable time to make that decision. Yet, we can look back now over the last eight or nine months, and it's been a pretty good period for investors, whether you're in stocks or bonds or, as you like to say, with diversification in both. As we always say— and some of this is cliche, but at the same time, there's a reason why it makes sense— that no one's going to ring the bell and tell you the exact time to get in. And oftentimes, you're feeling the worst is likely the time that you should be considering making an investment decision. And I know you think quite often about that, taking the emotion out of your investment decisions, just clinically looking at markets and how to maximize returns over the long term.

Yeah. And to your point, we've done a lot of research on this to say, how much of the return for the entire cycle do you miss out on? If you miss the first six months of the new cycle, it's a pretty significant portion of it. You're at the low in a market, and you hear that this is the time that you're supposed to be buying stocks or buying a portfolio or investing in the markets. That seems the worst possible time. I don't know why you want me to invest now, everything feels terrible. And you say, yes, that's right, that's the time you actually should be putting the money into the market. So my preference would be for people to just stay invested and through the entire cycle, as opposed to trying to pick highs and lows in terms of selling or buying into the markets on an ongoing basis. Just stay invested through the entire piece and you'll have a much better result out of it.

Sarah, always great to catch up with you. You've always got some good insights and important things to say, particularly around thinking about investments and the way you approach it. Those truisms that you have— if you follow Sarah on LinkedIn, you can see she posts a lot of great content, including her ten investment truisms—, is it still ten or did you actually officially add the eleventh one on LinkedIn?

No, it's still officially ten. The number eleven, which we actually talked about here— which is to focus on where markets are going, not on where they have been— has not officially been added to the list yet.

All right. But again, Sarah a great person to follow. Lots of interesting stuff there. And again, thanks for joining us today, Sarah.

Thank you.