Bonds had a pretty good year in 2023, but we’re still a long way from repairing the damage of the past few years.
And so, a reader has come to the end of her patience with one of the aggregate bond exchange-traded funds that gets recommended a lot for core exposure to the Canadian bond market. She’s owned this ETF since 2021 and it’s down 12 per cent from her purchase price.
If she sells, she calculates her loss at more than $3,000. But she considers this ETF to be a dud and feels that its future prospects aren’t promising at all. Could her money be put to better use elsewhere, she asks.
I doubt it. In fact, now seems the moment to consider taking money out of overweight positions in stocks or equity funds and moving it into bonds.
Bonds have been atrocious for the better part of the past three years, as exemplified in the three-year annualized loss of 2.3 per cent. That’s a total return, by the way. It reflects changes in bond prices and interest paid by those bonds.
Now, let’s stop looking back and try to figure out what’s ahead. In short, better times for bonds are coming at some point. Selling now means foregoing that upturn.
Tenacious inflation and high interest rates are responsible for the bad results for bond funds. There were consecutive annual losses in 2021 and 2022 and a modest rebound last year. Bonds have retreated a bit this year on confusion about whether inflation and rates will meaningfully decline in the near term.
The latest numbers on economic growth fuel the uncertainty about inflation and rates. The Canadian economy was a little stronger than expected in January, and early estimates for February suggest more solid growth. On the other hand, the job market report for March was disappointing. Add it up and you get a growing consensus that the Bank of Canada will cut rates as soon as June.
The economic outlook is important in assessing the prospects for an aggregate Canadian bond ETF, which holds both government and corporate bonds. There may still be some dips ahead for bond ETFs, but we are eventually headed into a period of slower growth, diminished inflation and lower rates. Bond ETFs will do well in those conditions, whereas stocks and equity ETFs will be challenged.
One last point to note is that while bonds have struggled in the past few years, stocks have done well. Dumping a bond ETF now to add exposure to stocks would mean selling low and buying high. The results are generally bad when you do this.
Rob Carrick