Hello, and welcome to The Download. I'm your host, Dave Richardson, and I'm joined by Sarah Riopelle this morning. It is the morning of Thursday, February 24, and of course, overnight, Russia commenced their invasion of Ukraine, and we're seeing the market reaction to that. I thought it would be a great time to get someone with Sarah's background in constructing portfolios for millions of investors across Canada. She has a perspective not just on what's happening in equity markets, but in fixed-income markets, commodities and such, because she runs the full spectrum. Sarah, welcome. Thanks for your time this morning.

Thank you for having me. A lot is going on this morning, as you know.

We were originally going to talk about some of what was going on in markets anyway and some shifts that you've been making to portfolios in general. Let's start with what's in the news. Let's not bury the lead. What are your thoughts on the Russian invasion and implications?

Unfortunately, we've been through a number of these types of events in recent years, and the one thing that we've learned is that putting out something in response is challenging because it will probably be wrong within the first fifteen minutes after we put this out. That said, let me share a couple of initial thoughts that I have gathered from various places so far this morning. In the near term, this likely means that energy prices are higher, commodity prices are higher. There's a risk-off sentiment in markets, and there's probably a host of new economic sanctions coming for Russia. Longer term, we probably are going to see higher defense spending on the back of this. Prioritizing energy security over climate change because the impact of this on energy prices and supply and demand within the energy sector, and then an economic decoupling from Russia. Western powers are probably going to put pretty significant sanctions on Russia in an effort to effectively sever that country's access to global capital markets, in response to this. Rising commodity prices, fiscal reforms have allowed Russia to actually build a substantial foreign exchange reserve, so they could probably withstand those sanctions for quite some time. It's going to remain to be seen how long this could potentially last. I actually spoke to Eric Lascelles this morning— I think you've had him on the podcast quite a few times— to get his initial thoughts. He said this invasion is worse than we had initially assumed. The global consequences of the damage to Russia's economy will be, by itself, fairly limited given the small size of the Russian economy. But we do need to look at the effect the commodity prices are going to have on other economies around the world. We think a lot has already been priced into commodity prices in anticipation of this, and which is why they're up in the 5% range as opposed to potentially the 20% range, because we've already put a lot of that in the prices already. Supply of natural gas from Russia to Europe will likely get cut. Initial street estimates show that maybe the European growth is going to come down 1 to 1.5%; less significant drops in growth elsewhere around the world. A lot of moving parts, a lot to consider from an economic perspective when we're still digging through all the data at this point.

Lots of work through in the economy. We're going to have higher commodity prices, particularly in energy, and potential for slower growth. We've already been going through a corrective phase. Some of it, as you said, is a lead into the anticipation that something was going to happen. We're not exactly sure what the scale was going to be, but something was going to happen here. But a lot of the attention has been on inflation— and obviously this doesn't help—, and what the Fed and other central banks around the world were going to do. Does this shift in any way our expectations about what's going to happen on the inflation and central bank front?

It does. I spoke to Dagmara Fijalkowski this morning, another frequent participant in your podcast. Her view is that this has important implications on the outlook for inflation. Our view was that inflation would begin to drop back to more normal levels in the back half of this year, and that may not be the case anymore, given recent events. We expect that the Fed will likely go slower, given the implications on economic growth. They may have to tolerate higher inflation, perhaps even stagflation in the near term. We also have to consider that the risk of recession is now likely a little bit higher than it was a few days ago. Right now, it looks like markets are pivoting back to expecting one hike from the Fed in March rather than two. There was some thought that we would get 50 basis points out of the Fed; it looks like it's shifting back more like 25 basis points. It's definitely going to be a balancing act for the Fed because they have to balance between the fact that we're going to see slower economic growth and that risk assets are falling, but we're still going to have high inflation. Should they be hiking to deal with the inflation problem at the risk of harming an already vulnerable economy? It's going to be a tricky situation that they're going to have to balance, and we'll have to see how the situation plays out.

A perfect storm of things pulling together, and it just makes it so challenging for them and also for equity markets, which we're seeing a fairly strong reaction this morning after markets already correcting. As always, there's a short-term view, and then we want to take a step back to the investors and think about longer term, and what this all means. How do you pull that together, Sarah?

