The end of the road for XBB

The iShares CDN Bond Index Fund (XBB) consists of about 300 investment-grade Government of Canada, provincial, corporate and municipal bonds. Federal bonds make up about 46%, provincial bonds make up about 24% and corporate bonds make up about 30%. The weighted average term to maturity is 8.58 years, the weighted average coupon is 5.18%, the weighted average yield to maturity is 3.27% and the weighted average duration is 5.87 years.
On March 30, 2009 XBB closed at 29.20 and today it is trading at about that price. Worst case scenario you would have collected a 5% coupon. Over the last year, the price of XBB has fluctuated between $28.86 and just above $30, mostly above the 200 day moving average however it’s time appears to have been equally split above and below the 50 and 100 day moving average. Today the price is well below its 200-day moving average. It is interesting to see that the 200-day moving average has increased since last March, which is viewed as a positive trend. Of late the technicals are bearish from a moving average, relative strength and MACD perspective. On the other hand, this could also be setting up to be an oversold position if we get more fear in the markets.

The fundamentals do not look particularly strong for XBB. Most economists expect interest rates to rise in Canada within the next year due to inflation. In a speech to the Ottawa Economics Association, Mark Carney agreed that inflation is running higher than predicted. In addition a Bloomberg article “Swaps jump as job gain signals central bank move: Canada Credit” reported that “The one-year overnight index swap rate, a security based on what investors expect the central bank’s rate will average over that period, advanced 4 basis points, or 5.8%, to .725 on March 12…. solidified bets for the first bank move in July”.

Canada may be ahead of the U.S. but we will also be impacted by what happens in the U.S. so it is worthwhile looking at what is happening there. According to US Global Investors in advisoranalyst.com, U.S. Treasury bond yields rose this week with long term yields hitting the highest levels since last summer and Treasury supply continues to hit the market with $118 billion auctioned this week. Credit Suisse put out in their chart of the day “Bond Investors Wary of Rising Rates”, “the ever-lasting flow of funds into bond mutual funds has left market-watchers to wonder why, given increasing inflation expectations…much of the new money has actually been going into TIPS and short term bond funds. At the same time, long term bond funds have been the least popular since 2008.” BCA Research confirms this point that “TIPS have enjoyed a long run of out performance.” That being said, in the short term BCR Research’s view is different on inflation expectations in the U.S.

An increase of 1% in the interest rate will wipe out the coupon i.e. reduce the price of XBB by 5.87%. With interest so low, you may want to avoid jumping into this vehicle or getting off at the next stop because the end of the road may be near.