Hello and welcome to the Download. I'm your host, Dave Richardson. And speaking of Download, I'm feeling down today, so if I don't have the normal energy that I have, I'm a little under the weather. Thus far this winter, me and the family have been pretty good in terms of avoiding this kind of stuff, but I guess it catches up with everybody. And that's why we've got a very young and healthy guest today. And that would be Eric Savoie. Eric, welcome. I don't think you've been on the podcast yet, have you?

No, I haven't. First time. Thanks for having me. I'm happy to be here.

So, Eric, why don't you introduce yourself, your title and what you do.

Sure. I'm Eric Savoie. I'm an investment strategist at RBC GAM, and I cover all things macroeconomy and markets. And so I help with our top down research and establishing our view in terms of where we think the economy and markets are going and helping with the decisions that go into the tactical asset allocation of our balanced suite of products.

And we're not doing video today, but you'd think Eric is just coming out of high school. But a brilliant guy. And that's why we wanted to get him on. Eric, we've had discussions with lots of guests; Eric Lascelles and Stu Kedwell and Sarah Riopelle and others. And for a lot of the last 18 months, we've been talking about the fact that probably the most likely outcome of all these interest rate hikes is that we go into a recession. And it just keeps sort of kicking down the road, it just doesn't happen, doesn't happen, doesn't happen. And now there's more talk about maybe we're going to avoid the recession. So what are you thinking right now in terms of economic growth and where we are with respect to recession — a soft landing, no landing — and where we are?

Yeah, that's right, Dave. The economy has been quite resilient in this phase of the cycle, particularly in the United States. And as you said, with all the tightening that we've seen impacting the economy, we would have thought that we'd see a little bit more weakness by now. And we are seeing a little bit of softness in different parts of the economy. But overall, we're just not seeing that level of deterioration that would be consistent with a recession. And actually, a number of the indicators that we've been monitoring for signs of a potential soft landing are turning in the right direction or a positive direction for the economy. Things like leading economic indicators, for example, purchasing managers indices, those have been rising for the last few quarters now and crossing above that 50 level that marks expansion versus contraction. And so in some regions, we're actually crossing above that 50 level more recently. If you look at the loan survey data now. This is very popular. In the wake of the banking crisis that we saw early last year, we saw significant intensity of tightening in lending conditions across all financial institutions across the world. And the intensity of that tightening is now diminishing. We're actually starting to see an uptick in a lot of those lending indicators. Consumer confidence. Of course, that's been one of the big stories in the US. The consumer just has not stopped spending. And some of the consumer confidence surveys that we look at are still relatively weak, but they have been improving and they are on a rising trend in the last few months. The housing market as well. Similar story. We have seen some softness, of course, as interest rates have surged to 20-year highs in the US and mortgage rates climbing as high as 8% on the 30-year fixed rate. But those have peaked late last year, and rates are still high. Activity in the housing market is still relatively subdued, but it is starting to pick up again. We're seeing an increase in sales and even prices starting to inch a little bit higher. And so expectations for corporate profit growth have been fairly robust. And so that's a suggestion that corporate America is in relatively solid shape here going forward. And then also the last thing that we're looking at, and the big one, is inflation, which is no longer at the extreme levels that we saw in 2022 and has come down quite significantly, moving in the right direction and closing in on the 2% level that central banks are targeting. So when we take all this together, overall, we would have to assess that the odds of a soft landing have improved. The odds of a recession have diminished. And we think that even in that adverse scenario where a recession were to play out, we think that if it did occur, it would be of a mild variety and potentially short lived.

Yeah. And I know as I've been out speaking to investors, I put up so many charts with economic numbers where when they look a particular way, there has always been a recession. So tightening of business lending amongst banks in the US is one of those critical ones. And you just don't get that recession. And now you're seeing some of these numbers reverse. And of course, this is all good news because we'd rather avoid a recession. Recessions are tough for people functioning in the economy. But all of this has been about inflation. And what we did see through the month of January and a little bit early in February in terms of any numbers that have come out, is we've had a little hiccup in inflation. We're still heading in the right direction, but when do we get inflation down to the targets that the central banks have?

