Transcript
Hello and welcome to The Download. I'm your host, Dave Richardson, and we are joined by our favorite portfolio guru, Sarah Riopelle. Sarah, welcome.
Thanks for having me again.
Happy New Year.
Happy New Year to you. Are we still allowed to say that? I never know when we have to stop saying happy New Year.
Well, it's the first time I've seen you this year and the first time you've seen me. So I think that's the guiding principle, although we are January the 10th. I mean, the year's almost done.
Yeah, exactly.
At least we're a couple of months in anyways. Did you have a good holiday? Family's good?
Yeah, it was good. Had the kids home. My parents came, so lots of family time, which can be both good and bad. So good to have the break, but also good to get back at it at work.
Yeah. I share that view. It's nice to have and then it is nice to get back to normal work. Sarah, by the way, I don't know if she's going to be able to move her camera around because we sometimes have these cameras quite professionally positioned for our YouTube videos. But she was just showing me her Lego collection. She's quite an engineer as well as a portfolio manager. Well, I guess you're a portfolio engineer as well because that's what you do in terms of putting together portfolios. So not surprising that you'd like the Lego.
Well, one of the things that makes me successful, probably, is my obsessive-compulsive attention to detail on the work side. That also translates into building 10,000-piece Lego sets on the personal side.
Yeah. And then you've got the equivalent of some horror movie where a giant cat comes in to destroy parts of major cities. That's part of your thing there, right?
True. I was just looking at one of my larger Lego sets and noticing how many pieces are missing that the cat has gone in and stolen.
So if you hear the news that a giant cat is roaming London, England, it's only a miniature version. Don't take it seriously, although we should mention, I often spend this time of year, we typically go after Christmas, over New Year's to Southern California, and that is just unbelievable what's going on down there. So all our best go to the people down there. I know some of our colleagues live down in the Los Angeles area, so all our best go to them and anyone from that area who's listening?
Yeah, absolutely. It's terrible the images that we've been seeing on the news.
Absolutely. So let's get to the topic at hand. And I'll mention, again, as I've been starting all of these early 2025 podcast that we're doing a series with about 15 different portfolio managers talking a little bit about 2024, looking back a little bit, and then looking forward around their views and what's going to happen, what they think might happen in 2025, themes that investors should be aware of so they can make better decisions around their portfolio. Again, the marketing folks, Sarah, are always on me. They're on you, too. They're always giving you grief. Remember to subscribe if you're watching us on YouTube, or wherever you get your podcast, click to follow or subscribe. Give us a review. Sarah's fabulous ensemble today should at least get a five-star review. That's pink, right? The colorblind guy thinks it's pink. Is it pink?
I don't know. Sure. Let's go with pink.
Let's go with that. It’s so lovely. Here's where we do the transition, Sarah, because you're losing patience.
We're going to talk about the lovely 2024 that we had in markets.
How did you know? It was lovely, wasn't it?
Yeah. The difference a year makes from our conversation that we had a year ago versus now. A lot of activity in 2024. We came in 2024 with a variety of macroeconomic challenges in mind, but those have largely faded over the last 12 months. Inflation cooled nicely. Central banks began cutting interest rates, and that led to investors becoming more confident in the economic outlook. We came in the 2024 concerned about recession risk, and we came out of 2024 with high confidence that we would achieve a soft landing. We had big shifts in interest rate expectations during 2024 as investors dialed back their estimates for how many cuts we could possibly get from central banks. That had a big impact on fixed-income markets during the year. We came into the year with bond yields at around 4%, we fell as low as 3.5% in September, and then we managed sharply to something more like 4.5% after the US election in November, and now sitting around 4.7% on the US 10 year. So lots of movement around in bond yields and the fixed income market during 2024. The stock markets encountered some pockets of volatility during the year, but managed to deliver a second year of impressive returns as investors embraced that likelihood of the soft landing that I mentioned earlier. So the strongest returns came from the US market, in particular US mega-cap technology stocks. But it did broaden out to more parts of the market in the back half of the year as stocks received a boost after Donald Trump's election win in November, because investors in the US, in particular, thought that that would signal more growth, lower taxes, less regulation. International markets did underperform the US, particularly after Trump's election win because of some of his policies that he's proposing that could have an impact on international markets in favor of domestic growth. But all in all, I would say that it was a good year for investors. Solid results from both stocks and bonds led to good returns for balanced portfolios for a second consecutive year. And in fact, if you look back over the last five years, a balanced fund has earned an annualized return of almost 8%, which is a pretty impressive return when you consider the variety of challenges that we've had to navigate through since 2020.
