After reaping big returns from stocks and bonds for years, investors need to prepare for weaker gains in 2017 and future years, strategists say.Richard Drew/The Associated Press
As 2017 begins, bond investors face a nasty outlook no matter where they turn.
They can pursue the higher yields on offer in the United States, but in doing so, they have to accept the risk that rising rates will hammer the value of their holdings.
Alternatively, they can continue to endure dismal yields in Canada and Europe, in hopes that already low rates will fall even further.
It's an unusually bleak outlook for an asset class that has enjoyed decades of good returns. Bond prices move in the opposite direction to yields, so the long decline in rates that began a generation ago has provided a powerful, persistent boost for their results.
That trend now appears to be at an end. According to forecasters, U.S. rates are at the start of a sustained move higher – bad news for bond holders, since bond prices fall as yields rise.
The Federal Reserve's dot plot, which tracks the expectations of the U.S. central bank's key decision makers, suggests investors should brace for three rate hikes in 2017 as the economy gathers strength.
To be sure, the picture looks different in Canada, where Capital Economics predicts sluggish growth will force the Bank of Canada to lower its key rate in the first half to only 0.25 per cent. In continental Europe, too, a sputtering economy will put a lid on any rate increases for the foreseeable future.
But while non-U.S. bonds are unlikely to be hit by imminent rate hikes, they're far from the most appetizing of bets.
European bonds are already trading at sky-high valuations because of the continent's bottom-hugging rates. For their part, Canadian bonds offer uninspiring yields that suffer in comparison to their U.S. counterparts.
So what are fixed-income investors to do? One way to boost the yield on your bond portfolio is by purchasing riskier securities. Another method is to lengthen the maturities of the bonds you hold.
However, neither strategy seems like a sparkling notion right now. Years of low rates have driven up the price of all fixed-income investments, making them expensive wagers if things go wrong.
The lowest risk strategy is to stick to higher quality, shorter-term bonds – those that mature in five years or less – because they'll suffer less than longer maturities if rates do start creeping higher around the world.
Another good plan is to keep expectations in check. The Canadian 10-year government bond pays 1.8 per cent at the moment, barely enough to keep pace with inflation.
Given the limited prospects, fixed-income holders should buckle up for a challenging year ahead, observers say.
"We believe global bond yields have bottomed – and prefer equities over fixed income," money manager BlackRock wrote in its 2017 outlook.
Ian McGugan