We're certainly seeing risk off in the markets right now. What that means is equity markets are down and bond yields are falling, which means bond prices are actually rising. The S&P 500 is now in correction territory. So much of this is likely already priced in and bond yields have fallen from just over 2% a week ago, when we're down closer to 1.85% for US ten year as of this morning. Interestingly, bonds are doing exactly what we expected them to do in a diversified portfolio. We've always talked about them providing a ballast in times of equity market volatility, and that's what they are doing today. It's going to offset some of the pressure on returns in a balanced portfolio. We've actually tracked these types of events for a long time, and I asked Eric Savoie to update some of that work that we've done. It looks at what we call acts of war through history and the impact that that's had on markets. On average, the decline is about 2.7% over five days after the act of war is initiated, with a full recovery within twelve days. If you describe it as an external event— there's some other types of events that we describe as external— it's a similar pattern, although it takes a little bit longer for markets to recover after the initial event. On the bond side, we see the same kind of risk off pattern where bond yields decline over a fairly short period of time and then recover rather quickly. As always, this time could be different. In this particular case, it's hard to say how much of the sell-off is related directly to the Russia-Ukraine situation, as opposed to changing expectations around central banks. It's going to remain to be seen at what's going to happen. But we still believe that from a longer-term standpoint, we tend not to focus on geopolitical conflict as having a long-term impact on markets because there's been plenty of conflict over time. The market has digested adjusted expectations and then moved on from there. We don't want this conflict to get in the way of our long-term planning because, frankly, it really hasn't in the past. We don't expect to in the future. But that's not to say we're not going to expect some continued volatility in the near term in markets.

It's one of those where I've been getting a lot of questions from investors and advisors lately that relate to: why would I own fixed income right now? Rates are going up, what's the purpose? You need an event like this to remind you exactly why you have fixed income in a diversified portfolio, because fixed income is what's working. This was the original purpose of our call today, you recently had made a shift in your asset mix, which favored fixed income, interestingly enough. Can you talk about that?

As bond yields were rising in January, we decided to make some changes to the fixed income. We actually moved cash to bonds. We started that process in January, we moved 25 basis points when yields were around 1.9%. They had risen up to around 1.9% over the course of January. We did a small piece then. And then a couple of days ago, yields got over 2%, and so we moved another 25 basis points from cash to bonds at that time. We're still underweight bonds within the asset mix because of our long-term view that yields will rise over time. However, we are less underweight than we were a month ago because with the rising yields, we thought a lot of the valuation risk in the bond market had come out. We thought it was a good opportunity to narrow that degree of underweight. We still have higher-than-normal cash. We have more bonds than we did about a month ago, which is going to help to cushion some of the impact on returns of this equity market sell-off.

Sarah, I know you're a huge proponent of getting advice around your portfolio diversification, taking a portfolio approach to investing. Again, you highlighted all the reasons why that's so important at a time like this. Is this an event where investors should be acting? When you're talking to friends, family, loved ones today, when they're calling you in a panic— I've already gotten a call from Mom this morning.

My dad is on my text at the moment.

There you go. What are you saying to them about what they should be thinking about right now? Is this a time to act, or is this a time to sit back and let your portfolio, the way it's constructed, your overall investment plan, do what it was designed to do?

This is what I told my father this morning when he texted me: please stop watching the headlines. The markets will not look good today as they digest the headlines. But this should not promote you to act or panic and sell. You need to stick to the long-term investment plan that you so diligently prepared with your financial advisor. When you prepare those plans, it's not with the eye to the next week or a month or even year. It has a long-term view. What's happening today should not impact your expectations for the long term. You should try to, as best you can, ignore the noise and the volatility and stick to your long-term investment plans.

And that calming voice is why we've got you on today, Sarah. Nobody does it better. So, Sarah, I know you have a busy day. We’ll let you get back to looking over all the things that you have to look over on a day to day basis and I really appreciate you taking the time this morning.

Great. Thanks so much.