Yeah, and that would be above expectations over a five-year period, 8%, and actually fairly significantly above expectations. So although we've obviously been through a lot of challenging times in the real world, in the investment world, and challenging times from market performance as well, if we look back at 2022, you pull it back out over five years, over a longer-term period and once again, the death of the 60/40 portfolio, as I believe you've said many times on this podcast, has been greatly exaggerated.
Absolutely. And it really reinforces that need to try to ignore short-term noise in markets and focus on those long-term returns. We have navigated a lot of volatility and a lot of change in markets over the last five years, but when you stretch it out to look at that five-year time period, we've actually generated quite strong returns for a balanced portfolio. And so it's important not to get too focused on short-term volatility and stay committed and focused on your long-term investment plans.
Yeah. Couldn't give better words of wisdom to kick off the year. So as we just finish off our look back at 2024, was there anything there that surprised you at all about 2024? From our conversation exactly a year ago, it wasn't exactly the way you thought it might play out, right? But anything really you think of as a surprise last year?
That's a great question. I think the main thing was the overall resilience of the market, especially in the US. As you mentioned, at the beginning of last year, we thought there was a high probability of a recession. But the economy really surprised us in its ability to digest the impact of that rapid increase in interest rates. We thought that that could likely have a stronger impact on the economy and markets than it eventually ended up having. So investors reacted well to the developments that interest rates were not going to have as significant an impact on the economy as we expected. And they were enthusiastic by the combination of moderating inflation, following interest rates, and then eventually, Trump's election win. I think the second thing that I found surprising was the valuation that investors were willing to put on the Mag Seven stocks in the US. That group of large cap technology stocks earned over 60% in 2024, contributing more than half of the S&P 500's total gain for the year. Time will tell whether those stocks can live up to these enthusiastic expectations. It currently feels like there's a lot of good news priced in. So we're a little bit cautious about that segment of the markets going into 2025. And I think the last thing I'm probably surprised was how rapidly investors changed their expectations for interest rate cuts by the Fed. Expectations for cuts changed rapidly and quite wildly throughout the year. So we started the year expecting six cuts for the year. That was reduced to one cut by April. In the end, we got three cuts and about 100 basis points in total by the end of 2024. The expectation in September was that we were going to get another 150 basis points of cuts in 2025. And now that's being scaled back to 25 to 50 basis points of cuts. So lots of movement and expectations for Fed cuts and the impact it had on bond yield throughout the year. I think the silver lining of all of that change is that that's allowed us to make some changes to our bond allocation during the year. So we have taken advantage of this volatility as the expectations for Fed cuts have moved and we've actually tactically made changes to our bond weight during the year, and that's helped us to add some incremental return for our clients.
Yeah, lots of focus on volatility in equity markets all the time, but there's been you might even say unusual volatility in fixed income markets, really coming out of COVID, since the post-COVID period. And being, as you say, tactical, being active in the approach that you're using in fixed income has become more important than ever. And there's been some real opportunities that have been created by the market. I know you and the team have taken advantage of those.
Yeah, absolutely. One example was, leading into the US election, we were expecting some volatility in yields depending on who ended up ultimately winning the election. So we were actually watching yields closely on election night and had a trade prepared. We went into that period actually underweight bonds by a little bit. So we were watching yields move higher. And around midnight on election night, when it became clear that Trump would be the ultimate winner, bond yields actually moved higher. And that gave us the opportunity to buy some bonds and increase our weight back up to neutral positioning at fairly good prices. And so we're always watching the portfolios. That's just an example of one of the ways that we tactically manage the portfolios. I mean, who knew that we had people up at midnight on election night in the US actually putting trades in the portfolios in the market?
Yeah. I think I mentioned before, I was in the middle of a speech in Vancouver. So you're past the election. And at the point, I got up to start the speech before I droned on for a little over an hour. During the speech, yields moved up about 10 basis points on the US 10-year treasury, which was a signal. As I started to speak, it wasn't completely certain that Trump was going to win. By the time that hour was up, that win was becoming very apparent. I just want to add a couple of things in as context before we head into 2025, because as we mentioned, we're a little bit into 2025, not a lot, but we're on January 10th. We had the jobs report out of the US this morning, which came in a little stronger than expected. Unemployment, I think, was down as well, which continues to feed into that narrative of growth that continues to exceed expectations, and that creates more issues for inflation. The market didn't like that. You mentioned the valuation of some of those particularly high-flying stocks, the Magnificent Seven, and a couple of handfuls of others that have risen dramatically in the last half of the year, and particularly in the last couple of months of the year. And we're seeing those stocks pull back a little early in this year as your base interest rates, long-term rates, have started to move up and expectations around, as you were talking about, one of the surprises is how investors shifted very quickly to the expectation that rates were going to fall a lot, very fast. And now some of those expectations likely need to be ratcheted back. So we'll be watching that.