Yeah, that's right. I would say in the last few prints, you've seen a little bumpiness in the inflation data. But overall, we still think that the inflation story is very much of a positive one. So we remain constructive on the outlook for inflation falling back toward that 2% level targeted by central banks. Maybe not by the end of this year, but perhaps at some point next year. And it's becoming increasingly clear to us that a big part of the surge in inflation that we saw from 2021 to 2022 was a result of supply chain constraints, as a result of the pandemic and then the war in Ukraine, and at the same time that was met with massive demand fueled by significant monetary and fiscal stimulus. That was all happening at the same time, causing a rapid rise in prices pretty much across all categories and everywhere in the world. But since then, a lot of these pressures have diminished. Stimulus has turned from extremely accommodative and easing financial conditions to now one of outright tightening. Supply chain problems have eased significantly, and we're seeing a number of other indicators that we track moving in the right direction. If you look at money supply in the US, with the Fed reducing its balance sheet, money supply growth is now in slight contraction. Used car prices, which was one of the big pain points for consumers, if you look at the latest prints, is now actively declining a little bit. Rent increases have moderated to now low single digits and even have started to fall a little bit, depending on the region. Commodity prices have been relatively subdued. And inflation expectations, which is quite important for consumer investor psychology, has remained well anchored around that 2% central bank target. So we take everything together. We remain optimistic that inflation continue falling. We do recognize, though, that there's been significant progress made from that 9% peak that we saw in 2022 down to now. We're around 3.5% on the US CPI inflation. So that last stretch from 3.5% down to 2% will likely be more difficult or take longer to play out. But we do still think, and we're fairly confident that we are ultimately on that trajectory towards lower inflation readings.

Yeah, and that's what's most important. That it directionally keeps moving down. And again, you're going to have some hiccups here and there, month to month, but overall, you're ultimately going to get down to the right spot. So I know, Eric, as you introduced yourself as an investment strategist and portfolio manager, that means you're always thinking about risks. I've worked with enough of you guys over the years to know that. So what are the risks to this assessment?

Yeah, a lot of what we've been talking about so far have been all the positives, and there are quite a bit of positives things moving in that right direction. But we always want to keep in mind the various risks that could play out or unfold that could challenge our positive view. Geopolitics comes to mind, particularly with the military conflicts that we've been seeing in the Middle East. Some of this stuff, depending how it plays out or how intense it gets, could put some upward pressure on inflation again. We started to see some increase in shipping costs as a result of the attacks that we saw on some ships in the Red Sea. It is not nearly to the effect that we saw during Russia's invasion of Ukraine, but some of that stuff could pose a potential threat to inflation in the near term. China is another big one. Growth there seems to be dwindling. They have problems, and those have been in place for quite a while in terms of their property market. But there's a highly indebted nation with growth potentially continuing to slow, and that could be challenging in terms of the broader global growth story, because they are such a key contributor to global growth. And, of course, we've talked about the effect of interest rates and rising interest rates, and that tightening has still been injected into the system, and it is still there. And it might just be that the lag between which you get that increase in rates and the ultimate impact on the economy could just be delayed for whatever reason — because there's been so much stimulus as a result of the pandemic — and it could just take a little bit longer for that to bite. So we are still watching that. And then one of the other big ones is the US election later this year in November. That's going to be exciting, as it always is. It'll probably be a close race. It looks like it's going to be a Trump versus Biden face off. And of course, when you get close to those key events, you could get a pickup in market volatility just as investors are not quite sure which way things are going to go. So these are some of the key risks we are monitoring. And we recognize that even if the prospect of a soft landing has improved, the economic expansion is still mature and we would say that the odds of recession, even though they have diminished, remain quite elevated and are above average at this point in the cycle.

