Opportunity in Bonds – Canadian bonds and more

June 1, 2024No Comments

Let’s talk about Canadian bonds, US Bonds and Junk Bonds.

Hello and welcome once again to the Smart Money Dumb Money Show. And I’m in a little bit of a different location today at my house. I had a bunch of stuff I had to do this morning around the house but work never stops. And as they say, money never sleeps. So here I am recording this video from my home. I wanted to talk today about a fairly simple securities [00:00:30] type and that is bonds. I want to cover the profile and the potential that I see in US bonds, Canadian bonds, and I’ll even take a look at good old junk bonds and just see if there’s any possibility of profits on the bond markets and the subsequent bond ETFs that you can buy out there. So, let’s get started. [00:01:00] It’s a straightforward topic I wanted to cover today, so we’re going to jump right to the charts.

Canadian Bonds

What we have right here in front of us is the Canadian bond. I wanted to start with this one because some of you might be aware that Canadian inflation figures came out about a week ago from when we released this recording, and they weren’t bad. They were pretty good I think [00:01:30] because of some of the crushing of the Canadian economy. As you probably know through my blogs, I’ve talked about productivity problems in Canada and I’m not the only one that’s talked about this stuff. In fact, this is just me reciting information from well-known economists. I’m just a second messenger here. But our productivity is at a world-class low. Our growth in GDP is literally [00:02:00] world-class low, like at the bottom, just like our productivity debt to GDP number of business closures, all these things.You can read my blogs, I’ve written a few on this subject lately, but Canada’s got a bit of an economic problem and for that reason, it doesn’t surprise me that even though the grocery cost and the carbon tax cost on your gas litre, I’m not surprised that that’s being offset by the [00:02:30] problems throughout the rest of our economy. So, net-net we have still a fairly high on inflation rate unemployment, I should say not inflation, unemployment rate. And that of course can keep inflation low when people just can’t buy stuff. Let’s get into the bonds and we’re interested from an investor’s point of view. And the question is do we have an opportunity in the Canadian bonds market? And I think the answer is yes. You can see [00:03:00] here that there’s a bit of a trading range. In fact, this is very well defined.

canadian bonds - stockcharts

You can see the neckline on this range except for one spike to $20. But most of the time the neckline has been landing around 19 and a half. Well, it’s currently, this is the iShares long bond ETF, which is just a great way of playing it. It’s XLB on Toronto, the XLB ETF, and I think the security is going to go up to around 19 and a half at the minimum. [00:03:30] You probably heard that Bank of Canada governor Tiff McCollum recently said that there’s probably room for him to start easing. And that will imply, and I think with the economy in rough shape in Canada that they’re going to ease. And with that in mind, I think the 19.50 target, which is the neckline, is the lowest target that I would have. I think there’s reason for that [00:04:00] neckline to be broken, and I think there’s opportunity if it is broken and takes out that small amount of resistance at 20.

But real resistance at 19 and a half if that happens. I think we’re looking at the old neckline here is resistance and that’s around $22, $23. I think there’s tons of upside is what I’m saying on a relatively safe security. And you can see if we look down, it’s fairly oversold. This is the money flow index. The money flow has not been going into this ETF, which implies it’s not going [00:04:30] into bonds. And, the MACD has been low. But look at the histogram it’s been picking up and this is RSI at the bottom again coming from a fairly low position but still not at the very bottom. So, it’s showing that the momentum hasn’t completely lost itself in this security. I just think there’s a lot of reasons that we may see the bond market on the Canadian side pop over the next year.

It may take [00:05:00] a while, but I think you don’t have a lot to lose because it’s bonds. It’s usually high-quality bonds and you get paid a yield in between. So that’s the Canadian bond story. I thought I would go to the next chart, which is the US long bond. Now I will disclose, I hold a position in this ETF through our Valuetrend platforms, our equity platforms. Now you would say, why would I hold a bond in the equity platform? Simply because we’re trading this, we’re [00:05:30] treating it like an equity, we think it’s oversold. The trend is down, no doubt about that. It’s not as pretty a picture as the Canadian bond market right now. And I am not in this security in the equity platform, but maybe looking at buying some. Whereas we do hold this as an equity position in our equity platforms for the trade.

So, despite the downtrend, it’s pretty oversold. You can see that on the same indicators that we were just looking at some [00:06:00] upside showing on the MACD, RSI and Money Flow index. These signs are telling me that we’ll probably get some sort of rally like it has been in a series of lower highs and lower lows. This low, if it is not going to proceed into a lower low, then that may be the beginning of some sort of turnaround in this trend. But I can’t say that for sure at this point and I don’t predict. So, what I would predict is that it’s relatively oversold, so [00:06:30] it deserves a bounce. Where will it bounce to? Well, the next stop would be around 95 and it’s trading at 90, not bad, maybe even as high as a hundred, which is where it hit not too long ago.

I think it’s an okay opportunity and once the US Fed starts talking about easing, that may not happen until the second half. As far as the talk is, I don’t think they’re going to ease in 2024. And again, if you read my blogs, you know how [00:07:00] I feel about that. I think that they are stuck in a very strong stagflation environment. To an effect, I think we in Canada are too, but it’s the US we really must be concerned with. And I think they are facing a stagflation environment. So, their economy is just starting to slow. Canada’s economy has been in the doldrums and it’s probably not going to crawl out of that hole for quite some time, but the US is just about probably to enter into a slowdown and that would inspire the Fed to eventually [00:07:30] start easing. At this point though, it’s a little bit of an oversold market, so I don’t think, again, there’s a lot of downside.