That's right. And if you took at the beginning of 2024, people thought that the terminal rate for the Fed funds was going to be about 3%. So they thought that the Fed would deliver cuts that would push us down with 3% level. That's now looking more like 4% as opposed to 3%. And so the number of cuts that the market is expecting the Fed to make is quite a bit less. So therefore, you have to adjust your expectations for interest rates going forward that will have an impact on valuations that you can put on equities in the market. And so it's just another example that you have to be constantly reviewing the outlook and revising expectations and making sure that you're adjusting your portfolios and the asset mix in the portfolios to reflect those rapidly changing expectations.
So let's shift to 2025, which we already have. What's your expectation for what 2025 looks like?
Growth conditions are favorable as we enter 2025. The economy looks like it has a lot of tailwind behind it with these easy monetary conditions. A soft landing is likely to be achieved. Odds of recession are now fairly low. There seems to be a lot of good news priced in the equity markets, as we talked about. So we believe that investor confidence could potentially be tested by a variety of risks that are on the horizon. What are those risks? There's the three-year-old war in Ukraine, there's conflicts in the Middle East, there's ebbing growth in China. I think the big unknown is probably Donald Trump and his election as incoming President in the United States. He's proposed a number of policies during his campaign that if they actually get implemented, could have an impact on growth and inflation, both within the US and around the world. So that's going to be something that we're going to have to watch very closely. Our base case scenario was that the global economy will continue to grow at a modest pace in an environment of easing inflation, and that will enable central banks to dial back interest rates, although maybe not as much as we have expected six months ago. With the recent rise in bond yields, we think the bonds are now at levels that offer decent return potential with modest valuation risk. So we like the bond market here. After such a long run in equities, many investors might be concerned about valuations in the equity market. So we believe that our models are showing that valuation excesses are concentrated in US mega-cap stocks. And that outside this group, equities range from fairly to attractively valued. So there is some opportunity for equities in areas outside of the large-cap US equity market. But that being said, given how far we've come in equities and given some of the rapidly changing expectations around the Fed, we do think heightened volatility is something that we should expect in the month ahead. We always get volatility in the market, so that's not something that's new to us, but with a lot priced in the market already and a lot of unknowns around what Donald Trump might be able to achieve, I think investors should be prepared for heightened volatility over the coming months.
Yeah, and expensive markets tend to lead to more volatility, if you look historically. Because again, the expectations of markets when they get very expensive are very high, and it doesn't take much to miss those expectations and create that volatility. If you look at the year overall, I think 2024 was not a particularly volatile year, but there were some spikes at different points in time that were, even on a historical level, quite dramatic. When you get to these higher valuations, that's always something to keep an eye on and something that we've been talking about for quite a while on the podcast with all of the different guests that come on, is you get those valuations, and you need to be concerned about volatility. Volatility creates opportunity, but it can also create lots of... What were you going to say?
Well, I was going to say, volatility certainly creates concern from the perspective of investors. But to your other point, I also think that it creates opportunities to manage the asset mix. We don't look at volatility as a risk, per se. We look at it as an opportunity to make adjustments to the asset mix and potentially add incremental returns on behalf of clients.
Okay. How do you position things then for this coming year?
We're coming into the year with a neutral position in the asset mix. As we balance the risks and opportunities going into 2025, our asset mix is sitting on a neutral position. We think that's a good starting point because if we can take advantage of those opportunities as they present themselves during the year. We're maintaining appropriate diversification without taking excessive risk and looking for opportunities to make adjustments to the asset mix. As I mentioned earlier, in our view, bonds appear reasonably priced, and the recent rise in yields has improved that return potential. We've been more tactical in our fixed-income allocation over the last 12 months, and we expect to continue to do so going forward. We've maintained a neutral stance in equities for the last 12 months or so, and given elevated valuations in the US market in particular, we do think that there's some vulnerability to stocks, so we're going to watch that quite closely. But we do think that there's good value in equity markets outside of the US. And so while we might be neutral equities at the top level, we have been making some adjustments to our regional equity rates to take advantage of some of those valuation differences between the US market and the other markets. And so while we might be neutral across the asset mix, we are making changes beneath the surface to take advantage of where we see opportunities.
