Resilience in Bond Markets

Resilience is an important element in overall strength and North American fixed income markets showed it in good measure in November recovering October’s losses and then some. After posted its sixth up month (+1.7%) in the last seven, the broad Canadian bond market has returned ~6.5% since April (Chart 1). Similarly, the aggregate US bond market has delivered a return of ~6.4% over that stretch. Despite those strong returns of late, bond market participants are still expressing concerns as we move toward year end, with yield retesting their post-US election highs in early December. A resurgence of inflationary concerns and a resilient labour market in the US have driven a recalibration of policy expectations, all of which are weighing on bond prices. For the month of November, the Canadian Universe Bond index was up 1.7%, pushing YTD and 1-year returns to were 5.0% and 8.6%, respectively (Table 1). The aggregate US bond market rose 1.0% MoM in November, increasing its YTD and 1-year returns to 3.2% and 7.0%, respectively. Investors are continuing to benefit from historically attractive yield levels with the aggregate Canadian and US bond markets yielding ~3.6 and 4.8%, respectively (at the time of writing). Generally speaking, risk assets have enjoyed a strong run of late thanks to continued earnings growth and positive risk sentiment buoyed by expectations for a growth-oriented new government in Washington. YTD (again, to the time of writing) the S&P 500, Dow Jones Industrial Average, and Nasdaq composite have rallied ~36.5%, 25.1%, and 42.8%, respectively. The S&P/TSX has lagged somewhat, with a YTD return (to Dec 13^th) of ~20.6%. So, with returns in Canada and the US of approximately 14% and 23%, respectively, 60/40 balanced fund investors are on pace for an historic year in 2024.

Chart 1:

Source: FTSE/Russell; Bloomberg

Over the month of November, YTD and 1-year, Canadian Federal bonds returned +1.0%, +3.4% and +6.4%, respectively (Table 1), while the overall Universe Bond Index returned +1.7%, +5.0% and +8.6%, respectively. Corporate bonds continued to outperform their government counterparts, returning +1.7% on the month. Further, with returns of +7.1% YTD and +10.6% over the past year, Canadian investment-grade corporate bonds have far outpaced government debt. Provincial bonds rose 2.4% on the month and have returned 4.6% YTD and +9.0% over the past year.

COTM (Chart of the month)

Source: Bloomberg

Given the massive outperformance of corporate bonds over Government of Canada bonds, there has been considerable debate about valuations in credit markets. On average, the incremental yield or credit spreads in North American investment-grade corporate bonds are at or near their tightest levels since the GFC. Thus, many pundits argue there is very little value left. That said, as the COTM highlights, there are still parts of the corporate bond market where value can be found. The credit curve, which shows the average credit spread for different terms-to-maturity, is still relatively steep for corporate bonds with shorter terms. This implies that investors are being paid additional yield to invest out to 10 years (green shaded area) and in our view, better opportunities exist. Conversely, the credit curve is very flat as you move toward the longer-end of the curve (red shaded area), implying very little additional reward for investing in the long-end of the corporate market. Thus, we are focusing our corporate bond exposures in the green area and are being very selective in our exposures in the red area. All that to say, opportunities still exist in corporate debt, you just need to know where to find them.

Market Review

Here is summary of market movements within both Rates and Credit thus far in 2024:

Rates positioning: (i) Neutral duration; (ii) yield curve neutral; (iii) overweight Cdn prime residential mortgages; (iv) overweight RRBs; (v) overweight USTs.

Credit positioning: (i) overweight credit; (ii) maintain a quality bias in favour of IG over HY, and more defensive credits within IG; (iii) overweight Cdn corporates, underweight US.