I mean, look, even if it went to the lowest point, which was last October’s point, you’re still only talking less than 10%. So, if that’s the downside, and you can make a trade up to here or maybe higher, then I’m interested. And we did take a small position. I think it’s about a 2% position in our equity platform for that trade. So that’s where I see the US market through the TLT ETF. [00:08:00]


Junk Bonds

And then finally I wanted to talk about junk bonds compared to Canadian bonds. And I’ve got a couple of things to say here. I’m going to be showing the junk bond chart on a blog. Probably it’s going to be posted before you see this video. And so, you’ll be able to see the next chart I’m going to show you on that blog and understand a bit about it. But what I’m showing you here is that junk bonds, unlike what you saw on the Canadian bonds ETF in the US long bond, ETF, [00:08:30] the junk bonds, this is a US ETF, they are at their old highs.

Now the problem with that is that they are moving at a price range that is coinciding with risk appetite because nobody buys junk bonds unless you have a high-risk appetite, and you have high confidence in the market. This is one of those signs that the stock market’s getting a little bit overbought [00:09:00] because risk is increasing across the board, not just in stocks and stocks like Nvidia, which just did report good news, but still the PE ratios and all that stuff are pretty darn high on some of these high flyers. And that goes for the junk bonds, which is kind of a trickle down from the effect of risk appetite on the larger account markets. When we come to bonds, you don’t buy junk bonds unless you’re expecting that nothing could go wrong because junk bonds are the worst [00:09:30] credit quality bonds you can buy. They’re not called junk for no reason.

canadian bonds - stockcharts

There’s a problem with their credit ratings and there’s a problem with their security, and yet people are bidding them up to all-time highs. So, there’s a risk appetite situation and I would stay away from the junk bond market. And that’s to do with the height of the prices and the spread off of the high-quality bonds. This chart shows us the junk bond spread. [00:10:00] And what I mean by that is let’s just use fictional numbers here. Let’s pretend that on a high-quality 20-year bond, like the TLT ETF, we were just looking at, let’s pretend that the yield is 3%. I don’t have that in my head, but I think it is somewhere near 3%. So, junk bonds would pay a premium over that yield. So, you can see that if times are tough, the premium gets up into the 10% range.

In other [00:10:30] words, if TLT was yielding 3%, the JNK would be yielding 13%, something like that. Okay? And that’s during times of distress. You can see in 2020, that was during the COVID situation, everybody was panicking. And we saw junk bonds, of course, nobody wanted them, so the yields went up to reflect the falling prices. And you can see during the bottom of [00:11:00] when the markets were doing well. At the bottom of the spread was when everybody was happy just before the 2022 reduction in risk appetite, which resulted in a stock market pullback and a pullback on the JNK EFT as well as junk bonds in general. You can see spreads narrow, and this was down to around where it is right now, which is 3%. Well, guess what, that led into the bear market of 22 on stocks and the bear market [00:11:30] on JNK, same thing here.

We were fairly low on risk appetite and that led into a severe correction. Now, COVID was an element on its own, but still, I think the junk bonds took it on the chin more because of the lack of fear coming into that. So where are we right now? We’re at the same levels we were at during the heights of complacency in 2021. And you would [00:12:00] see this through history is that junk bond spread premiums reduce during periods of complacency when there is a high appetite for risk. We saw that on the junk bond ETF just a second ago. Everybody wants junk bonds, and you can see that the price is high. And the spread off TLTs is low. And remember the TLT if I flip back to that. We go back to the TLT, which is high-quality bonds, it’s depressed. Who wants [00:12:30] a high-quality bond when you can buy a low-quality bond and get hardly any risk premium through the yield for that?

So, if TLT is yielding 3% and the spread premium is only 3, yeah, you’re getting 6%. But that’s a pretty small premium. You’re being paid over perfectly safe bonds with all the risk of owning the worst credit quality companies on [00:13:00] the market. So, this is an interesting phenomenon that only occurs when risk appetite is very high. And I will be talking about this in a blog very soon if I haven’t already by the time you see this video, where it’s a sign of complacency. Just like all those sentiment indicators I talk about such as the VIX and put-to-call ratio and smart money dumb money, well, this is another one. We’re seeing complacency. Now, I do want you to notice that the complacency back in 21 lasted a while. It wasn’t [00:13:30] just hit it and rise, so the premium stayed low so that junk, JNK ETF could stay high for a while, maybe move a bit higher.

But what it’s telling us is that it’s not going to last forever, because these are crummy bonds. They’re low-quality bonds, and you’re not going to see people accepting a very small premium on that risk as soon as they begin to default or the markets themselves start losing [00:14:00] their risk appetite. So, I wanted to talk to you about these three ways of looking at bonds. So, the Canadian bond market on the long end, the US bond market on the long end, both of those being high quality and then junk bonds. Okay? And what that means overall. I hope this has been of a little bit of interest to you. I do think that long bonds can be an okay part of a portfolio right now. I think the risk isn’t all that high. There’s always risk on every security, but you’re definitely not buying high, [00:14:30] you’re buying low. And we’re seeing some signs, particularly on the Canadian market, I must add for some upside eventually on the Canadian bonds. I don’t think it’s a super crazy trade to go into high-quality Canadian government-issued and AAA corporate-issued types of bonds.

So, with that in mind, I will end by saying don’t buy junk and own a diversified portfolio with quality securities [00:15:00] like high-quality bonds. I hope that helps and I hope you understand more about Canadian bonds and the bond market than you did 15 minutes ago. Thanks for watching and we’ll see you next week.

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