Here are four lessons we can learn from looking back.
1. Cash can have a downside: From 1980 to today, bonds1 have outperformed short-term liquid investments in flat and falling rate environments. Cash2 is comfortable, with money market funds or certificates of deposit generally yielding more than 4% with little to no risk, but it might cost you if you linger too much in the easy zone.
2. The 80s are not repeating: The early 80s were a different time, with mortgages at 21.5%, GICs at 17.5%, and inflation close to 14%. Inflation and rates did rise recently, but we have returned to normal levels, and expecting yearly returns of 35%3 from bonds is unlikely.
3. Chronically low rates are not the norm: Interest rates stayed low for a long time after the financial crisis. We got used to low-cost money as interest rates often dipped under inflation. If we don't have major economic problems, it would be unexpected to see interest rates slowly return to pre-COVID lows.
4. Uncertainty may create chances: As investors moved their liquidity to money market funds and cash instruments, the bond market began to anticipate future rate reductions. For a long time, low uncertainty made choosing debt securities easier. The new environment of fluctuating rates is one that active management could benefit from.
In a situation where interest rates might go down and markets might fluctuate more, investors should take advantage of the long-term returns and fixed income that bonds offer by moving cash into bond portfolios. Holding too much cash could be a disadvantage as bonds have usually performed better than short-term liquid investments and reduced the equity risk post-rate hikes.
- Source : Bank of Canada & Statistics Canada.
- Source CIO Office (data v ia Refinitiv) Total return is
measured as the sum of the starting yield, the roll yield, and the
duration impact of the rate change (assuming parallel shifts in the
yield curve). For corporate bonds (representing approximately 30% of
the Broad Universe index) we assume no change in their spread
against government securities.
Bloomberg, FTSE Canada Universe Bond yearly returns.
- Source: Bloomberg, FTSE Canada 91 Day TBill5.
- Average yearly performance of FTSE Canada Universe Bond yearly vs the FTSE Canada 91 Day TBill.