Canadian bonds performed well in 2016, then slumped

2016 saw no movement in administered interest rates in Canada after they fell in 2015. While the Bank of Canada remained on the sidelines in 2016, the U.S. Federal Reserve has been busier. After leaving its federal funds rate at 0.50 per cent for most of the year, it finally moved to raise that rate by 25 basis points in December. Further increases are expected in 2017.

As we enter the New Year, the U.S. Federal Reserve is poised to increase its target range for its federal funds rate even further. Before the December hike, Fed officials had anticipated two more hikes in 2017. But now that number has been increased to three, as the Fed modestly raised its economic growth expectations, while modestly lowering its forecasted unemployment rate. It also noted the move to higher inflation in explaining its decision to raise its rate.

While the Fed’s intentions to raise its federal funds rate in 2017 reflects a generally positive outlook for the U.S. economy, the Bank of Canada’s non-action in 2016 suggests a more subdued outlook. In explaining its decision to maintain its overnight rate target at half-a-per-cent in early December, the bank noted that while there have been gains in employment in this country, a “significant amount of economic slack remains in Canada, in contrast to the United States”.

Given the mixed global economic conditions in 2016, Canadian bonds performed well earlier in the year, only to slump later on as the U.S. Fed moved to raise rates and the election of Donald Trump to the White House stoked the perception that inflation will soon rise.

On a year-to-date basis, the FTSE TMX Universe Bond Index has risen by just 1.0 per cent, underperforming the S&P/TSX Composite Index’s 17-per-cent return by a wide margin. Government bonds underperformed corporate issues.

Straight preferred shares still more attractive than floaters

After suffering a devastating loss of 22.5 per cent in 2015, the S&P/TSX Preferred Share Index moderately rebounded in 2016. The index is now up about 5.6 per cent from a year ago.

Our recommended straight preferred shares enjoyed an average price gain of 5.9 per cent. On a total return basis, their gain was 12.1 per cent. Our floaters rose an average 7.0 per cent, and had an average total return of 11.3 per cent.

In 2016, we recommended that investors concentrate on straight preferreds rather than floating-rate preferreds.

The rebound in preferred shares in 2016 has brought them closer to fair value, though they still remain quite attractive compared to bonds. Meanwhile, our straight perpetual preferred shares outperformed our floaters in 2015 and for much of 2016. This decreased the attractiveness of the perpetuals compared to the floaters. But the recent outperformance of our floaters has widened the spread between these two types of issues, making the perpetuals still relatively more attractive.

 

This is an edited version of an article that was originally published for subscribers in the January 6, 2017, issue of Money Reporter. You can profit from the award-winning advice subscribers receive regularly in Money Reporter.

Money Reporter, MPL Communications Inc.
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