Hello, and welcome to The Download. I'm your host, Dave Richardson. We're always happy to have our guest today with us because she brings such a broad perspective about what's going on in markets, the global economy, and pulls it together in portfolios for the money that she manages. That's Sarah Riopelle, who leads portfolio solutions at RBC Global Asset Management. Sarah, welcome.
Hi. Thanks for having me again.
We've actually just spent quite a bit of time on the road together, doing some presentations and some live Q&A sessions with some financial advisors. We've got a lot of great questions about what people are thinking about around these investment markets, which continue to compound. A very difficult first quarter in both fixed income and a little bit in equity, particularly some areas of equity. Let's get right into it, because again, I know you've got a real appreciation for what investors are thinking about right now. We've seen this volatility, and as I mentioned, both in stocks and bonds in the early part of 2022. What are your thoughts and what do you think this means for investors as we look forward?
We've definitely encountered significant volatility so far this year as the markets have worked through a variety of developments. Those include the war in Ukraine, the possibility of slower growth, high inflation, which is persisting longer than expected, the resulting impact of that high inflation on monetary policy, and then now the rising odds of recession. Against that backdrop, central banks have begun to raise interest rates, and that's marking the transition away from that era of extraordinary monetary accommodation that we've had for the last several years. We're seeing that wind up of quantitative easing and introduction of quantitative tightening. That's a significant shift over the last couple of months. That's likely going to act as a headwind to the economy and asset prices going forward. So our own forecasts are looking for economic growth to continue to slow and for inflation to be higher for longer. We expect price pressures, however, to peak at some point this year and eventually move lower, but they will remain above normal over the medium term. As you said, it's been a tough period of adjustments for investors, especially when you compare it to the period strong gains and relatively low volatility that we saw during 2021. We were out talking to advisors over the last couple of weeks, and this is a message I gave to them quite often. It's periods like this that it's important to focus on the things that you can control. That includes keeping your emotions in check, staying invested, focusing on your financial goals, because you have to remember that you have no influence over what the markets are doing. You just have to try and ignore that short-term noise and stick to those well-thought-out financial plans.
Yes, that was such an important message. I've heard you deliver this. Anyone who follows you on LinkedIn has seen posts that you've put up with your thoughts around this. We get into these volatile periods in markets. We get into these periods of quite a bit of uncertainty. Of course, individuals hate uncertainty. Markets hate uncertainty. You see that in the way markets are reacting. It's at that point that people start to move away from the basic principles and the basic approach that they use, the planning approach that serves them so well and try to do something different because the short-term results aren't what they want, when in fact, what they should be doing is running back to those core principles, sticking with them. That's what's ultimately going to lead them to more success.
Absolutely. I totally agree with that.
The big question then on the mind of investors, and particularly conservative investors. More aggressive investors, people who invest more so in equities kind of understand what they're buying into, which is you're going to see that volatility from time to time. But more conservative investors in an environment of rising interest rates, where it's affecting the fixed income, the bond side of their portfolio. What are your thoughts for conservative investors, all investors who are using fixed income? How do you manage the fixed income portion of your portfolio?
Well, we've seen a substantial jump in fixed-income yields over the last few months, and that led to negative returns for bond funds. For example, the U.S. 10-year yield climbed as high as 2.97%. That's its highest level since the spring of 2019. That significant and rapid climb in yield since December has led to a 9%ish loss in the broad bond market in the U.S. That's the largest decline in that index since the early 1980s. It's definitely been a difficult period for bond investors. Where do we go from here? For first, I think you have to consider some important implications associated with an increase in interest rates. While it's painful in the near term, it's not all bad in the longer term. You have to consider it from the perspective of the total return of your bond investment. That includes both price and interest income. While it's true that rising yields can create capital losses in the short term, it also sets the stage for higher interest income and does higher future returns. That's something that I try to remind bond investors of. And then when interest rates are rising, you can purchase new bonds at higher yields, and then over time, the portfolio is going to earn more income than it would have otherwise if interest rates had remained lower. It's important to not lose sight of that, and also not lose sight of why you hold bonds in the first place. They provide income, stability, diversification and liquidity within portfolios, especially in the face of equity market volatility. Looking forward, the massive increase in yields that we've seen recently has actually taken away some of that valuation risk that we saw in bonds. We think that a further sustained rising yields from here is probably going to be limited over the next year. We are now expecting modestly positive returns for government bonds, and that actually represents a pretty meaningful shift in our view because of the last several quarters, we saw a significant risk of negative returns for bonds. But now that that adjustment has actually taken place, that risk is significantly reduced and we actually have positive return forecasts for bonds now.
