After a rough start to the year for both equities and bonds turned even worse in April, investors are monitoring a number of market risks as they adjust portfolios and brace for what’s next.
The S&P 500 dropped by 8.8% in April for its worst month since the start of the pandemic. The tech-heavy Nasdaq composite was down 13.3%, its biggest monthly drop since the 2008 financial crisis, while the S&P/TSX composite ended its fifth straight month of declines with a 5.4% drop in April.
There was no relief in bond markets, with corporate spreads widening and the yield on 10-year U.S. Treasuries rising (it briefly topped 3% on Monday for the first time since 2018).
Bond markets declined almost 4% in Canada and the U.S., leading to double-digit losses for the bond universe this year, a report from Richardson Wealth said.
“After the bond market whispered the ‘R’ word with the 2-year/10-year yield curve inverting, the April showers came and no market was spared,” the authors wrote.
With bonds not fulfilling their traditional role as a portfolio stabilizer, the report said, some investors are wondering if there’s any point in holding them. The authors’ advice: take a breath.
Annual returns for a balanced 60/40 strategy over the past three years have wildly outperformed: 16% in 2019, 9% in 2020 and 12% in 2021, the report said. Bonds fell last year while equities soared, but bonds delivered 7% in 2019 and 9% in 2020.
“Put the recent weakness in prices into a longer-term perspective,” the report said. “Now that stimulus and spending are pivoting back to normal, so are returns.”
The Bank of Canada raised its benchmark rate to 1% from 0.5% earlier this month, and governor Tiff Macklem said he won’t “rule anything out” regarding future rate announcements. Many analysts expect the Federal Reserve to raise its overnight rate by 50 basis points at Wednesday’s policy announcement.
While Richardson Wealth doesn’t recommend ditching bond holdings, some adjustment may be required. With the exception of the “very active” alternative space, which may prove beneficial for fixed income, the authors recommend passive funds whose fees don’t eat into limited returns.
Longer-duration bonds have outperformed for decades as rates trended down, but the authors have favoured short duration this year with rates starting so low and rising.
As for equities, the news isn’t all bad. A BMO report noted that Canadian stocks are still up 7.8% from a year ago after dropping 2.2% so far this year.
And while big misses from large companies have drawn headlines, more than 80% of S&P 500 companies have beaten expectations halfway through the latest earnings season, the report said.
“There is clearly still a re-marking of valuations going on against a backdrop of higher interest rates,” BMO said.
With most economists not ready to make a recession call yet, Richardson Wealth said the equities correction and prolonged bearish sentiment could present a buying opportunity for investors with the appetite.
“For those more-aggressive investors, we would focus on the parts of the market that have suffered the most. That means tech or even the broader U.S. market,” a separate Richardson Wealth report said.
International developed markets are cheap and the strong Canadian dollar provides an extra margin of safety, the report said.