Saturday, July 21, 2012
U.S. bond prices have risen for the past 30 years... The 10-year Treasury now yields less than 1.5%. Most people buy bonds for income. And the yields they receive today are dismal. But investors continue rushing for the perceived safety of sovereign debt. (U.S. Treasurys are viewed as virtually risk-free – the ultimate safe-haven asset – since the dollar is the world's reserve currency.) People are scared and irrational.
Stocks are much cheaper than bonds today. And in many cases, offer better yields. (Blue chips like semiconductor giant Intel and giant cigarette-maker Altria yield 3.2% and 4.6%, respectively). But stocks have plenty of room for upside.
Bonds, on the other hand, are "zero bound." In other words, yields shouldn't go below zero since a negative yield would mean investors were literally paying to hold a borrowers debt. And since bond prices move in the opposite direction as the yield... a downside limit on bond yields should also constrain potential capital gains.
And with yields so low, bonds don't have much room for capital appreciation. As "Bond King" Bill Gross – who manages the world's largest mutual fund, the PIMCO Total Return Fund – wrote for the Financial Times in February:
As Gross points out, bonds have far more downside (increasing yields) than upside today. Still, investors are pouring money into fixed income.
Currently, six countries have negative yields on government bonds maturing in two years or less – Germany, Denmark, Finland, Switzerland, the Netherlands, and Austria. (Denmark and Switzerland are outside of the European monetary union.)
And this week, investors accepted negative yields on two-year German bonds at the primary auction. The average yield on the 4.2 billion-euro bond sale was negative 0.06%.
Switzerland's two-year bond has the lowest yield at negative 0.55%. Why do investors pay to own these bonds when there's little room for capital appreciation?
Some strategists think it's a currency play... Investors will stomach a small, negative yield for the potential of currency appreciation should the euro disband (or should certain countries leave the euro). The money they're parking in government bonds would then be revalued with a stronger currency.
It's like hedge funds buying credit default swaps (insurance contracts on debt that pay out in case of default) leading up to the subprime crisis... It's a negative-carry trade, meaning losses are guaranteed, but finite. As we saw during the crisis (when hedge-fund managers like John Paulson made hundreds of percent), the upside can be huge.
Yields on government debt could always go lower – markets can stay irrational for a long time. But our money's on stocks. Take Dr. David "Doc" Eifrig's Big Pharma recommendations, for instance. Abbott Laboratories, Johnson & Johnson, Eli Lilly, and Pfizer all traded at 52-week highs this week. Doc has all but Pfizer in his Retirement Millionaire model portfolio.
DailyWealth Trader co-editors Amber Lee Mason and Brian Hunt discussed the uptrend in these stocks in Wednesday's issue...
Doc's Retirement Millionaire portfolio is loaded with high-quality companies paying huge, healthy dividends. In his most recent issue, Doc added another high-quality, high-yielding stock to the list...
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This company has grown earnings 50% since 2008. But its shares are 33% below their peak price in mid-2008. The company trades for less than sales and less than two times free cash flow. And it pays a safe, 3% dividend. Since 2007, it's increased the dividend nearly 65%.
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Date Range:7/12/2012 to 7/19/2012
Date Range:7/12/2012 to 7/19/2012