Big losses for 'risk-free' assets

Brandon Snow's picture

One of our traders at RBC, Charlie McElligot, shared this table last week:

ETF YTD Yesterday
HYG (high yield ETF) -1.8% -1.4%
MBB (MBS ETF) -3.4% -0.7%
LQD (investment grade ETF) -6.4% -1.1%
MUB (muni bond ETF) -6.4% -0.4%
EMB (EM bond ETF) -11.6% -0.7%
TLT (UST long bond ETF) -13.1% -2.2%
SPY (S&P 500 ETF) +19.8% +1.2%

While bonds may always be considered "low risk" by compliance departments, the numbers this year remind us that "low risk" does not mean "no loss." It's not surprising with these numbers that the rotation into equities continues (chart also from Charlie):

While I am the first to admit equities don’t offer the same value they did two years ago, relative to bonds they are still very compelling. When you look at historic valuations in junk bonds vs. equities, you can see a great divide: yields on junk bonds have fallen nearly in half (10.5% to 5.8%) over the last five years while multiples in equities are flat (16x forward earnings). It's not just about returns, you have to think about the quality of the underlying companies. For example, in the table below I compare balance sheet and profitability metrics for the largest companies in the high-yield bond index to the largest companies in the dividend aristocrat index:

Both profitability and quality of balance sheet are significantly worse for the top companies in the junk index compared to the dividend aristocrats index. It's also worth noting that in the 2008 market crash, the junk bond index did not do a good job of protecting capital as it declined 37% peak to trough.

While I think equities now trade close to fair value, there remains a significant undervaluation relative to the fixed-income complex. Even though the commonly held belief is that bonds are "safe" and equities are "risky," there have been significant losses in so called risk-free bonds so far this year. Meanwhile, we have delivered good returns in the last few years with a focus on equities and without taking on excess risk or volatility (click on links below for details):

Cambridge Canadian Equity

Cambridge Canadian Growth Companies

Cambridge Canadian Asset Allocation

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