We’ve been in a bull market for bonds since 1994, Mr. Dallal said. Today, the threat of rising rates and inflation is such that you’ll sometimes hear talk of a bond bubble.
That’s the kind of hyperbole we’ve had to put up with since the investment community was scared half to death by the financial crisis. If something rises a lot in price, slap a “bubble” label on it.
For a good argument why there’s no bubble in bonds, check out this Let’s Talk Investing online video I did with Sheldon Dong, vice-president of fixed income strategy at TD Waterhouse. Basically, he argues that bonds, with their characteristically modest returns, don’t fit the speculative profile of a bubble investment.
Financial bubbles also tend to pop in a very messy way. But, again, bonds don’t fit the profile.
Remember the 11.4-per-cent drop for the Canadian bond market back in 1980-81? Mr. Dallal found that it took only four months for the bond market to recover. The worst case in the period between 1950 and June, 2011, was a slump in the mid-1990s that lasted 12 months.
Still jittery about bonds? Mr. Dallal looked at rolling three-year annualized returns dating back to January, 1950, and the worst result for bonds was a decline of 2.3 per cent. The comparable worst decline for Canadian stocks over a three-year period was 11.1 per cent.
These rolling returns were calculated by taking 36-month slices of data, say January, 1950, through December, 1952, then bumping them ahead by a month to February, 1950, through January, 1953, and so on.).
Negative three-year returns for bonds occurred only in 0.4 per cent of the periods examined by Mr. Dallal. When he narrowed his analysis to the period from January, 1950, to December, 1980, where interest rates were generally on the rise, he found negative three-year returns only 0.8 per cent of the time.
Bonds never lost money in any five-year rolling period in Mr. Dallal’s analysis. Canadian stocks had five-year losses 1.3 per cent of the time.
Mr. Dallal has two suggestions for investors who want their bond holdings to hold up as well as possible during a period of rising rates. One is to focus on short-term bonds, or those maturing in less than five years. Note that you’ll get a lower yield with short-term bonds than you would with those maturing over longer periods.
Another approach is to mix some corporate bond exposure into your portfolio. Mr. Dallal said that as short-term interest rates rise, corporate bonds tend to outperform government bonds.
Adjust your bond holdings to prepare for higher rates, but don’t sell them. History shows bonds are much less risky than stocks, and they’re quick to recover when they do lose value.
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A look back at the severity of bear markets for bonds going back to 1950. Note that rising bond yields mean falling bond prices.
| Trough Date | Bear Bond Market (%) | Number of Months | Yield Increase % From | Yield Increase % To | Percentage Change in Yield (%) | Number of Months to Recover |
| January-57 | -4.3 | 18 | 2.9 | 4.1 | 43.3 | 11 |
| September-59 | -6.1 | 16 | 3.8 | 5.5 | 43.0 | 9 |
| March-68 | -4.3 | 12 | 5.5 | 6.9 | 26.1 | 5 |
| July-74 | -9.2 | 5 | 7.7 | 9.6 | 24.4 | 6 |
| September-75 | -5.5 | 7 | 8.2 | 9.7 | 19.0 | 5 |
| March-80 | -11.1 | 8 | 9.8 | 13.5 | 36.7 | 3 |
| July-81 | -11.4 | 13 | 11.3 | 17.1 | 51.2 | 4 |
| May-84 | -5.2 | 4 | 11.9 | 13.9 | 16.9 | 8 |
| February-85 | -4.0 | 1 | 11.4 | 12.3 | 8.1 | 4 |
| September-87 | -6.5 | 6 | 9.0 | 11.1 | 24.1 | 5 |
| April-90 | -6.1 | 4 | 9.7 | 11.5 | 19.1 | 4 |
| June-94 | -11.2 | 5 | 6.9 | 9.3 | 35.4 | 12 |
Notes
-Trough date means the date on which the bond market bottomed out in a particular bear market period.
-The DEX Universe Bond Index was used here going back to its origin in 1980; prior to that, longer-term government bonds were used.
Source: CIBC World Markets