Yeah, and some of that might have to do with the fact that central banks, who we were looking at just a couple of months ago or a month and a half ago, with March being the first month where the bank of Canada or Federal Reserve starts to lower interest rates, that seems to be getting pushed back, which means the number of rate reductions during the year would get pushed back. So when you wrap all this together, what are you seeing coming out of central bank policy as we move forward?

Right. So central banks throughout most of the world are now on pause. They've been on pause since the summer of 2023. Most central banks recognize that a significant amount of tightening has been injected, and we're now at a point where interest rates are sufficiently restrictive to curtail economic activity and bring inflation down. And really, that's worked pretty well so far, so much so that central banks can reasonably expect it to provide some sort of relief at some point in 2024. And so the question now seems not whether the Fed will cut interest rates, it's more a matter of when they're going to cut the rates and, when they start cutting, how much easing are they actually going to deliver? And like you said, at one point, the futures market was pricing in six cuts over the year ahead for the US federal funds rate, with the first cut happening in March. We had always thought that was a bit aggressive for our own view. We thought maybe something like three to four rate cuts over the year ahead with the first cut, maybe by late spring or early summer. So more middle of the year rather than early in the year. And over the past few weeks, actually, the markets moved closer in line with our view. They're not quite there yet, but market-based expectations have been dialed back to something like four to five rate cuts over the year ahead instead of six. And so still a little bit more than what we'd expect, but we think it's a little bit more reasonable in terms of market expectation. Of course, the expected path for rates is in constant flux, and a lot of it will depend largely on the incoming data. We've got an inflation print coming out on Tuesday. Central banks will have to carefully navigate the situation and adapt as necessary, as they've done all throughout this cycle. And so if the economy were to enter a more severe downturn, it's more likely that we'll get more cuts than what the market's expecting. And then on the flip side, if the economy hangs in there, if inflation remains a little bit stubborn, we might even get a little bit less rate cuts than the market's pricing in. But overall, the message is quite clear. Central banks are telling us that investors can expect easing at some point this year. And so what that means also is that the high interest rates that are available now in cash or money market instruments, we think are unlikely to be sustained in here. And so investors should anticipate at some point, over the course of the year, that the reward for having cash or short term money market instruments will diminish a little bit and potentially even further into 2025 if the rate cutting cycle persists.

Which then gets you to the discussion of bonds. And we've talked a lot about bonds on this podcast over the last, really almost a year. If you go back to the period leading into Covid, then through Covid, and then the resurgence coming out of COVID as rates start to go higher. Then through October, November, December, long-term rates came down one and a quarter percent, only to reverse and pop back up 40 or 45 beeps. So it's been a much wilder run in the bond market than I think most bond investors are used to. So what's the view on bonds now with where we're sitting today, looking out over all the things that we've discussed up to this point, including what central banks are going to do? Are you as excited about the bond market as you would have been back in late October, early November, or are you a little more muted in terms of your view of bonds right now?

Right. It's been an exciting time to be a bond investor, that's for sure. The wild swings. I mean, 100 basis point move in the sovereign bond market is pretty extreme. And we've seen, into the fall last year, up 100 basis points, and then two months later down another 100 or even more than 100 basis points at one point. So we were at 5% in the US ten-year in October, and now we're hovering just a little bit above 4%, but it pierced briefly below 4% for a couple of weeks there. Yeah, you're right. We have seen a powerful rally in bonds since October. At that point, bonds were the most attractive across all of the models that we maintain and monitor, than we've seen in 15 years, dating back to just before the financial crisis. And so at this point, looking at our models on a valuation basis, or at least when bond yields are at 5%, bonds were especially appealing at that moment. I would say, since you've had that 100-basis point decline in yields down from 5% to 4%, we're still very much constructive on the outlook for bonds for the reasons that we talked about. Interest rates are likely on the way lower. Inflation is probably on a downward trajectory. We're near the end of the economic cycle. Potentially, the risk of a recession is still elevated, but perhaps a bit lower than it was before. And so in this environment, we still expect something like mid- to high-single digit returns for sovereign bonds over the year ahead. And that's a view that would be supported by our models, as long as inflation continues to go lower. And if you think about it, the bond investment generates the return two ways. You get your capital appreciation and your interest income. And so investors have enjoyed a lot of capital gain. If you got in at 5%, yields around 5%, down to 4%, a significant amount of that capital gain has been delivered. We think from this point going forward, with yields around 4.15% on the US ten-year, there might be a little bit of capital gain left, but you still have that interest income there that bond investors will enjoy. And so taking those things together, the outlook for bonds, we think, is still quite good. Something like mid- to high-single digits over the year ahead, depending on the region, we think would be quite reasonable.

