When Canadian inflation goes up unexpectedly, that is bad for an investor. Though rates have generally been quite stable within the Bank of Canada's target 1-3% range for the last 20 years, data back to the early 1950s shows periods of big jumps and high inflation, such as the chart below from Global-Rates.com. RetailInvestor.org has another chart going back to the 1870s in his discussion of inflation risk. It show huge swings between high inflation and deflation.
Rampant, totally out-of-control inflation can have the same effect as outright default. The chart below from the Credit Suisse Global Investment Returns Yearbook 2011 shows the devastating impact of hyper-inflation on bonds amongst major European countries of France, Italy, Germany and the UK during the 20th century.
It wasn't just inflation that experienced large swings in the past. An investor in US securities would also have been affected by the shifting value of of the US dollar against the Canadian dollar. Investments in non-US foreign securities, which have become ever more popular and accessible through funds and ETFs in the last quarter century, would also have been strongly affected by the movement of the Canadian dollar against many foreign currencies.
The Oanda website, from which the chart below is copied, shows Historical Exchange rates for major foreign currencies going back to the early 1950s. Retail Investor.org has a chart on this page for the US vs Canadian dollar back to 1925. These charts show major shifts and upward /downward movements lasting decades, which might, at first glance, be thought to depress returns for the Canadian investor caught on the wrong side of the long term trends.
In a summary of the renowned book Triumph of the Optimists by the same authors as the Credit Suisse Yearbook, the CXO Advisory blog notes that once exchange rates and local country inflation are netted out the real equity return is what counted most and "local exchange rate fluctuations have not presented a significant disincentive to diversifying internationally in equities over the long term".
Including both Inflation and Currency, what were the worst returns for a Canadian investor?
The best available free online resource for seeing the combined effect of inflation and currency for the Canadian investor appears to be Stingy Investor's Asset Mixer. By filling in 100% allocations to each asset class in turn, it is possible to see how each fared over the maximum period of available data. Results are in real-after inflation Canadian dollars and assume no fund fees, which we will look at separately in a future post.
- Worst drop 1971 -11.6%, recovery 11 years
- Total down years 9 / 41 or 22%
Canadian Bonds 1970 to 2010
- Worst drop 1980 -10.9%, recovery 2 years
- Total down years 5 / 41 years or 12%
- Worst drop 1973 -39.6%, recovery time 6 years
- Total down years 13 / 41 or 32%
- Worst drop 2003 - 26.9%, still recovering; next worst 1972 -25.5% recovery time 12 years
- Total down years 17 / 40 or42%
- Worst drop 2000 -49.7%, still recovering 11 years later, next worst 1973 -49.1%, recovery time 10 years
- Total down years 13 / 41 or 32%
Developed World Stocks EAFE 1970 to 2010
- Worst drop in 1973 -45.8%, recovery time 5 years, next worst 2000 -42.1%, still recovering
- Total down years 14 / 41 or 34%
- Worst drop in 2008 -43.1%, still recovering, next worst 2000 -35.6%, recovery time 5 years
- Total down years 8 / 23 years or 35%
Bottom Line: Currency and inflation contribute to return downside over periods of up to a decade. The investor must be able to exercise patience.
Disclaimer: this post is my opinion only and should not be construed as investment advice. Readers should be aware that the above comparisons are not an investment recommendation. They rest on other sources, whose accuracy is not guaranteed and the article may not interpret such results correctly. Do your homework before making any decisions and consider consulting a professional advisor.