End Of Cycle: Rising Short-Term Interest Rates,

Falling Long-Term Bond Yields

In keeping with our latest theme that we are at or near the end of the economic expansion that began in 2009 (with the exception that in 2016, oil price declines caused a brief retraction of the Canadian economy): short-term interest rates are rising.

The Bank of Canada raised its "overnight" lending rate, as expected, by 1/4%. If you borrow at prime, your cost is now 3.7%. 

If you borrow to invest, a balanced portfolio, in the first half of 2018 likely returned less than 1% (depending on the balance and asset allocation strategy). You will not be on the positive side of that equation.

Probably a good time to consider, for the time being anyway, to consider your options and use under-performing assets to pay down your lines of credit or margin.

As we often suggest bond markets lead all financial markets and in Canada, the yield curve, which we have been following closely, continues to flatten:

The spread from 2 year Govt. of Canada bonds to 30 year Govt. of Canada bonds has narrowed to 0.24%. The 30 year bonds now yield about 2.2%, down from 2.5% a couple of months ago. Longer maturity bond prices are higher. This is good for our collective portfolios because we have structured the average length of our bond maturities to take advantage of this situation. You don't get that tactical advantage from owning a bond ETF.

Bond investors are telling us that they want the safety of Govt. bonds and longer term maturity dates because they do not fear inflation (i.e. economic growth that causes inflation) as the economic cycle draws to its end. Which, in essence, is the sense that both the Bank of Canada and the U.S. Federal Reserve are going to speed up the end of the cycle with their tighter monetary policies.

Meanwhile households are paying more to service their debts and consumers will have to consider their spending habits, especially if they are unable to hold their jobs in the wake of an economic downturn.

For stock market investors, especially those who borrow to invest, the costs no longer justify the risk.

Better to wait for the new cycle to begin, when interest rates are lower and stock prices offer better value.