Time to take profit in bonds

Speculating can be fraught with danger. Hold too long in a bull market and you can quickly lose all your gains. Famed American investor of the 1920s, Bernard Baruch, reportedly claimed he got rich by selling too soon.

Bonds have been in a bull market, with a few brief interruptions, since 1982. At that time, 20-year Government of Canada bonds yielded close to 20 per cent. Today, the corresponding figure is closer to two per cent. And bonds have done particularly well this year, even though their prices were widely expected to give ground. Thanks largely to the accommodative policies of the European Central Bank and the U.S. Federal Reserve, the average Canadian fixed-income fund has gained 3.3 per cent over the past six months.

But does a continuing bull market make bonds the preferred game for investors to play now? Perhaps, but we recommend a more circumspect approach. And now, more than ever, we suggest bonds rather than bond funds.

Economic and monetary arguments these days focus on whether inflation will return or whether deflation should be the major concern, especially in Europe. The former would make now the worst time to buy bonds. The latter, of course, might extend the bull market in bonds. Among market observers, the debate rages on, leading many to speculate on bonds — a winning strategy, now, for more than 30 years.

But investing should never be simple. And speculating can be a tempting activity. To control his temptation, American humourist Mark Twain revealed “When I feel the urge to speculate, I lie down until the urge goes away.” Perhaps we don’t really need to lie down, but at least let’s pause for a moment’s reflection.

Low rates and high prices

To start with, interest rates on bonds are now in historically low ranges. Equivalently, bond prices are near historic highs. It’s arguable we’re now in a bond bubble. Is that the time to speculate?

If you hold bonds or bond funds now as a speculation on interest rates, you probably don’t want to sell. It’s only human nature to be at your most bullish on an asset when you own it.

But there’s a better approach to the interest-rate market now. We’re talking about dividend-paying stocks and the funds that specialize in them. Many stocks yield more than do 10-year bonds. Plus, dividends come with tax advantages and, perhaps more important, they come with at least the potential for increases over the months and years to come.

It’s true that bonds, especially government issues, make more conservative holdings than do common stocks. That’s provided you intend to hold them to maturity and use them as tools for cash-flow management.

It’s also true that large firms, especially regulated utilities such as power and telecommunications companies, make more conservative investments than do other common shareholdings.

Plus, a diversified mutual fund of such stocks adds even more safety, but at the expense of a management fee, of course.

We always recommend thinking of bonds as a cash-flow tool. Buy them for regular income, and, especially, with maturities that match your future needs for cash.

But if you’re speculating on interest rates using bond funds, we think now’s the time to start redirecting your portfolio to include the potential for some growth, albeit modest growth, from such yield-oriented funds as PH&N Dividend Income, RBC Canadian Dividend and Scotia Canadian Dividend Funds.

 

 

Canadian Mutual Fund Adviser, MPL Communications Inc.
133 Richmond St. W., Toronto, On, M5H 3M8, 1-800-804-8846

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