The TSX average yield is roughly 3 per cent, or better than the rate of inflation.Mark Blinch/Reuters
Stocks go up and down, but alarm bells really started to go off when the Toronto Stock Exchange's S&P/TSX composite index briefly fell below the 12,000 mark this week.
That left the TSX back to roughly where it was 10 years ago. For Canadian investors, it's a grim reminder of a lost decade.
Stocks will inevitably rebound, as they did in a big way Thursday and Friday.
More troubling, and much less discussed, is what's happening in the fixed-income market. Yields on 10-year Government of Canada bonds hit an all-time low this week, before recovering a bit Friday to sit at 1.25 per cent.
With inflation running at 1.4 per cent a year, the real rate of return on these ultrasafe bonds is actually negative – as it has been for most fixed-income securities for some time.
That means Canadians are actually losing money when they play it safe.
There are, of course, dividend-paying stocks. The TSX average yield is roughly 3 per cent, or better than the rate of inflation. But that is still a pretty slim return.
Low-for-long has become the new interest-rate reality for Canadians. This has profound implications for savers, retirees, as well as the financial institutions that are contractually bound to make fixed payouts, such as pension funds and insurance companies.
Many retiring Canadians will have to get by with much less than they had banked on.
"This effectively means that many seniors have under-saved, and pension funds that have to pay out defined benefits are realizing that they are seriously underfunded," said macreconomist Steven Ambler, a professor at the Université du Québec à Montréal. "A lot of individuals and pension fund managers are being pushed to take on risks that they weren't planning on bearing in order to increase the expected rate of return."
The Canada Pension Plan Investment Board (CPPIB), the largest pension fund in the country and the manager of the Canada Pension Plan's portfolio, has tried to compensate for diminished returns by investing more in infrastructure projects and real estate.
The CPPIB is big, and takes in a steady and dependable flow of CPP contributions. It can afford to be patient, and assume more risk.
Many insurers and private-sector pension funds aren't so fortunate. They have much less wiggle room in the current interest rate environment, forcing them to make even riskier financial bets.
"For defined benefit pension plans, if the realized return is inadequate to meet future liabilities, there will be difficulty in making targeted payments to plan participants, or, in the worst case, there could even be a solvency problem," Prof. Ambler and economist Craig Alexander warned in a recent C.D. Howe Institute report.
The Bank of Canada has also been keeping a close watch on pension funds and insurers, looking for evidence of risky behaviour that might endanger the financial system.
When interest rates fall, pension funds and insurers face a squeeze between the rising value of their current liabilities and the declining value of their assets.
Low interest rates have also sent a clear signal to Canadians – to pile on more debt, and stake more of their financial futures on the value of their homes.
"The period of low interest rates has provided the inducement for them to take on excessive debt," said economist Paul Masson of Weatherstone Consulting. "And it has added to the demand for certain assets, such as real estate, where a correction is likely."
The low rate environment doesn't appear to be going away any time soon.
Prof. Ambler and Mr. Alexander estimated that the real return on risk-free investments, such as government bonds, could hover at, or even below, 1 per cent for the next couple of decades.
In Canada, the long-predicted return of higher rates still seems a long way off.
This week, the Bank of Canada opted not to cut its benchmark lending rate, and still appears more likely to lower rates than raise them in the months ahead. Bank of Canada Governor Stephen Poloz acknowledged this week that the economy won't likely return to full capacity until late 2017, and perhaps later.
Retirement could be surprisingly meagre for many Canadians.