Why bonds are beating the Dow

Last year, bonds were a lousy place for your money.

According to figures published by the National Post, the average Canadian bond fund lost 1.5% of its value in 1999. The average foreign bond fund did even worse, losing 11.2%.

As a result, many people decided to dump their bonds and bond funds. What were supposedly safe investments had turned sour. Plus, the stock markets were hot.

But now it’s a different story. It may be hard to believe, but Canadian bonds have actually done better in 2000 than the stocks of the fabled Dow Jones Industrial Average, Wall Street’s long-time barometer of financial health.

Bonds enjoyed some very healthy gains in the first half of this year. And the longer the term of the bond, the bigger its profit has been.

Maturity impact

All bonds have maturity dates, at which time the issuer redeems them for their face value, typically $1,000. Those bonds with the longest time remaining until maturity typically show the biggest swings up or down when prices move.

When bond traders believe interest rates are going to rise, the price of the long bonds gets hit hardest in the market. Whenhey believe rates will fall, the long bonds get the lion’s share of the profits.

That’s exactly what has happened so far this year. That explains why mutual funds that specialize in long bonds, such as the Altamira Bond Fund, have done so well in 2000. That fund gained 7.8% in the six months to June 30 — better than many stock funds.

What’s ahead?

The action of the bond market so far this year suggests that professional traders are convinced we are not going to see a resurgence of inflation. Nor do they believe that we are moving into a period where interest rates will threaten to return to double-digit levels.

If that were seen as a real possibility, bond traders would be dumping their long bonds and knocking down the prices.

This doesn’t mean we won’t see some more short-term interest rate increases, if the U.S. Federal Reserve Board and the Bank of Canada feel they are necessary to keep the economy under control.

But the pros are betting that any such increases will be temporary, and that we will experience yet another so-called soft landing. That would allow this boom to continue for some years yet.

If they’re right, it suggests more profits ahead for bonds. They may not continue to beat the Dow, but a return to the losses of ‘99 doesn’t seem to be in the cards.

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