What Happened

 

From July 1 to September 15 things went along quietly. From September 15^th to 30^th, it got decidedly unquiet! That’s the technical term.

 

So what happened? Well, this happened:

 

 

This chart is the yield of 10 year Government of Canada bonds for the past year. That red circle- that’s September 15^th. Remember with bonds, yields going up means that the prices of bonds are going down.

 

“Isn’t getting paid MORE interest from my bonds a good thing, Sam?”

 

Absolutely it is a good thing for investors, even if the temporary pain of bond prices dropping is unpleasant. Remember that we tend to hold bonds until maturity so if you buy a bond at $98 and it drops to $97, it feels bad but all we care about is getting $100 for that bond when it matures.

 

Now for another chart, the TSX Index over the same period, and yes, the red circle is again September 15^th.

 

 

What changed? Well for the past year, since interest rates started to rise at a rapid pace to combat inflation, the general equation of thinking for many people was as follows:

 

Rising short term Rates à Slowing Economy à Recession à Lowering of short term rates

 

This is the reason why you could get a higher rate on a 1 year bond/GIC compared to a 3 or 5 year bond/GIC. In the lingo of the industry, we have an inverted yield curve (short term interest rates are above longer-term interest rates).

 

September 15^th just happened to coincide with a change to that thinking. The economy hasn’t gone into recession, in fact the US has had good GDP numbers (Canada less so but we will follow the US economy fairly closely). Suddenly now we have expectations that interest rates might NOT go down that much, if at all, for a while. That’s lead to an increase in longer term bond yields in response to these changing expectations.

 

How does this impact me?

 

First, the stock market is adjusting to this idea of a more normal interest rate environment. Yes, I said normal. Company earnings are mostly fine but now there is a real split between the haves and the have-nots. Of course share prices of plenty of well-run companies have been especially hit as they are more sensitive to interest rates- companies like Banks, Telephone companies and Electricity companies. Are we going to stop using banks or turning the lights off at home? Not at all. They will be fine, and we consider this period part of the normal ups and downs of investing in stocks.

 

Second, with yields going up for longer bonds, we are starting to add to holdings with a little more time until maturity. Creating a little more certainty of yield for longer periods of time is a good thing for the overall risk-adjusted returns of investment portfolios.

 

Have a wonderful fall, it’s the best time of the year in much of Canada.