Yeah. And we've been talking about it, when you go from 5 to 4%, even if you think the trajectory is down, there's only so low that rates are likely going to go through this economic cycle. So you've used up some of the powerful gains that you get on that move from 5 to 4%. It's still nicer than, say, when you were holding bonds back in 2020-2021. When rates are bottoming out, you're getting paid almost nothing to hold them. Now at least you get paid to hold the bonds. But some of that reward is taken away. So it makes sense to pull back on that. And I think that's what you've done in your models, in your asset allocation. You've taken a little bit of the bet on bonds off the table. And then what have you done with that? And where do you sit right now in terms of your positioning with your portfolios.

Right. To talk about it, I think it helps a little bit to review where we've come from and to put this move into a broader context in terms of our portfolio positioning over the past decade or so. And so, for many years, and especially immediately following the pandemic, when interest rates were at historic lows, we had been running extremely large underweight positions in fixed income within our balanced portfolios. And the reason for that was that we thought that bonds offered very little return potential and that valuation risk was extreme, thinking that interest rates would eventually go up at some point. We thought that move in interest rates higher would take a more gradual approach, although it happened very quickly. And then the other thing is, we thought that the diversification benefit on bonds was quite minimal at the time, when you had yields at extremely low levels. But into 2022, as central banks began to increase rates quite aggressively and yields began to rise, we've been gradually narrowing that underweight position that we had in fixed income. Ultimately, by mid 2023, we completely closed that underweight position. And then by the fall, we actually nudged our position slightly overweight in bonds for the first time in as many as two decades. So that speaks to the opportunity that we saw in the bond market at the time and just the degree of how much we had moved our allocation over time. We tend to run underweights in fixed income and overweights in equities within our balanced portfolios because we aim to capture that equity risk premium that's available to investors over the very long term. And so, two things happening there. One is we thought the appeal of fixed income was getting increasingly attractive as yields were going up, and then also relative to stocks, as equity valuations were going up, that the appeal of equities was diminishing slightly. And so this has got us to move closer to a neutral allocation within our asset allocation. And so, yeah, the latest move that we did was recognizing that yields had come down quite a lot in a short period. And so we decided to take a little bit of profit off of that move. And so we trimmed our fixed income position by 50 basis points and moved it to cash. And so there's a couple of reasons for that. One is, even though we still think the fixed income market is attractive, it is not as attractive as it was when it was at 5%. And so, reflecting a little bit of that at the margin in our positioning. And then we wanted to boost our cash buffer just a little bit to have a little bit more dry powder in case there was market volatility arising at some point over the next few months. And that puts us in a little bit of better position to take advantage of that. But overall, we recognize there's still significant uncertainty in the outlook, a wide range of potential outcomes. And then with this latest asset mix change, trimming our bond allocation a little bit, we're now fully aligned with our strategic neutral asset mix within our balanced portfolio. So we think that's a good position to be at right now, given the high degree of uncertainty that we see on the horizon.

So, Eric, if I just ask you one more question. And maybe you want to go and dig away and come back another time and answer it instead of today. But when do you think investors get almost an all-clear sign on equities? Because again, I have a strong bias towards equities. With what's out there right now, there's still a sense that there's enough uncertainty, there's enough risks out there — and you've articulated this all through this discussion — that there's still a reluctance to really say equities are a place to overweight. But at some point, you will get there. What do you think needs to change from where we are right now to get to the point where you're starting to shift to an overweight in equities?

