Hello and welcome to The Download. I'm your host, Dave Richardson. Really happy to be joined today— we don't have her on enough— by Sarah Riopelle, who runs portfolio solutions at RBC Global Asset Management. Hi, Sarah.
Hello. Thanks for having me. I think October was the last time I was here.
Yes, that's way too far in-between appearances. We want to fix that in 2022. That'll be my New Year's resolution. I'm sure everyone will be happy if we get you on a little bit more, because it's always great to hear you and hear your insights, particularly when so much is happening in markets. It's been a really eventful couple of weeks and a lot has happened. A lot has changed since we last spoke. So what's your view of the economy? How has it evolved? What's your mindset right now?
Well, as we talked about last time, we're really impressed with the resilience of the global economy throughout this whole pandemic period. It's been supported by monetary policy, fiscal spending, and then an effective vaccine program. Right now, leading indicators of the economy still continue to be strong, looking for robust economic growth, although they are down off of their highs from earlier in 2001. But the volatility we've seen in the last couple of weeks is a result of some new risks that have come on the horizon. The Omicron variant presents a new threat. The extent to which the spread can be contained is going to be critical to know whether it's going to have an impact on the global economy and markets. China presents another major source of uncertainty; stricter regulations, slowing growth, highly indebted real estate sector, all pose challenges for the second largest economy in the world. And then inflation is also running hot. High demand, shortage of workers, supply chain constraints are all impacting inflation. And so we expect above-normal inflation to continue over the medium term at this point. Add to that, central bank policy. Central banks are looking to dial back monetary stimulus. Some have already begun to outright tighten. In the US, the Fed started tapering its asset purchases in November, and seems to be increasingly ready to raise rates, which we expect to happen sometime next year. So the removal of this accommodation that we've had over the last eighteen months is a shift in monetary policy, which at the margin should be less supportive of financial market. Something that bears close watch.
So all this created some additional volatility in markets. Has it changed your forecast in any way as we head into the New Year?
Maybe a little bit around the edges. So bond yields have increased over the past quarter, reflecting those higher-inflation expectations and the prospects for higher interest rates, going forward. The bulk of the rise in interest rates has been around the short end of the yield curve, while the longer-term bonds have been much more tempered in terms of movement. We continue to think that sovereign bond yields are showing a significant valuation risk, so we expect yields to rise gradually over time. There are some secular forces that are going to limit the extent to the rising yields over the near term, but certainly something that bears watching. Looking at equity indices, they've climbed the new highs during the quarter. As you said, we've had some increased volatility over the last couple of weeks, as it slowed down a little bit with the Omicron variant and some of these other risks that have come out. Our model situates equity valuations above fair value. So the S&P 500, in particular, is the most expensive equity market in the world. Many markets outside of the US are no longer trading at discounts to fair values either. So we expect valuations are going to be a headwind going forward, but we have had very strong corporate profits as an offset. So S&P 500 earnings are up about 47% so far this year, versus 2020. So it has released tremendous growth in corporate profits to support equity markets from here. Looking ahead, mid- to high-single digit nominal GDP growth should be supportive of double-digit earnings growth going forward as well. So, despite the increased volatility and elevated valuations, we still have fairly strong prospects for equity markets over the next twelve months.
For you, Sarah, what you do so masterfully, is you take all of this and out of all that information, all of your thinking, you build portfolios. So how are you reflecting this in changes for asset mix across different risk profiles in your portfolios?
We made a small reduction in the equity weight to reflect some of the risks that we just talked about in the market. We still believe that stocks offer better potential, especially relative to bonds. But we have to recognize elevated valuations, narrowing equity market breadth, recent widening in credit spreads and some inflation concerns, and also the new Omicron variant, all pose some additional risks to markets. As a result, we're flagging the deterioration in this backdrop with the second cut to our equity weight over the last couple of months. So 50 basis points out of stocks and into cash. We remain overweight stocks, just a little bit less so than before. Looking at bonds, as I said, the prospect for higher yields likely means very low, potentially negative total returns from the bond side of the portfolio going forward. Any meaningful increase in bond yield is going to pose a risk to returns on the bond side of the portfolios. The reason that we put the proceeds of the equity sell into cash is to have a cushion against volatility. We're going to look for opportunities to deploy that cash into the market at better valuation levels. I will also be on the lookout for improving technicals in terms of breadth and more participation from international markets in a rally going forward. As I said, a little bit less stocks in the asset mix but we remain overweight because we believe the prospects for stocks over bonds remain superior.
Yes. Not that surprising. We've had Eric Lascelles on talking about the economic cycle and where we are in the business cycle. We're moving solidly into the middle of that economic cycle. Not surprising that you'd make these kind of moves at that point in the cycle.
Yes. Absolutely. That's correct.
Great. Sarah. Well, as always, a fantastic update. Very tight and concise. Right on the mark. Thanks again for joining us. And again, we're going to get you back more often in the new year.
Perfect. Thank you. I look forward to it.