A change, it had to come We knew it all along
We were liberated from the fold, that’s all
And the world looks just the same And history ain’t changed
‘Cause the banners, they all flown in the last war
As inflation rapidly accelerated towards the end of 2021, bond yields woke up from their decade plus slumber breathing fire and brimstone. Subsequently, bonds have once again become a worthwhile asset class for the first time since the global financial crisis.
I will explore the historical behaviour and characteristics of bonds. Importantly, I will also discuss how they have reclaimed some of their status as a valuable part of investors’ portfolios.
Riding the Roller-Coaster for the Long Term
Notwithstanding that stocks have periodically caused investors some severe nausea during bear markets, those who have been willing to tolerate such dizzy spells have been well-compensated. In Stocks for the Long Run, Wharton Professor Jeremy Siegel states “over long periods of time, the returns on equities not only surpassed those of all other financial assets but were far safer and more predictable than bond returns when inflation was taken into account.”
As the following table demonstrates, not only have stocks outperformed bonds, but have also trounced other major asset classes. The effect of this outperformance cannot be understated in terms of its contribution to cumulative returns over the long term. Over extended holding periods, any diversification away from stocks has resulted in vastly inferior performance.
Real Returns: Stocks, Bonds, Bills, Gold and the U.S. Dollar: 1802-2012
With respect to stocks’ main competitor, which are bonds, Warren Buffett stated in his 2012 annual letter to Berkshire Hathaway shareholders:“Bonds are among the most dangerous of assets. Over the past century these instruments have destroyed the purchasing power of investors in many countries, even as these holders continued to receive timely payments of interest and principal … Right now, bonds should come with a warning label.”
The Case for Bonds
Notwithstanding that past performance is not a guarantee of future returns, the preceding table begs the question of why investors don’t simply hold all-stock portfolios. However, there are valid reasons, both psychological and financial, that render such a strategy less than ideal for many people.
The buy-and-hold, 100% stock portfolio is a double-edged sword. If (1) you can stick with it through stomach-churning bear market losses, and (2) have a long-term horizon during which the need to liquidate assets will not arise, then strapping yourself into the roller-coaster of an all-stock portfolio may indeed be the optimal solution. Conversely, it would be difficult to identify a worse alternative for those who do not meet these criteria. Continue Reading…
To Hedge FX Risk, or Not to Hedge: Currency markets are notoriously difficult to call but can meaningfully impact portfolio returns. ETF Strategist Bipan Rai provides a detailed framework for investing outside the Canadian market.
Image Getty Images courtesy BMO ETFs
By Bipan Rai, BMO Global Asset Management
(Sponsor Blog)
Admittedly, using a spin on a famous Shakespeare quote to start a note on currency hedging1 is verging on trite. Nevertheless, if Hamlet were running a portfolio of overseas assets, his primary concern would have to be the “slings and arrows” of currency markets — which are notoriously difficult to call but can meaningfully impact portfolio returns.
For Canadian investors, looking abroad provides several benefits. The most important is diversification, whether it’s through access to other regions that are less correlated with Canadian markets or to other products that aren’t available domestically.
However, investing abroad also means taking on foreign exchange risk given that international assets are priced in currencies other than the Canadian dollar (CAD).
For illustrative purposes, consider Chart 1, which shows the total return for the S&P 500 in U.S. dollars (USD) and in CAD terms for Q1 of this year. In USD terms, the index was up 10.6% over that time frame, but since that period also corresponded to weakness in the CAD relative to the USD (or USD/CAD moved higher) the index outperformed in CAD terms (up 13.3%). That means that Canadian investors would have fared much better leaving their USD exposure unhedged ex ante.
Chart 1 – S&P 500 Total Return for Q1 2024
Source: BMO Global Asset Management
Now let’s look at an alternative period in which the CAD strengthened against the USD. Chart 2 shows a comparison of the total return for the S&P 500 from April 2020 to April 2021 (in which USD/CAD was lower by over 11%). During that period, the total return index outperformed in USD terms by close to 20%. In this scenario, an investor who had hedged their FX risk would have been in the optimal position.
Chart 2 – S&P 500 Total Return Between April 2020 – April 2021
Source: BMO Global Asset Management
As these examples show, currency risk is a key consideration for any investor who wants to look beyond Canada for diversification. That risk can cut both ways, which amplifies the importance of hedging decisions. In our minds, the decision to hedge foreign exchange (FX )risk (including the degree to which foreign exposure is hedged) comes down to the following:
An investor’s view of the underlying currency pair
Whether the currency pair is positively or negatively correlated2 with the underlying asset
In this note, we’ll make a brief comment on the first point but focus largely on the second one. as we feel that should be given more weight for hedging decisions.
FX Markets are Tough to Call
Taking a view on the underlying currency pair is easy to do — but difficult to capitalize on.
Indeed, foreign exchange markets are notoriously fickle. One reason why is the relationship between predictive factors and currency pairs is rarely stationary. For instance, a lot of market participants tend to use front-end (2-year) yield spreads as a proxy for central bank divergence in the spot FX market. Chart 3 shows the current correlation between those spreads and the different CAD crosses, and as expected, the relationship isn’t consistent from a cross-sectional perspective.