Yeah, you're right. I think the equity market is very interesting at this point. There's such a high degree of concentration within the market, or at least within the leadership of the market, to a very narrow set of mega cap technology stocks in the US. So you've got the Magnificent Seven — which some are saying now should be reduced to Magnificent Six, because Tesla has not been performing so well lately. But still, that group of stocks is really carrying the market or the broader indices higher. And you're right to say that the equity market still seems a little bit concerned, because if you exclude those stocks, the market underneath the surface is not performing nearly as well as the overall index would suggest. And so some things that we would look at, the market has already sort of nudged into the direction of a soft landing as we saw the rally in late last year. In that rally, we did see broad participation across all cap sizes, small, mid, large cap across regions. So there was broad participation in the rally late last year, but it sort of fizzled out into the beginning of this year. And we're back to that large cap growth dominance again. The market is sniffing out that there's some risk there. I would say, to be more confident on taking risk in equities, we'd like to see further improvement in those economic leading indicators, maybe sustain above those 50 readings that are important across most of the world for several months. And we really would like to see the Fed actually start kicking off the easing cycle. They seem to be talking about it a lot, and that gets investors confident. So investor confidence is really elevated at the moment. And so now the next step is for the Fed to actually deliver that easing that it's promised. And if it doesn't, if rates don't come down as much as expected, there is a risk of disappointment in the equity market, particularly in those expensive mega cap technology stocks. Those valuations really require lower rates, heightened investor confidence and basically their stories to continue playing out in a positive direction. So it's possible, we looked at different scenarios for the market. There is a fair degree of optimism penciled into the estimates. And if you look at it, it seems difficult to get there based on our economic view, but if you get a little bit of better growth than expected, if you get maybe some improving margins, so if profit margins expand a little bit, you could get to those earnings numbers that are penciled into the consensus projections, and that would be very good for the market.

I think one of the things, though, that people who've been listening to the podcast over the years are aware of is sometimes that enthusiasm or overconfidence in investors in markets. Again, as this group of stocks has continued to lead and the index hits all-time highs, you actually need some of that to dissipate. Sometimes things get a little bit too excited, and that's when things get riskier. And we're seeing a little bit of that. You've got investors who are very confident in terms of risk taking. I just saw bitcoin up over $50,000 US today, and that was sitting down in the mid-teens at different points last year. So the risk appetite has increased, which you think is, oh, that's a good thing. Everyone's excited. That means things go higher. It's usually a time when it's time to actually be a little bit more cautious, because if everybody's on one side of the trade, you probably want to start thinking about being on the other side. You wanted to say something about that?

We do tend to see that. We've done analysis on investor sentiment and returns for the market following periods of extremes in sentiment, and you very much see that. From starting points where investor sentiment is extremely optimistic, you tend to get weaker returns going forward. And conversely, when you start from a point where there's extreme investor pessimism — think of like everyone's saying, the world is ending kind of thing, or the economy is definitively headed for recession — those tend to be the points where you get very good returns from that point forward. And so we're very much right now in the point of extreme optimism. And as Dan Chornous would say, it's a very interesting point to be at, because the real test of a bull market is how long it can sustain that overbought condition. And it can be very difficult or uncomfortable for many investors as the market continues to just defy gravity and continue higher. But that's where we are right now.

Yeah, well, maybe that inflation report tomorrow will be one of those things that shifts the view or reinforces it. So that'll be one to watch. Eric, hey, thanks so much for popping on. We'd love to get you back again. That was fantastic stuff.

Sure. Thanks for having me. I'd be happy to be back.

All right, Eric, we'll talk to you later. And again, everyone, thanks for listening and thanks for all your comments. We really appreciate it. Continue to listen in. If you notice, we're upping the number of podcasts we're doing on a weekly basis. We're going to try and keep this pace going as more and more people listen and bring you some new great guests like Eric Savoie, and look forward to continuing to have you listen in as we move forward. We're back with Stu’s days and some others the rest of the week. Everyone, take care.