Milan Cacic
May 03, 2024
Money Financial literacy Economy Commentary Weekly update Weekly commentaryBONDS… MAYBE IT'S TIME FOR A REVISION TO THE MEAN?
Bonds have been the worst performing asset class over the past three years. As a matter of fact, the bond market has now been in a drawdown for 45 months. This is the longest bond bear market in history. The chart below shows just how significant this bond market drawdown has been.
For those who need a refresher course on how bonds work: bond prices go up when interest rates go down and bond prices go down when interest rates go up. Imagine you purchased a one-year $100 5% coupon bond from the bank of Canada. Now imagine that overnight interest rates on a one-year bond went up from 5% to 10%. What do you think you could sell your bond for? If I can now buy a $100 bond that pays me 10%, I will have $110 after one year. If the bond that you bought yesterday only pays 5%, it would only have $105 after one year. In order for me to make 10% on the bond that you have, you would need to sell it to me for $95. I would then make five dollars on the coupon/interest from your bond and another five dollars in gain from the $100 value at maturity. In this example, the price of a one-year 5% bond would drop approximately 5% to account for the new higher interest rates available in the market. You may recall from previous notes that these price movements are magnified for bonds with longer duration.
This is what has taken place since December 2021. In August 2020, the 10-year US treasury [bond] hit a low interest rate of 0.5%. Since then, interest rates have steadily increased to 4.6% today (a 900% increase). During this time, bonds have had negative returns and have not contributed any value to the investment portfolios.
As you have previously heard from us, history usually repeats itself. At some point, interest rates will go down and bond prices will go up. We believe this revision to the mean will come soon. When it does, the bond component of the portfolios will once again contribute. And it will most likely be significant when it happens!
I've also included a piece from our CIBC Economics team entitled "Is the Canadian labour market already weaker than it appears?”.
As always, if you have any questions, please feel free to give us a call at any time.
Have a great weekend.
Milan