I guess one of my favorite analogies on this is one that someone we've both worked with over the years, Dan Chornous, used to talk about: the ball. You've got a ball and you're in a swimming pool and you take that ball and you push it down under the water. Think of the ball as the global economy. During Covid, for good reasons, we locked up the global economy, so we pushed it down under the water. Then as things reopen, you release the ball and the ball jumps up out of the water. It doesn't just come back up and sit on the surface. It kind of overshoots and then settles back down. We've seen that with inflation and now interest rates, particularly longer term interest rates. You've got a bit of that overshoot, and then you get into a period where things calm back down and normalize, and that, as you suggest, could be good for bonds. In terms of positioning, how are you positioning the portfolios right now?
I think the key theme that we have to continue to think about is volatility. I think that we're going to continue to see heightened volatility because of the variety of risks that we've talked about already. The range of potential outcomes for markets is much wider than usual, and so we have to be aware of that. I think that the bond market has mostly adjusted, but there is still some downside risk in equity markets, especially given the heightened recession risk that Eric Lascelles has been talking about over the last couple of weeks. The significant repricing in assets since the start of the year has provided us with opportunities to actually make some adjustments to our asset mix. Over the last couple of months, we've narrowed our degree of underweight in fixed income in recognition that the rising yields has reduced the near-term valuation risk. We're maintaining a slight underweight in fixed income given our longer-term view that rates could rise from here. Notice I said “longer term”; we think that most of that adjustment has happened for the near-term and medium-term period. Then, we've also been active in our equity position. We've added to our equity allocation in stocks in the early days of after Russia's invasion of Ukraine. We later trimmed that position as the situation evolved, and we realized that it was going to have a larger and longer lasting impact on the global economy. Since just this week, we've also reduced our equity weight, again placing the proceeds into bonds. What we're doing is actually moving the asset mix closer to neutral than we had been for some time, reflecting the rising risk of a recession. All told, we continue to expect stocks to outperform bonds over a one-year forecast. We're maintaining a modest overweight in equities. But we've narrowed that degree of overweight over the last couple of months.
We have a frequent guest on the podcast, Eric Lascelles. Eric would say that we're in that transition from the middle of the business cycle and starting to show some signs that we're starting to dip our toe into the later stages of the business cycle on some metrics. Not surprising that we're in around neutral and moving even more so towards that position. Like I said, we were out traveling across Canada over the last three weeks, and you got asked by a lot of people what should they be doing during periods of volatility. I know you got great answers on this. What do you say to those investors?
You mentioned LinkedIn earlier. I actually published a LinkedIn post on this topic last week, which is getting some good positive responses. That post was focused on what I call the top 10 basic truths of investing. I'd actually published the original list back at the beginning of 2020 before the pandemic. We had a conversation about it as we were preparing to go out on the road to talk to advisers a couple of weeks ago, and we decided to refresh the list. This is 2.0, the new and improved top 10 basic truths of investing. The focus, I think, is the importance of diversification, maintaining a long-term perspective, time in the market is more important than trying to time the market, especially in these periods of volatility. Some of the old ones are still there, but I added a few new ones. The new truths focus more on that emotional side of investing that we talked about earlier and how staying focused on your long-term goals is the key to investing success. That's especially true during periods of volatility like the ones that we've seen over the last couple of months.
I start most of my client presentations or investor presentations that I do looking at the impact that emotional decision making can make on portfolios and so many studies that show the average investor earns much less than the market returns and it's all about making emotional decisions, buying high, selling low and missing the returns. Whereas if you just stick to the plan as we talked about, you're much more likely to succeed. As I said, I really suggest that you take a look at what Sarah has on LinkedIn, not just now, but all of her posts are just fantastic. Whether you're a very sophisticated investor or you're just learning or just starting to invest, they're just words to live by. There's really some excellent content there and these basic truths of investing, I think, are something you can almost print off, post on the wall and just stick to as you're investing, whether you're just starting to invest at 20, or whether you're moving into retirement in your late 60s or 70s. So, Sarah always great to get you to come on because you always add so much value and we look forward to catching up with you again, probably a little bit quicker than we normally do.
That's awesome. Thank you so much for having me.