Chart 3 – Correlation Between Two-Year Spreads and the CAD Crosses
* * Correlation window is 2 years. The CAD is used as a base currency for this analysis. The spread is tabulated by subtracting the foreign 2-year yield from the CAD 2-year yield. Source: Bloomberg, BMO Global Asset Management.
We can also see this by looking closer at the relationship between a factor and a currency pair over time. Chart 4 shows the rolling 100-day correlation between USD/CAD and the price of oil (proxied by the prompt WTI contract3) going back ten years. Note how frequently the strength of the correlation (as well as the sign) changes over time. Continue Reading…
Top investment executives told a webinar held Wednesday morning that investors should not mix Politics and Investing. Even so, while market observers at Franklin Templeton view the upcoming U.S. election as essentially a “toss-up” they seem to believe that a victory or sweep by the Republicans’ Donald Trump would be more positive for stocks than a Kamala Harris win.
Grant Bowers, portfolio manager and Senior Vice President for Franklin Equity Group, said “it’s a 50/50 tossup for the presidential winner. Both candidates are well known so it’s not surprising” there’s been little market volatility in the runup to the November 5th election. Generally, he’s bullish no matter the outcome. The economy did well in Trump’s first term while a Harris victory would be a continuation of Biden policies. The real differences are on tariffs, fiscal policy and regulation. “The most likely outcome is a split government” but there would be more volatility if there is a sweep by either party.
Of course, it’s quite possible that investors won’t know the official outcome for several weeks. If the process of counting votes drags on and there are legal challenges like there were in 2020, investors can expect more protracted volatility.
Sonai Desai, Chief Investment Officer for Franklin Templeton Fixed Income said the U.S. economy is set to do “quite well. I agree there’s a reduced probability of Recession: that’s not our baseline for a while.” If there’s a Republican sweep and broader tariffs measures introduced by Trump, “that might limit the Fed’s appetite for massive rate cuts.” Her baseline is that even with a Republican sweep, there won’t be a literal imposition of tariffs: that didn’t happen in 2016, so “I don’t think we will get the full range of cross-the-board tariffs.” Either way, the mighty U.S. consumer will “continue to consume and I don’t see that changing with the Election.”
Clearbridge’s Jeffrey Schulze
In the very long run, of course, any short-term market volatility from elections is likely to be a blip, which is why Franklin Templeton tells clients not to mix investing and politics.
In an analysis released early in October, Clearbridge Investments Head of Economic and Market Strategy Jeffrey Schulze, CFA, showed the following annual returns for the S&P500, all positive for equities no matter which party wins and whether or not they get full control or are in a divided government. Based on that, the best outcomes for investors would be a Democratic president with a Divided Government or Full Control by a Republican president.
“We view a Trump win, likely coming in a sweep scenario, as net positive for equities as it preserves favorable corporate tax treatment and builds on tax elements that expired,” Schulze wrote in the October 1st update, “A Harris win, likely coming with a divided Congress, would be mildly negative due to fewer provisions of expiring tax legislation getting extended due to political gridlock.”
Trump win likely positive for Stocks
“In aggregate, we view a second Trump presidency under a sweep scenario as net positive for equities. The expectation is for a more favorable corporate tax regime and less of a regulatory burden, both of which should boost corporate profits. Conversely, there is the potential for increased tariffs and retaliation from U.S. trade partners … We view U.S. stocks as best placed under Trump, with banks and capital markets, as well as the oil and gas complex, well positioned due to lighter regulation. Aerospace and defense is also likely going to benefit as well as biopharmaceuticals. Areas that could see pressure are restaurants and leisure, due to the less availability of labor, as well as EVs, autos and clean energy producers.”
Harris win might be “mildly negative” for Stocks
A Kamala Harris win would be less positive for U.S. stocks, Schulze writes: “We see a Harris win as mildly negative to equities should she preside over a divided Congress. It will be more of a headwind to the markets should we see a Democratic sweep as she will then be able to implement higher taxes on corporations and high-income individuals, as well as push a more ambitious regulatory agenda. However, tax credits for low-income individuals would provide an offset, creating an economic boost to this segment of the economy.Tighter regulation could weigh on biopharmaceuticals, banks, capital markets, energy as well as mega cap technology. But again, we caution against basing investment or portfolio positioning solely on the regulatory environment. Areas to be bullish about under Harris would be consumer discretionary, specifically restaurants & leisure, home building and building products.”
Generally, Franklin Templeton continues to advocate a “stay the course” stance for investors geared to the long term. The chart below shows that going back to 1944, the U.S. stock market has risen steadily over time regardless of which political party is in the White House.
Stephen Dover, chief market strategist and Head of Franklin Templeton Institute, acted as Moderator in Wednesday’s webinar, fielding audience questions. He also wrote a U.S. election update earlier this month, headlined “Uncertainty Reigns.”
