Monday, October 10, 2022

The Inevitable Masquerading as the Unexpected

Rising interest rates are causing a lot of unhappiness among bond investors, heavily-indebted homeowners, real estate agents, and others who make their livings from home sales.  The exact nature of what is happening now was unpredictable, but the fact that interest rates would eventually rise was inevitable.

Long-Term Bonds

On the bond investing side, I was disappointed that so few prominent financial advisors saw the danger in long-term bonds back in 2020.  If all you do is follow historical bond returns, then the recent crash in long-term bonds looks like a black swan, a nasty surprise.  However, when 30-year Canadian government bond yields got down to 1.2%, it was obvious that they were a terrible investment if held to maturity. This made it inevitable that whoever was holding these hot potatoes when interest rates rose would get burned.  Owning long-term bonds at that time was crazy.

One might ask whether we could say the same thing about holding stocks in 2020 when interest rates were so low.  The answer is no.  Bond returns are very different from stock returns in terms of unpredictability.  We use bond prices to calculate bond yields; one is completely determined by the other.  The situation is very different with stocks.  Even when conditions don’t look good for stocks, they may still give better returns than the interest you’d get if you sold them to hold cash.  All the evidence says that most investors are better off not trying to time the stock market.

Most of the time, investors are better off not trying to time the bond market either.  However, the conditions in 2020 were extraordinary.  Long-term bonds were guaranteed to give unacceptably low returns if held to maturity.  This was a perfectly sensible time to shift long-term bonds to short-term bonds or cash savings.


The only way house prices could rise to the crazy heights they reached was with interest rates so low that mortgage payments remained barely affordable.  Fortunately, the government imposed a stress test that forced buyers to qualify for a mortgage based on payments higher than their actual payments.  This reduced the damage we’re starting to see now.  Unfortunately, there is evidence that some homeowners faked their income (with industry help) so they could qualify for a mortgage.  This offset some of the good the stress test did.

We’re starting to hear calls for the Bank of Canada to stop raising interest rates.  It’s hard to tell how much of this comes from homeowners and how much is coming from the real estate industry.  I have some sympathy for homeowners who really didn’t understand how much their mortgage payments would increase as interest rates rise, but not enough to support bailing out homeowners or keeping interest rates artificially low.

As for real estate agents, there are simply too many of them.  The size of this industry is unsustainable.  It’s never easy to be pushed out of your job, but that’s what will happen.


A common human failing is to see past events as inevitable; we call this hindsight bias.  To make sure I’m not guilty of this myself, I went through some past posts I wrote.  A common theme was that interest rates could rise at any time, and we need to protect ourselves.  I certainly didn’t know when they would rise, but the need to protect yourself and your family from interest rates returning to normal levels was obvious.  Owners of long-term bonds have paid the price, and the pain is just starting for mortgagors.  This mess is the inevitable masquerading as the unexpected.


  1. My confession: I screwed up on the long term bonds thing. I have a plain passive portfolio and have used VAB as a core bond holding. I actually read your articles on long term bonds last year, but elected to stick with VAB. Thinking about why I did that: I thought I "got it" mathematically, but stuck with VAB because doing otherwise felt like trying to time something. I think I felt at the time that, despite the math, rates could still go lower (saw EU with negative bond yields and all that) so thinking to switch duration at that time felt like an attempt to market-time something that, for all I knew, could go either way. Perhaps that was partially true - bond yields could have gone even lower/negative? But maybe the balance of probability was not in favor of that.

    Anyway, based on the difference in returns between say VAB and VSB, and bond weights in my portfolio, my mistake looks to have cost me about 2% total return this year. Which stinks, but won't break me. And isn't even my most costly mistake yet. Learning isn't always free. :)

    Fortunately I've avoided the probably bigger mistake of having a $900k variable mortgage.

    1. I understand the hesitancy to time the fixed income market. Because I invested in only stocks for so long before retiring, I didn't think much about bonds. I just assumed that my decision to be a passive index investor would carry over to bonds. But I realize now that these markets are different. There is much less uncertainty with bonds. This makes it much easier to detect extreme situations.

      In some ways I'm avoiding market timing by deciding that I don't want to own something for 5 minutes that I wouldn't hold for decades. This was the situation with long term bonds two years ago. Maybe these conditions will never happen again. Who knows?

      I find it much easier to see the craziness of going into debt for 7 times a couple's combined income.

    2. Agreed. So the timing question now becomes, whether to switch out of long term bonds at this time? Some long term bonds at this level might actually make some sense (a fund like VAB is only a portion long term anyway).

    3. As I see it, holding long-term bonds to maturity at current rates isn't obviously a bad idea. So, I'm not spending any time trying to guess whether to be adjusting the duration of my fixed income holdings.