The fixed-income portion of a balanced portfolio is supposed to provide stability, but lately bond markets are not holding up their end of the bargain.
The largest domestic and diversified bond exchange-traded funds, the BMO Aggregate Bond Index ETF (ZAG) and the iShares Core Canadian Universe Bond Index ETF (XBB), are both down 8 per cent year-to-date. Even the more conservative iShares Core Canadian Short Term Bond Index ETF (XSB) has dropped 2.8 per cent. Meanwhile, the S&P/TSX Composite Index is up 4.6 per cent for 2022 despite high levels of volatility.
It’s important to note off the top that investors in individual bonds don’t lose money if they hold them to maturity, unless the issuer defaults. They get what’s on the label – interest payments and their principal back at the end.
The experience is different for holders of bond funds. In a rising interest rate environment, the value of bonds held in a fund fluctuate from what is usually a $100 face value. For instance, the Government of Canada bond issued last year at a $100 price, maturing in 2031 and paying 1.5 per cent annual interest, is trading Wednesday at $92.50. The 1.5 per cent coupon payment is less attractive because rates are rising. A new 10-year bond issue would have an annual interest in the 2 per cent to 2.5 per cent range, based on current conditions.
Virtually all bond prices have fallen in the past year and this has pushed the net asset value of bond funds lower.
Bonds are down, stock markets are choppy and this is characteristic of an inflationary investing backdrop. There are few places for an investor to hide.
In a recent research report, Scotia Capital strategist Hugo Ste-Marie detailed the asset class performance during the inflationary 1970s. Mr. Ste-Marie first noted a number of differences between then and now – developed world growth today is far less resource intensive for one – but still found the relative returns instructive.
From 1969 to 1979, the S&P 500 produced a mediocre average annual return of 1.6 per cent while, thanks to rising energy prices, the Canadian equity benchmark climbed 5.9 per cent annually. U.S. equities trailed inflation by a huge margin – the S&P 500 lost a cumulative 40 per cent in value over the period, after inflation adjustments.
Commodities were the clear winner in the ‘70s. The Bloomberg Commodity Index leapt 764 per cent for the decade, an average annual return of 24.1 per cent. Domestically, energy, gold and economically sensitive industrial stocks formed the market leadership.
There are some investors who were born in the 1940s and 1950s and have practical experience in inflationary environments, but the vast majority of us have become accustomed to much different conditions. Interest rates have been falling, and bonds rallying, since 1982. Banks and technology stocks have come to dominate the benchmark while resources, until very recently, have declined in importance.
I’m not entirely convinced we’re set for another decade of inflation, but as long as this era of rising rates last, investors in both bonds and equities are likely to be frequently surprised and uncomfortable with their portfolios.
-- Scott Barlow, Globe and Mail market strategist
Also see, from David Rosenberg: Yes, my resolve at being a bond bull is being tested - but a sea change in markets is now imminent
This is the Globe Investor newsletter, published three times each week. If someone has forwarded this e-mail newsletter to you or you’re reading this on the web, you can sign up for the newsletter and others on our newsletter signup page.
Stocks to ponder
Diversified Royalty Corp. (DIV-T) This is a lesser-known royalty company that may be of interest to income investors given its 7 per cent yield. Analysts have a unanimous buy recommendation and believe the share price may be headed significantly higher. While you may not have heard of this small-cap stock, you likely are familiar with one or more of its six royalty partners: Mr. Lube, Air Miles, Sutton Group Realty, Oxford Learning Centres, Mr. Mikes Restaurants, and Nurse Next Door. Diversified Royalty’s business model is to acquire trademarks from franchisors in return for royalties based on their top line sales. Jennifer Dowty talked to its CEO, Sean Morrison, for insight on where the company is heading.
The Rundown
Gazprom over Suncor: Why ESG funds held more Russian energy stocks than Canadian
Prior to Russia’s invasion of Ukraine, funds that embrace environmental, social and governance principles favoured Russian energy stocks over Canadian energy stocks by a wide margin. As David Berman tells us, it’s a surprising finding that highlights a key challenge for ethical investing.
Oil shocks don’t always short-circuit stocks
Surging oil prices dent economic activity and fuel inflation, but are not necessarily bad for stock markets. A look at four previous major oil shocks - 1974, 1979, 1990 and 2000 - suggests it is a brave investor who bets with any certainty how equities will react over the coming year to the current surge in energy prices. Jamie McGeever of Reuters explains.
Copper may be too relaxed about Russian supply threat
Doctor Copper has sat serene amid the chaos engulfing London Metal Exchange trading this month. It’s maybe because copper seems much less exposed to a disruption of Russian supply than other industrial metals such as nickel, which has been rocked to the point of breakdown by Russia’s invasion of Ukraine. But is it? Or is Doctor Copper in for an unwelcome surprise? Longtime metals correspondent Andy Home shares his insight.
Also see: London nickel trading shows signs of recovery after two weeks of chaos
Why investors shouldn’t run from stocks amid the Ukraine crisis and a surge in Wall Street’s ‘fear gauge’
History shows that deviating from a well-considered, long-term investment plan is rarely a good idea. Investors should avoid making rash decisions in moments such as the one we are currently experiencing. Duane Ledgister of Connor Clark & Lunn Private Capital presents some charts that prove his point.
Options mavens see stock rebound as chance to pick up downside protection
Risk appetite has rebounded on Wall Street after a brutal start to the year, but some strategists warn the lull in volatility may be brief and urge investors to guard against more stock market gyrations.
Others (for subscribers)
The most oversold and overbought stocks on the TSX
13 TSX large cap stocks profiting from higher inflation
Wednesday’s analyst upgrades and downgrades
Tuesday’s analyst upgrades and downgrades
Tuesday’s Insider Report: Buying action in this REIT yielding 4.8% with it hovering near a record high
Luxury fashion company Lanvin Group, owned by China’s Fosun, plans New York listing via SPAC
Globe Advisor
Fears rise over ‘greenwash’ bonds
Are you a financial advisor? Register for Globe Advisor (www.globeadvisor.com) for free daily and weekly newsletters, in-depth industry coverage and analysis, and access to ProStation - a powerful tool to help you manage your clients’’ portfolios.
Ask Globe Investor
Question: I am about to come into a fairly large sum of money, a portion of which I plan to donate to charity. To donate in the most tax efficient way possible, I’m thinking of donating shares I already own that have a substantial capital gain. Can I immediately buy more shares of the same company or do I have to wait 30 days?
Answer: When you donate listed securities that have appreciated in value, you win in three ways. First, you get the satisfaction from helping a good cause. Second, you avoid capital gains tax. Third, you receive a charitable donation receipt for the market value of the securities. The only loser is the Canada Revenue Agency, which gets less tax revenue.
After you donate your securities, you are free to repurchase shares of the same company. There is no need to wait 30 days. The 30-day waiting period only applies if you are selling shares for a capital loss and want to repurchase them without violating the superficial loss rule.
--John Heinzl (E-mail your questions to jheinzl@globeandmail.com)
What’s up in the days ahead
Commodities can be volatile, but the recent spike in fertilizer prices is leaving many observers convinced that Nutrien Ltd.’s blistering rally over the past month has long-term potential. David Berman will explain.
Click here to see the Globe Investor earnings and economic news calendar.
More Globe Investor coverage
For more Globe Investor stories, follow us on Twitter @globeinvestor
You may also be interested in our Market Update or Carrick on Money newsletters. Explore them on our newsletter signup page.
Compiled by Globe Investor Staff