Government Budgets: Is the Bond Market Broken for the Average Investor?
Regulators tell financial advisers that their clients should have portfolios tied to their risk tolerance. Historically, this has been accomplished with fixed income securities in portfolios. Generally, the older you are, the more secure your portfolio should be and the more fixed income you should have.
The problem for years has been that bond yields have reached a level where the investor’s situation is worse every year after inflation (taxes and fees). For Canada, the overall bond market has a worst-case return (similar to the yield to maturity adjusted for callable features) of 1.58 percent. For the entire world of investment grade fixed income securities, the YTW is 1.11 percent. They first collapsed during the days of the European debt crisis in 2012, when Mario Draghi said they would do the right thing. It happened again around the surprising results of the BREXIT vote in 2016 and those lows were broken in the early months of COVID-19 in 2020.
Rarely is a week that goes by where we don’t get a question on Berman’s Call that looks something like: My bonds (GICS) don’t meet my needs, can you recommend a dividend paying stock that has 4- 6 percent please resend? This central bank intervention, which forced yields down, led many investors to higher yielding bonds without necessarily understanding the risks. It’s like asking for a dividend-paying stock to replace fixed-income securities: there is a radically different risk profile of high-yielding bonds or stocks (junk) compared to good quality securities or government debt.
The chart shows how low the credit spreads are and it is amazing how tight the unwanted bond spreads are, they are clearly the riskiest they have ever been. Investors are simply not paid for the extra return. Even in the premium universe, a return of just over 2 percent falls short of prevailing inflation expectations.
To make matters worse, adding now that the world’s central banks seem to want more inflation makes bond ownership even riskier. In an environment of creeping inflation expectations, even safe government bonds aren’t such good stores of (real) value either.
The bond supply to come over the next few years, as deficits explode, will make it more and more difficult to balance portfolios. The Federal Reserve and the Bank of Canada are talking about normalization, which is laughable since they will be forced to monetize the debt as far as the eye can see. I can’t wait to know when Canada balances its budget again!
This week, on our weekly Thursday Spring 2021 Berman’s Call virtual tour, we’ll be focusing on budgets, taxes, and the use of fixed income in your portfolios for years to come. Register on www.etfcm.com or to www.investorsguidetothriving.com for a weekly presentation of 30 to 40 minutes which changes each week according to the current evolution of the market followed by a question and answer session of 30 to 40 minutes.
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