A Comment -- General Comments From an Expert (A Commentary)

Canadian Banks. Moodies has downgraded Canadian banks, but there is really only one banking system that even comes close to the Canadian banking system in terms of strength, and that would be Singapore. Canadian banks are fantastically strong, and the regulator is very competent. He doesn’t think the valuations are particularly demanding right now. (See Top Picks.)

Bond Markets. Heading into this year, there was a pretty nice selloff. We saw US 10’s get up to 3%, and it was almost one of those year-end capitulation type trades. 2013 was obviously a bad year, and had negative returns. It’s very unlikely to have a repeat, so he was less negative. However, we have had a pretty nice rally, and are up almost 5% on the year in Canada already. Thinks the market got overdone. Everyone was calling for higher rates to happen for the last 5 years, so he has always stayed positioned to stay Short on ordinary credit. We had some bad weather and economic data has not been as strong as most were hoping for, whether it was overseas, China or Europe. US numbers have not been great, and there was a contraction in the 1^st quarter. We are now at the point where we may slowly creep back up. The record lows right now are in Europe. German 10 year yields are at 1.3%, whereas the US hit that level back in mid-2012. He is probably back to where he was this time last year, where within your overall asset allocation you want fixed income to be at a minimum. For example, someone who is usually 60% equities and 40% bonds, they are probably down to 30% in bonds with the balance going to equities or elsewhere.

Real Return Bonds for 2026? To go that far out is very dangerous right now. A Real Return Bond pays you a guaranteed rate of return in past dollars. A 2021 bond would have been issued in 1991, and it will pay you in 1991 dollars, which is worth about $2 today. The problem with Real Return Bonds is that rates have been depressed by the Federal Reserves quantitative easing program, and Canada has followed suit. As rates are expected to rise over the next several years, it is not about rising inflation expectations, but about rising real yields, which means these are really going to get hurt. Either stay Short and look to getting some credit, or floating rate notes will give you the same sort of inflation protection that a Real Return Bonds does.

Earning 2% on bonds versus 7% on a stock? It’s all about the guarantee. With a Canada government bond yielding 2%, you are guaranteed to get that 2%. On the stock, 7% is not just on the dividend stream but what are you going to be able to sell the stock for when you need the money. There is a lot more risk and volatility on stocks. There is always a place for both stocks and bonds.

With the potential onset of inflation and higher interest rates, what could the impact be on high risk, high-yield corporate bonds, and is there a tipping point where the risk is going to be far greater and not worth it? We are getting close to that tipping point. The real story with the higher yield and high risk bonds is the yield pickup over government bonds. Historically that has been as low as 3% extra to as high as 12% extra. Right now we are at around 4%-4.5% extra. Relatively expensive. When that does start to turn, this asset class will sell off just as hard as equities will. Be very selective of the bonds you are buying or hire a good manager that can do that for you.

How would you structure a bond ladder with $100,000 in a registered account, including types and maturities of the bonds? On an RRSP ladder you are going out every year to 10 years minimum, because the RRSP is a long-term strategy. He would exclusively go into strip coupons with a 50-50 mix between provincials and corporates for the extra yield.

(A Top Pick Feb 24/14. Up 3.39%.) Ville de Montreal 3.5% Sept 1, 2023. Had a pretty good run alongside what you have seen in bond markets overall. Municipal space is still very cheap compared to investment grade corporates.

Target Bond ETFs (RQE-T) or (RQF-T)? He is not a fan of bond ETFs. They are targeted to pay out most of the capital, on the maturity date that you put in on day 1. Bond funds are a great one-stop shop giving you exposure to the bond market without having to do a lot of legwork. If you have more than $10,000, there is no reason why you shouldn’t buy bonds directly. You can take out a lot of the excess manager fees. By their nature, bond funds have to sit on cash where you don’t have to. Also, these are pretty concentrated portfolios, and there is no reason you couldn’t replicate it on your own.

Convertible debentures? When you look at the convertible market, especially in Canada, you are buying the debt of unrated small cap companies. Pretty risky market. Doesn’t think there are enough names out there that you would want to buy.

Preferred shares. Can the issuer convert Fixed-Reset Preferreds to Fixed-Floating Rate Preferreds after 5 years at the rate reset time? Every 5 years, with most of the preferreds but not all, as an investor you have the option of taking a new five-year fixed rate or going to a floating rate for 5 years. Interestingly the spread that you get on the preferreds versus Canada bonds is preset at the time of issue.

Laddered GICs? With government bonds, you can cash them in any time, but with GICs, you are locked in and can’t get your money out. Because of that, GICs do give you a better yield. GICs are constrained to just financials, and you have to trade every 5 years. With the bond market you can go a lot further to maturity, and you can create a much better long-term strategy.

Markets. There has been a huge rotational correction in the market. Generally speaking you have a lot of the broad indices around the world moving up. Both tech stocks and small caps that were doing really well until March, and then basically went to sleep for 3 months, are back participating in the market.

Stock selections. He does “computer assisted stock selection” with MorningStar/cpmas (?) providing the framework. Has his own recipe that then puts different weights on various characteristics, such as ROE, stock price change, PE multiple, etc. Has approximately 730 stocks in his database, and is looking for stocks that are in the top 5% which, hopefully, will have above average earnings growth. He typically invests in small to midsize companies in order to get the growth.

Technology Stocks. Since the beginning of 2013, tech stocks have done very well with lots of financing related to that. A lot of Canadian companies are starting to show good performance. US investors and venture capitalist investors are looking north of the border, which is a good source of competition and awareness. During the Internet go-go years of 1997 to 2000, you had stocks trading at unbelievably high multiples. You have that now in the US with many of the concepts stocks, but there are very few Canadian stocks caught up in that mania.

Markets. Europeans are worried about major deflation. The ECB was the buyer of last resort for EU bonds and they finally came in. It makes no sense that yields are lower than US treasury. There are major issues in Spain with youth unemployment. You want US exposure with a currency hedge. He does not want exposure to the Euro right now. Rails have earnings driving stock prices so they are not really too expensive. Oil by rail probably has a couple more years to go. Pipelines are what he thinks we need, however. He can’t buy new highs in rails here. The trend is probably not over, even if stretched, though.