Valeant, Bombardier Even Worse Than Energy in Canadian Bond Rout

  • High-yield performance trails the rest of the developed world
  • Here comes a housing bubble to add to commodities woes

Canada’s bond market has been ravaged by the global commodities rout. So when a drugmaker and an aerospace company join the misery with even bigger losses, investors can’t be blamed for rushing to the exits.

Turmoil with market heavyweights Valeant Pharmaceuticals International Inc. and Bombardier Inc. has helped push Canadian high-yield bonds to their worst performance since 2008. They trail the returns of their Group of 10 industrialized peers this year, with further risks still ahead.

The bulk of the losses stem from a collapse in commodity prices, including crude oil, as China’s growth slows and the world’s second-largest economy shifts from debt-intensive capital spending toward domestic consumption and services. Add to that the trouble at Valeant and Bombardier, as well as a potential housing bubble and an interest-rate hike by the U.S. Federal Reserve, and the economic headwinds just keep coming for Canada.

"This will likely remain a more difficult environment for some time, from both an economic and investment perspective for Canada," said Eric Lascelles, chief economist at Royal Bank of Canada’s RBC Asset Management unit. "I don’t think we’ve freely and nimbly emerged from this experience just yet."

‘Suffering More’

Investors in Canadian high-yield bonds have lost 3.7 percent year to date, compared with an average positive return of 2.8 percent among the Group of 10 industrialized countries, according to the Bank of America Merrill Lynch Global High Yield Index. And although energy companies and miners make up the majority of Canadian issuers, Valeant and Bombardier have caused the most pain for investors.

Valeant, the Laval, Quebec-based drug-maker at the center of a pricing scandal and shareholder battle-of-words featuring billionaire Bill Ackman, has lost 12.6 percent this year. Bombardier, the Montreal-based plane and train manufacturer that has long stood as a national champion, dropped 12.4 percent amid ballooning costs from an oft-delayed new jetliner.

"The Canadian high-yield market and the Canadian economy are two peas in a pod right now, in the sense that the Canadian economy is suffering more than most of its G-10 peers as is the high-yield space," Lascelles said.

Bubbling Up

Signs of a growing bubble in Canadian housing are also weighing on foreign investor sentiment, said Benjamin Tal at CIBC World Markets Inc. Canada Mortgage and Housing Corp. reported in October that there was strong evidence to suggest the housing markets in Toronto and Montreal are overvalued, with a moderate risk of overvaluation in Vancouver, Edmonton and Saskatoon.

"It’s still a major factor impacting the psyche of investors outside Canada," CIBC’s deputy chief economist said from Toronto. American investors are expecting a correction in housing prices. he said, because they went through one.

And then there’s the Fed. Stronger-than-forecast U.S. jobs numbers have put the prospect of an interest-rate hike in December back on the table, and such a move would weigh on high-yield bonds for the next year if commodity prices don’t improve by 10 percent to 15 percent, Tal said.

"In the U.S., there’s the constant fear that Fed will raise, which is a negative," he said.

Outperform Equities

Richard Kos, a high-yield portfolio manager at Manulife Asset Management Limited, said he is among those exposed to energy and mining issues (he said he’s avoided Bombardier for three to five years). Still, there remain opportunities for high-yield investors in non-commodity names, especially in financials and food, he said.

"Throughout the many crises there have been over the last 20 years, high yield has always emerged -- not unscathed, but it has shown itself to be a good source of total return," he said. High-yield bonds have outperformed equities this year and are still a good source of diversification and yield in a low-rate environment, Kos said.

Ultimately, Canada’s reliance on its energy industry ties it to global markets and puts it at the mercy of Chinese demand, said CIBC’s Tal.

"We are a small, open economy, and we are linked to the commodity market," he said. "When China is slowing down, that’s clearly a factor that impacts Canada much more than it impacts the U.S."

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