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Canadian investors have been routinely advised to reduce their exposure to Canadian equities and go south to all those snazzy U.S. stocks, like Apple and Microsoft. That way they reduce their risks from commodities and a weakening loonie.
That advice has had particular resonance for snowbirds, who want to have U.S. assets and income as a hedge against a weak loonie. As the greenback rose in value relative to the loonie, so did the cost of their winter vacation.
But that obvious strategy today is not the optimal strategy.
The TSX composite has performed insipidly this year, but its price return has been very close to the Dow Jones industrials: a decline of 2 per cent compared with the 2.3-per-cent drop in the DJIA. When the dividend tax credits are included, the TSX has been a measurably better performer for Canadians than the Dow. (Yes, the S&P 500 is up more than the Dow, but even that tech-heavy and commodity-light index is up a mere 1.5 per cent.)
However, for loonie-phobic Canadians who worry that the upcoming election could switch Canada from dull conservatism to soft socialism, there is another strategy that, on a tax-adjusted basis, will actually increase their incomes.
Most Canadian investors have large exposure to bonds through managed Canadian bond funds. Dull, perhaps, but secure, and they pay income.
And therein hangs the tale of the benighted bond yields of the industrial world.
The American dollar has been strong, in large measure, because it is backed by a stronger economy than those in most of the industrial world, which means the Fed should be the first central bank to end the era of near-zero interest rates.
Historically, the basic rule of bond investing has been that the bonds of strong, well-managed economies with strong currencies yield less than bonds of weak, debt-ridden economies with unattractive currencies. This year that rule has, for now, ceased to exist.
Eurobonds issued by most member nations other than Greece are denominated in a currency backed by no government, no tax system, no army, and no navy – yet they yield less than Treasuries, despite, or actually because, the European Central Bank (ECB) is printing money frantically. The ECB is striving to cover the debts of its participating governments, which are trying to stimulate the mostly weak economies of its membership. The widely-used basis for global yield comparisons is the 10-year bonds of issuing nations. The Treasury yields 2.09 per cent. Its German counterpart yields a picayune 0.61 per cent. But Italy's bond yields just 1.78 per cent in paper backed by a nation with the fifth-largest debt in the world, and an economy that has been in recession for six years.
Canada's 10-year bond yields are merely 1.36 per cent, in a currency that has been notably weak – mostly because of plunging commodity prices. Global investors like Canadian bonds because Canada is led by a government that managed the global crash so splendidly, continues to stress prudence over popularity, and has a widely-admired central bank. (That enthusiasm could evaporate if Canada spurns the Trans-Pacific Partnership to protect the 12,000 disciples of the secular religion of dairy protectionism, or if the next government in Ottawa is seen to be placing popularity over prudence.)
So Canadian investors can increase their income from bonds by selling Canadian bond funds and buying high-quality U.S. ETF bond funds. By so doing, they also reduce their near-term political risk.
Ordinarily, if an investment yields far more than seemingly comparable investments, there's a hidden risk. However, these globally-bizarre yield spreads give Canadians a unique opportunity to acquire U.S.-dollar assets and income, and be paid nicely for that privilege.
There is another potential benefit: If the TSX continues to perform well compared with its U.S. counterparts, the attractive tax-effective dividend returns from sticking with Canadian stocks means that overall returns from holding Canadian equities while participating in the world's leading bond market hold a lot of appeal – particularly for snowbirds.
We are basically bearish on bonds, so we do not advocate using cash or Canadian stocks to buy high-quality U.S. bond ETFs. Simply switch from those low-yielding Canadian bond funds to their U.S. counterparts. Steer clear from any ETFs anywhere that include low-quality or junk bonds. Your U.S. bond ETF should include only Treasuries and corporates of double-A or better quality – and no tax-exempt state or local bonds.
For most of recent history, Canadian bond yields have been higher than comparable U.S. yields. This current flip-flop may not last much longer. Using this strategy, your investment income will increase and your currently-unknown investment risk from domestic politics will be down.
Then you can go back to what most investors enjoy more – exploring the risks and rewards in the stock market.
Don Coxe is chairman of Coxe Advisors LLC. Based in Chicago, he publishes the Coxe Strategy Journal for investors, and is an adviser to several commodity funds.