Hello, and welcome to the Download. I'm your host, Dave Richardson. It was my birthday yesterday, so for a present, I have a very special guest, Sarah Riopelle. Sarah, hello. How are you doing? I haven't seen you in a long time.

I know. It's been a few months, but happy belated birthday. I hear you had a really fabulous day of presentation to clients.

Yeah, I had an 18-hour day yesterday, but I'm in Vancouver and I'm going to sneak down to Seattle. I don't know if I've mentioned this on the podcast, but I'm a huge Oregon Ducks fan and they are playing quite a consequential game at the University of Washington this weekend. So I'm going to head down there. That'll be my birthday celebration. A little late, but awesome.

That's good. I'm sure that'll be fun. Not so exciting over here.

No, not exciting and getting cold in Toronto.

It is cold in Toronto and the market keeps us on our toes, which is, I think, why we're here today.

Oh, I thought we were just going to talk about what's going on in our personal lives because everyone's so keen on hearing about that. So, yeah, let's get to the markets. I guess we do have to do that. So, we've been seeing bond yields rise. From your perspective, quite frankly, they've gone a little bit higher than we would have thought that they were going to go, in terms of the peak, particularly on the long end— maybe not so much the Fed funds rate or Bank of Canada rate. Those we thought they could go higher. But at the long end, you've seen yields go higher. So what, in your view, is driving this?

Yeah, well, I'm sure anybody who comes on here to talk to you has probably let you know that we're data dependent and things are very volatile, and they change quickly. And so there was that caveat. So, yes, bond yields have indeed moved higher over the summer and particularly in the past few weeks. What was driving that? Well, inflation data is coming in hotter than expected, a little bit higher than we had hoped. And then the Fed has emphasized that interest rates may need to stay higher for longer to get inflation back down to that 2% target. So it's this higher-for-longer theme that has taken hold and pushed bond yields higher. So the bond market had been pricing in imminent interest rate cuts in the forecast over the next few months and quarters. But this better-than-expected data, moderate inflation, and this stronger labor market is suggesting that rate cuts may not be appropriate anytime soon. So, the bond investors are really embracing that higher-for-longer narrative, and that's led to meaningful repricing of bonds and yields rising substantially across the entire yield curve and yields briefly got to 4.9% a couple of days ago. That's a new high for the cycle and something, as you said, that we were not initially expecting.

Now, interestingly enough, they did stop short of 5%. It doesn't mean they won't get there, but that was meaningful, and we've pulled back quite a bit; 25 beeps from there, or 25 basis points. So that looks a little bit better and is reflected in the way you've been moving your portfolios. I should always give the formal introduction for you, Sarah, because you manage about $180 billions in diversified portfolios. So these are conservative, balance growth oriented portfolios that have mixes of stocks and bonds in them. So when you look at where you are relative to your neutral weighting, say for a balanced portfolio, for the first time in a long time, you are overweight bonds. Oh my goodness, that's almost never, right, Sarah?

Yeah, well, I've been doing this a long time and I think this is the first time we've ever been overweight fixed income in the asset mix. So what's driving that? Well, the big move up in yields and the move down in prices, we think that the fixed-income market has become quite appealing at this point. In fact, according to all the models and indicators that we look at, bonds are at their most attractive than they have been in probably over a decade. And so, what has really been driving that? We talked about a few drivers, but one of them is that the rapid increase in yield has restored positive real yields. Real yields are a combination of the nominal yield and then inflation. And for the first time in a long time, we're actually seeing a real yield of around 2% and we haven't seen that since the global financial crisis. So that's an important data point as well. The US ten-year rose above the upper limit of our equilibrium band, which was pointing to attractive valuations for bonds at these levels. And it's not just a US story; it's a global story. And our global composite of bonds is suggesting that sovereign bond yields around the world are quite attractive for the first time in many years. And then the last one is bond sentiment that has really achieved extreme pessimism. That might sound bad, but that's actually a counter indicator. Extreme pessimism actually usually points to positive returns in the bond market. So overall we think that the risk reward for bonds is quite favorable and more favorable than it has been for a long time. And from here we think that the potential for returns in the bond market are quite attractive. And even if we're wrong and yields do rise a little bit from here, we think that the higher yields are going to offset any potential capital losses from there. So we think that the downside from here is actually quite limited. So reflecting all of that in the asset mix— sorry, I cut you off— is that a couple of days ago, we moved a little bit of cash into bonds and pushed that weight to an overweight position. Just a small overweight, but an overweight position nonetheless for the first time in over a decade.

