The US Federal Reserve continues to tighten its monetary policy which causes bond yields to move higher. You should maintain a short duration for your bond holdings by transitioning into higher coupon, shorter-term maturities.
What to do about bonds now
Since our last update on bonds, the FTSE TMX Universe Bond index has continued to decline, though it has rallied a bit sometimes. Consequently, the index is now down nearly one per cent since the beginning of the year, compared with a 0.5-per-cent loss four weeks ago. Government bonds continue to lead the decline—down 1.1 per cent versus a 0.5-per-cent loss for corporate bonds.
The main cause of negative bond returns this year is the US Federal Reserve, which continues to tighten monetary policy as the US economy strengthens. Central banks around the world are expected to follow similar paths as the year progresses, which should cause bond yields to move higher still.
Our current recommendation is to maintain a short duration for your bond holdings by transitioning into higher coupon shorter maturities such as the Telus 5.05s of July 23, 2020; the Fairfax 5.84s of October 14, 2022; and the BC 8.75s of August 19, 2022.
What to do about preferred shares now
We continue to prefer floating-rate preferreds over straight, fixed-rate perpetual preferreds right now. That’s because we expect interest rates to continue to increase from their current levels. Thus the floating dividend rate will cushion some of the price sacrifice that non-floaters are likely to experience.
Over the past month, four of our six floaters have fallen in price, bringing their average yield to 3.37 per cent. With the dividend tax credit and the chance to earn higher returns as interest rates rise, a current yield of 3.37 per cent is not bad.
Alternatively, the average current yield on our three fixed-rate perpetual preferred selections is 5.34 per cent, significantly higher than our floaters. However, the prospects for their share prices are negative in a rising rate environment. We recommend you hold any fixed-rate preferreds you already have, and add to them for the long term if their yields move above 5.5 per cent.
In general, though, new money invested in preferreds should be mainly directed to our floaters.
This is an edited version of an article that was originally published for subscribers in the May 18, 2018, 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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