He concluded back then that the election remains “too close to call. A divided government in Washington, DC, with no single party controlling the White House, Senate and House of Representatives is likely … Investors should gird themselves for uncertainty and potential bouts of volatility preceding and following election day. It is quite possible that the outcome for the presidency will not be settled until the December 17 certification deadline.”
Dover expects market uncertainty to continue well past November 5th, if not until January’s inauguration of the ultimate winner.”Legal challenges, some of which have already commenced, add to uncertainty. Re-counts, delays and disputes over certification of results, alongside courtroom litigation are virtually assured if state election outcomes are close. Various legal and procedural challenges are likely to endure until at least December 17, which is the deadline for state certification of the presidential election results and the official nomination of state electors to the Congressional certification on January 6, 2025.”
However, Dover says his basic investment conclusions remain unchanged. They are as follows: Continue Reading…
Are CDRs the better way to hold U.S. investments? What are the pros and cons?
TSInetwork.ca
Canadian Imperial Bank of Commerce (CIBC)’s Canadian Depositary Receipts (CDRs) give investors the opportunity to buy shares and/or fractions of shares in any of a number of U.S. or other foreign companies, in bundles that start out trading at a price of about $20 Cdn. each.
CDRs come with a built-in hedging feature that reduces exchange-rate fluctuations. This feature costs you 0.60% of your investment yearly.
CDRs let you invest small sums in U.S. or other foreign stocks, some of which have exceptionally high per-share prices. (For instance, Nvidia recently was trading for $475.06 a share.) Note, though, that with highly liquid stocks like Nvidia, or the other shares underlying CIBC’s CDRs, investors can easily buy, say, just one or two shares if they want.
CDRs represent shares of U.S. or other foreign companies but are traded on a Canadian stock exchange in Canadian dollars.
CIBC currently offers about 47 CDRs that trade on Cboe Canada (formerly NEO Exchange). Here’s just a few of them:
Alphabet Canadian Depositary Receipts – GOOG
Amazon.com Canadian Depositary Receipts – AMZN
Apple Canadian Depositary Receipts – AAPL
Meta Platforms Canadian Depositary Receipts – META
Microsoft Canadian Depositary Receipts – MSFT
Netflix Canadian Depositary Receipts – NFLX
Nvidia Canadian Depositary Receipts – NVDA
PayPal Canadian Depositary Receipts – PYPL
Starbucks Canadian Depositary Receipts – SBUX
Tesla Canadian Depositary Receipts – TSLA
Visa Canadian Depositary Receipts – VISA
Walt Disney Canadian Depositary Receipts – DIS
Cboe Canada is recognized by the Ontario Securities Commission.
An individual CDR is not intended to equal the cost of a single share. Instead, each new CDR started out trading at around $20 Cdn., representing ownership of one or more shares and/or a fraction of one share of the underlying stock, depending on the stock’s price. As mentioned, shares of many of the largest companies in the world trade at significantly higher prices, although some trade much lower as well.
Dividends paid on the shares underlying CDRs will be passed through to CDR investors in Canadian dollars when received, based on the current foreign exchange rates.
The main negative about CDRs is the Fees
CIBC charges no direct management fees for CDRs. However, the CDRs are hedged against movements of the U.S. dollar relative to the Canadian dollar. That means the Canadian-dollar value of the CDRs rises and falls solely with the movements of the underlying stock.
Of course, hedging has costs: and hedging against changes in the U.S. dollar only works in your favour when the value of the U.S. dollar drops in relation to the Canadian currency. If the U.S. dollar rises while your investment is hedged, that reduces any gain you’d otherwise enjoy, or expands any loss. Continue Reading…
With economic uncertainty looming, taking control of your household finances is more important than ever. Preparing for potential downturns doesn’t mean drastic lifestyle changes: it means implementing smart, practical strategies that safeguard your financial well-being. By making a few savvy adjustments, you can create a solid buffer that shields your household from the effects of a recession while keeping your long-term financial goals on track.
Launch a Side Business
Starting a side business can be a powerful way to add extra income and recession-proof your finances. Whether you’re leveraging a hobby, tapping into a specialized skill set, or exploring new opportunities, a small business can provide a flexible, low-risk way to diversify your income. Consider ventures that align with your interests, such as freelancing, consulting, or offering home services, which tend to remain in demand even during tough times. By starting small and focusing on industries that offer consistent value, you can gradually build a side income that provides financial stability when it’s most needed.
Pay Down your Debt
Paying down debt is one of the most effective ways to strengthen your financial position ahead of a recession. High-interest debt, such as credit-card balances or personal loans, can quickly eat into your budget, making it harder to manage everyday expenses when the economy tightens. Focus on prioritizing payments to reduce or eliminate this kind of debt, starting with the highest interest rates. This not only frees up more of your income but also reduces financial stress. By becoming less reliant on borrowed money, you can better weather potential income fluctuations and maintain greater control over your finances.
Organize your Financial Records
Organizing your financial records can have many benefits, such as improved efficiency, better decision-making, and easier access to important information. Digitizing your documents can help you keep track of them more easily, save space, and add an extra layer of security to protect against theft or damage. After digitizing your records, try the process of splitting PDF content to break a document into smaller, more manageable files. Continue Reading…
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