As you said, a 60/40 portfolio or balanced portfolio did very well in 2024. That has historically done well. We touched on the five-year returns. Some investors who have just invested in the Magnificent Seven over the last 12 months have gotten bigger returns than even the very good returns in a balanced portfolio, but you have to remember, when you do something like that, you are taking an enormous amount of risk. It can very quickly turn on you the other way. Again, I think for some of those stocks, the last week or two has been a bit of an example of that. It can turn very quickly on you, whereas the returns you're getting out of a balanced portfolio on a risk-adjusted basis are very good. For most investors, it just makes a lot more sense to be more broadly diversified, particularly at a point in time where stock valuations are higher. Even though it's most likely rates come down, because inflation looks like it's moving under control, there is still always the risk that rates could continue to rise for any number of reasons that we've been talking about, in terms of government debt in the US, continued strong growth, more growth coming from around the world, lots of hotspots around the world that could drive energy prices higher. There's always risks sitting on the table that you need to be aware of. Well, maybe I don't, but you do because you're managing billions of people's money.
It's really important that it's not just about return. It's also about the risk that you take to achieve that return. People who are invested in just the mega seven stocks in the US, they've had a great return with very little pockets of volatility., Over the last two years, it's been a good place to be, but you have to balance that against the risk that you're taking. When that part of the market does turn, it could be a painful experience for investors. I really ascribe to the diversification argument. We've talked about this many times when we've done these calls or podcasts, I really believe in taking a diversified approach to your investment. You're seeking the return while also balancing the risks within the portfolio. Having a diversified portfolio that owns stocks and bonds on different kinds of bonds and stocks in different regions. And what that's going to do is to smooth out your risks and smooth out your return experience. You can still generate a strong return in a balanced portfolio. It may not be the plus 60% that you would get if you only owned the Mag Seven stocks, but it's going to be a much more consistent return profile, and that's going to keep clients invested in the market and keep them from panicking in the face of volatility. I just think that's really important. I don't have a crystal ball to know how markets are going to behave. I did a session with a couple of colleagues back in December, and our head of equity, Stu Kedwell, who I think you've had on the podcast a few times, had a really great quote that I'm stealing from him. He said, you can't predict, but you can prepare. We can't predict how markets are going to behave, but we can prepare ourselves for different types of market environments, different scenarios, and that's going to lead to smoother and more consistent returns going forward. So I'm going to really add to my parting message to you and the listeners here is that you can't predict, but you can prepare. And that's probably something that people should be focused on as we head into 2025.
Yeah. And for a guy sitting here in the middle of the Atlantic Ocean in the Azores, I'm halfway between North America and Europe, which actually, just to this exact moment, feels like a pretty good place to be. I think my house is technically on the African plate. So geologically, I'm in Africa, which is where all the plates merge. But basically, what I'm saying is there's a beautiful paradise right here in the middle. And I've just been seeing too many Canadian investors out at the extremes. When rates were higher, we saw everyone taking no risk and locking in high guaranteed rates. Then there's a whole other group of investors that are chasing these highflyers, cryptocurrency, etc, whatever it is, take on as much risk as you can. What I'm hoping 2025 is, is we see that more meeting in the middle, broader diversification for investors, and starting to see, hopefully without learning hard lessons, that that risk management part of portfolio management is critically important, and that is what you and your team do so well.
No, I totally agree. A balanced portfolio was never going to have the best return on the market, but it's also never going to have the worst return on the market. It's going to be slow and steady as she goes. It keeps people invested in the market. They won't panic in the face of volatility if you're giving them that smooth and consistent return experience, they can sleep better at night that way. I just strongly believe in the power of the diversified approach and the balanced portfolio to calm people down and keep them invested for the long term.
Again, great advice. And I do notice, and I'm sure some of the people watching on the YouTube version of the podcast saw that after I besmirched the character of your cat and portrayed him as destructive, your cat came in and showed up. So it seems like a very nice cat.
Yes, I have three of them. That's my youngest cat. He's now asleep behind. He's asleep in the cat tree behind me. A black lump just over there. Sorry about that.
No, no. We always love special guest appearances on the podcast and always love your appearances, Sarah. Again, happy New Year to you and your family. All the best to you. And thank you for taking the time out today.
It's my pleasure. Thanks very much.