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I have a question: If fixed income ETF performance stays this bad, where is the money going to go? The answer, with the reflation trade in equities flagging, is not as obvious as it may seem.

The first quarter of 2021 was a miserable one for bond investors. In the U.S., bonds with maturities 10 years and beyond endured their worst three months since 1980. This left the iShares 20 Plus Year Treasury Bond ETF, all US$14-billion of it, with a painful loss bigger than 12 per cent.

Domestically things were little better. The $4.3-billion iShares Core Canadian Bond ETF fell 5.8 per cent and the BMO Long Federal Bond Index ETF cratered 12.4 per cent.

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Investors should not start changing asset allocations after one bad quarter but inevitably there will come a point where the pain becomes too much for bond ETF holders. Selling pressure in fixed income markets will likely intensify.

The obvious destination for these assets are equity ETFs tracking the S&P/TSX Composite. After all, the index provided a solid 8.1 per cent return for the first quarter, almost double the S&P 500′s 4.5-per-cent mark in Canadian dollar terms.

Canadian equity returns were boosted by the benchmark’s high weightings (relative to the S&P 500) in sectors like mining and energy that are correlated to the global post-pandemic economic recovery. The recovery is continuing, but prominent strategists now believe it’s largely priced in to equities and most of the recovery-related upside in equities is behind us. This throws some doubt on the TSX’s continued outperformance.

Citi’s U.S. equity strategist Tobias Levkovich published a report last week identifying three sectors he believes look “peak like” in terms of forward earnings estimates - Banks, Diversified Financials and Materials. Combined, these cyclical sectors make up a huge percentage of the S&P/TSX Composite.

Meanwhile, Credit Suisse global strategist Andrew Garthwaite slashed his overweight recommendation in mining stocks as China’s economic growth rate cools and regulators tighten financial conditions.

The views of Mr. Levkovich and Mr. Garthwaite imply that Canadian investors looking to escape poorly performing bond markets may want to take a closer look at options beyond TSX-tracking ETFs, or at least avoid large overweight positions in domestic equities.

The timing could be tricky. Bond investors may be looking for new equity options at the same time market optimism is peaking.

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-- Scott Barlow, Globe and Mail market strategist

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

Hardwoods Distribution Inc. (HDI-T) This distributor of hardwood lumber and building products is a way for investors to play the strong U.S. housing market. Last week, the share price rallied to a record high on high volume, and the positive price momentum remains intact. The stock also has a unanimous buy call from five analysts. Jennifer Dowty has this profile.

Knight Therapeutics Inc. (GUD-T) The argument for investing in Montreal-based Knight Therapeutics is simple: Jonathan Goodman, the founder and chief executive officer of the specialty pharmaceutical company, did wonders for Paladin Labs, his previous company, and he can do it again with Knight. The problem? Investors have nothing to show for their faith in top management so far. David Berman looks at the latest investment case for the stock.

The Rundown

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Investors should pay close attention to these five takeaways from the first quarter

There was no meltdown. That’s the primary takeaway from the first quarter of 2021. The pandemic is still with us but, unlike a year ago, investors are taking it in stride. It all looks pretty routine on the surface. Except it wasn’t. There were many unusual developments in the quarter that will almost certainly have ripple effects as the year progresses. Gordon Pape looks at some key takeaways.

Where do stocks and bond yields go from here? BMO, Rosenberg, BlackRock and other market watchers weigh in

Money managers are debating whether the latest market moves are a sign that the economic recovery that’s widely expected in the months ahead is now nearly fully priced into markets. And where will the 10-year U.S. Treasury yield, so influential in setting the direction of stock markets and which hit fresh 14-month highs above 1.7 per cent on Tuesday, head next? Here are what several market strategists and portfolio managers are thinking.

Gold stocks, in a deep slump as the broader market rallies, could be worth a contrarian look

Here’s a trade for stubborn contrarians: Buy gold or the shares of gold producers now that they are out of favour and well off their highs. As David Berman suggests, the market may be too pessimistic about the commodity while ignoring factors that could give it a lift.

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A mom wonders if a TFSA is the best way to financially help an adult child

A mother wonders how to help a millennial-aged daughter who graduated with a BA and a college diploma and has been having trouble finding work that pays a decent wage. “Are we better off to contribute to her TFSA now or help provide a [home] down payment in perhaps 10 years?” she asks. Rob Carrick responds.

Markets finally seem ready to toss the junk rally

For several months, market leadership has been concentrated in low-quality and heavily shorted stocks, as investors chased windfall returns in beaten-down sectors and unproven businesses. This trend, loosely referred to as a “junk rally,” rewarded companies with heavy debt loads and negative earnings, while undervaluing those with strong balance sheets and profits. The month of March, however, saw the market’s most inflated and speculative pockets take a big step back, suggesting that the junk rally is running on thin fumes. Tim Shufelt reports.

Also see: Retail investor horde revives Canadian small-cap market

Why all investors need to keep a close eye on rising bond yields

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Bond yields remain low by historical standards but have rocketed higher in recent weeks. Those higher yields carry a mixed message. On the one hand, they warn of higher inflation ahead. On the other hand, they suggest economic growth may prove considerably stronger than expected. Why should most investors care? Ian McGugan explains.

Others (for subscribers)

The most oversold and overbought stocks on the TSX

Monday’s analyst upgrades and downgrades

Insider Report: C-suite executive buys this stock yielding over 7%

John Heinzl’s model dividend growth portfolio as of March 31, 2021

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Canadian dollar forecasts grow more bullish as economy strengthens

Number Cruncher: These profitable midcap U.S. stocks may be flying under your radar

Globe Advisor

The Financial Times: Twitchy resilience becomes the norm in equity markets

What to do when it’s time to convert an RRSP?

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Ask Globe Investor

Question: When will the banks start raising their dividends again? I read that the regulator recently unwound temporary rules aimed at helping banks weather the pandemic, and I’m wondering if that opens the door for dividend hikes.

Answer: I hate to break it to you, but the announcement you are referring to had nothing to do with dividends. On March 16, the Office of the Superintendent of Financial Institutions said that, effective May 1, it will unwind regulatory adjustments to market-risk capital requirements for banks. These adjustments were put in place at the start of the pandemic to give the banks the flexibility to address stressed conditions, but now that markets have stabilized the measures are no longer required, OSFI said.

The prohibition on dividend increases and share buybacks – which OSFI introduced in March, 2020, along with other measures to promote stability of the financial system – remains in place.

But there’s reason for optimism: With banks carrying large amounts of excess capital and vaccinations ramping up, a resumption of dividend hikes may not be far off.

Read John Heinzl’s full response here

What’s up in the days ahead

The investment case for emerging markets is getting riskier. We’ll examine why.

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

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