No, you didn't cut me off. I cut you off. But I was going to say that risk/return point is so critical. As you say, yields can go a little bit higher, but if I'm being rewarded more than you have been in 16 years to carry these bonds and what you're going to generate in income, yield off of those bonds is solid. Even if rates were to tick up and generate in the near term some losses, we look out longer term, we see rates coming down in the future. So that's where you're going to pick up the capital gains later. It’s not like when yields move from zero to 1%. This is a different scenario and clients and investors need to be very much aware of the difference between where we are now versus where we were in March of 2022.

Exactly. We've come a long way since then and it hasn't been an easy ride for many bond investors. But most of that pain is behind us and we're looking for mid- to high-single-digit returns and possibly even low-double-digit returns in the bond market from here. And so, you balance that against the risk reward, you balance that against the potential for maybe a little bit of higher yield from here, but you offset those capital losses with more interest income that you're achieving from the bonds. And the downside here looks quite limited. So risk reward was really favoring putting some money into bonds at these levels.

Yeah. And we always stress for people listening to get advice from their advisor. You're making your own decisions, get good advice and really important thing to do. But you also have some guaranteed rates that are higher now. And so again, if you're one of those investors who's more conservative, secure, very conservative, maybe in retirement, the options for generating income are a lot more interesting than they've been in quite some time. So something that you want to take a look at. But the other side of a portfolio is stocks. Now, overweight bonds, does that mean you're underweight stocks? Or what do we think about stocks given everything that's happening?

Yeah, so we funded that bond purchase with cash, not stocks. So we are actually sitting at a neutral position on stocks. So stocks have pulled back over the last several months, partly due to that higher-for-longer narrative on the bond side because that's weighed on valuations and also partly because the prospect of a recession is becoming a little bit more pronounced. And that's going to have an impact on the earnings side of the equation for the stock market. In fact, most of the gains in the US market so far this year have been driven only by a handful of those tech stocks. We call those the Magnificent Seven. And if you actually look outside those mega-cap technology stocks, the breadth in the stock market has been fairly narrow and most major market indices are actually close to flat, year to date, when you take out those tech names. Equity market valuations are not unreasonable, but we do remain concerned about the outlook for corporate profits in a recessionary environment. We still have a recession in the forecast over the next few months and so we think that earnings estimates are a bit too optimistic right now and probably vulnerable to downgrade should that recession take hold. So we continue to believe that stocks will outperform bonds over the longer term, but we're much more cautious in the near term, which is why we're sitting on a neutral position for equities within the asset mix.

As we've discussed on previous visits that you've had with us, you look out with the degree of uncertainty that's there— a somewhat neutral position with now a little bit of favor towards bonds because of what's happened through the summer and particularly early this fall—, that seems to make a lot of sense, right?

Yeah, for sure. And we talked about risk reward on the bond market and that's why we're a little bit overweight right now. The risk reward on the stock market just doesn't really favor us taking any significant risk positions within the asset mix until we get a little bit more clarity or certainty on what the outlook might hold. And so, we're better off sitting here neutral and waiting to see how things play out.

Yeah. And so when you're looking at each asset class and making decisions on where you want to be overweight or underweight— and you're never taking huge positions one way or another because you're generally going to favor stocks a little bit over the long term again because of the long-term performance—, but I think the difference between what a professional investment manager does versus what I see from a lot of investors who are managing their own money is there's a much tighter or a much greater view on that risk/reward trade off. So not just thinking about, okay, well, what is the upside here? But also thinking about what's the risk that it goes the other way. And that's why managing a portfolio is so complex and something that you do particularly well that some people struggle with when they're not factoring in all of the different things they should be when they're thinking about portfolio positioning.

Yeah, it's about balancing time horizons. To prefer stocks over bonds for the long term, but that doesn't necessarily mean that's the right positioning over the near term if there's risks to consider. It's about factoring in the return potential— so, upside potential—, but also the downside risk, if you get it wrong or if you're on the wrong side of an asset mix, which is why our asset mix changes tend to be quite small. Because we're also trying to manage the downside of potentially getting it wrong. We have a lot of humility in this. We've been doing it for a long time, but we don't always get it right. We understand that. So we want to make sure that in the hopefully rare occasions that we get it wrong, that we haven't taken such a big bet that we're going to negatively impact the performance of the portfolios that our clients are invested in. So small prudent adjustments to the asset mix over time. Our chief investment officer Dan Chornous calls it scratching out the inches, and so we're just looking at one basis point at a time, adding to performance for the portfolios and that's going to benefit the clients.

Well, you are very humble. You always display a lot of humility. Let me pump your tires for a second. I must have had 25 people come up to me and say: when is Sarah getting on the podcast again? We miss Sarah. So promise fulfilled, for everyone who asked. Sarah, thanks again for taking the time. It's always great to see you and always great to talk to you. I know everyone appreciates your view because it's so important to keep that big picture view of where you want your overall portfolio to be, because that's what's going to be critical in getting you to the finish line.

Great, thanks very much and go Ducks.

Go Ducks.