Will they never end, these trials that bond investors must endure?
The low bond yields we were all used to a year ago fell dramatically in the early days of the pandemic, crimping the flow of interest income from bonds and guaranteed investment certificates to almost nothing. Now, we also have falling bond prices. For the year through Feb. 22, the FTSE Canada Universe Bond Index was down about 3.5 per cent on a total return basis (share price changes plus bond interest).
Bond prices move in the opposite direction of bond yields, which have climbed steadily higher in 2021. The yield on the five-year Government of Canada bond started the year around 0.4 per cent and at midweek was close to 0.7 per cent. By bond market standards, that’s a dramatic change.
Rising yields suggest an expectation in financial markets that the economy will rebound from the pandemic lockdown, and that inflation might also be a concern. If we do see an economic revival in the months ahead, expect both higher bond yields and more price declines for bond funds.
Low bond yields have driven investors into a variety of alternative income-producing investments – high-yield bonds with a higher risk profile than bonds issued by companies with an investment-grade credit rating, emerging market bonds, preferred shares and, very often, common shares that pay a dividend.
The stock market overall has been great in 2021 – the S&P/TSX Composite was up about 6 per cent for the year through Feb. 22 on a total return basis. But some of the conservative dividend stocks you’d want to consider as a bond alternative are not doing well at all.
These stocks, notably utilities, are like bonds in that they’re sensitive to changes in interest rates. Rising rates weigh on the price of these stocks, which helps explain why the S&P/TSX Capped Utilities Index has been falling since early February and was up only about 1 per cent this year as of late in the month.
Price declines for bonds and bond exchange-traded funds are jarring because we hold these assets to provide stability in a portfolio. They can still do that. If stocks fall hard, money will flow into bonds and push prices back up again. A balanced portfolio will lose much less than one that just holds stocks.
BMO Nesbitt Burns said in a note this week that the utilities sector is the most rate-sensitive sector, underperforming by 9 per cent on average through cycles since 1990 where rates move higher. Communications underperformed by 3 per cent on average, while real estate has shown mixed returns.
The decline in bond prices so far in 2021 is a reminder that it’s not normal for everything in your portfolio to be humming along at the same time. Both bonds and stocks had a very solid year in 2020, but stocks are up now and bonds are down. In a flash, that trend could reverse itself.
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