Bond funds have crushed it in the past 12 months, but not enough to backfill years of disappointing returns.
The three-year average annual total return for the FTSE Canada Universe Bond Index was a loss of 0.1 per cent. The five-year annualized total return – that’s bond price changes plus interest – was 0.5 per cent, and the 10-year return was 2.1 per cent. Woof.
The 12-month return to Oct. 31 was 11.3 per cent, which for bonds is excellent. But in the month of October, the FTSE Canada Universe Bond Index fell 1 per cent. A reader wondered about this latest weakness for bonds, especially in light of the half-point drop in the Bank of Canada’s overnight rate a few weeks ago.
This reader correctly observed that bond prices are supposed to rise as interest rates fall. Why is this not happening?
The answer speaks to the complexity of the bond outlook today, notably the persistent strength of the U.S. economy and uncertainty over how a Donald Trump presidency would affect inflation. The cumulative 1.25-point drop in the Bank of Canada’s overnight rate this year reflects a weak economy here.
In the bond market, the influence of the U.S. economy blots out what’s happening in Canada. That’s why bond yields have been rising in both countries lately. Rising yields mean lower prices for bonds and bond funds.
The U.S. Federal Reserve cut rates recently, which suggests some concern about future U.S. growth. But we won’t see real and sustainable momentum for bonds until the U.S. economy hits a sweet spot of stable, low inflation with reasonable growth.
Until then, expect to see more ups and downs in bonds and bond funds. Those three-, five- and 10-year return numbers show how big a hole there is to fill.
To put the five-year return into perspective, $10,000 invested in the index on Nov. 12, 2019, would have been worth about $10,349 this Nov. 1. You could have done better with a no-drama high-interest savings account, but don’t take any lessons for the future from this observation.
Rates for savings are very much influenced by the Bank of Canada, which means they’ve been falling fast lately. Bond funds have done better in the past 12 months and have the potential to outperform in the next 12 months.