How to Avoid the Approaching Bond Market Debacle
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April 30, 2012
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By William Patalon III, Executive Editor, Money Morning
If you're an income investor, you probably feel like you're in one of those nightmares where you're trying to run like hell - but aren't getting anywhere.
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Martin Hutchinson and I were talking about this predicament last week.
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As editor of the Permanent Wealth Investor, Martin is our income guru here at Money Map Press. His advice on how to thrive in this lousy-income environment was so good that I had to pass it along to you - along with one of his favorite income plays.
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Traditionally, bonds - especially U.S. Treasury bonds - are the favored holding of income-seekers. But bonds face two big challenges right now - and we have the U.S. Federal Reserve to thank for both of them.
.
Martin Hutchinson and I were talking about this predicament last week.
.
As editor of the Permanent Wealth Investor, Martin is our income guru here at Money Map Press. His advice on how to thrive in this lousy-income environment was so good that I had to pass it along to you - along with one of his favorite income plays.
.
Traditionally, bonds - especially U.S. Treasury bonds - are the favored holding of income-seekers. But bonds face two big challenges right now - and we have the U.S. Federal Reserve to thank for both of them.
.
First, thanks to the ultra-low-interest-rate policies of the nation's central bank, Treasury bonds are yielding next to nothing. When I looked Friday afternoon, the 10-year was yielding 1.94% and the 30-year 3.12%.
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Now, according to the latest federal figures, the U.S. consumer price index (CPI) fell to 2.7% in March from 2.9% in February. The CPI is the "official" gauge of U.S. inflation. But as we explained back on March 2, this is a bogus number.
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The American Institute for Economic Research (AIER) says everyday prices - the ones that matter most to working Americans - are up a good 8% over the past year.
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So income investors who stick to traditional tactics are actually losing ground to inflation. And you absolutely don't want to outlive your money.
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If that were the only problem, it would be pretty bad. But there's a second challenge - and it's a doozy.
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You see, the central bank's Federal Funds rate - the benchmark that helps determine most borrowing rates that American consumers and businesses pay - remains down near zero. And while no one can predict with certainty when rates will change, there is one thing you can bank on: When rates do change, they can only go up.
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And since bond prices move opposite interest rates (bond prices fall when rates rise, and vice versa), those fixed-income securities will take a beating when rates increase.
And so will the investors who hold them.
.
Now, according to the latest federal figures, the U.S. consumer price index (CPI) fell to 2.7% in March from 2.9% in February. The CPI is the "official" gauge of U.S. inflation. But as we explained back on March 2, this is a bogus number.
.
The American Institute for Economic Research (AIER) says everyday prices - the ones that matter most to working Americans - are up a good 8% over the past year.
.
So income investors who stick to traditional tactics are actually losing ground to inflation. And you absolutely don't want to outlive your money.
.
If that were the only problem, it would be pretty bad. But there's a second challenge - and it's a doozy.
.
You see, the central bank's Federal Funds rate - the benchmark that helps determine most borrowing rates that American consumers and businesses pay - remains down near zero. And while no one can predict with certainty when rates will change, there is one thing you can bank on: When rates do change, they can only go up.
.
And since bond prices move opposite interest rates (bond prices fall when rates rise, and vice versa), those fixed-income securities will take a beating when rates increase.
And so will the investors who hold them.
.
.
To avoid the pounding of this inevitable "Whac-a-Mole" bond market, Martin suggests that income investors use higher-yielding dividend stocks as a partial replacement for bonds.
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However, don't necessarily pursue the "blue chips" that are yielding 2.5% to 3.5%. Martin cautions that those shares have already been bid up by other income-seekers and now trade at expensive premiums. That means these stocks are trading at pretty high valuations, and are inherently more risky as a result.
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Instead, go for the next tier - the shares of companies with dividend yields high enough to make a real difference in your pocket.
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One such play that Martin has recommended both to Permanent Wealth Investor and Private Briefing subscribers: Safe Bulkers Inc. (NYSE: SB), a global shipper with a 9.12% dividend yield.
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As the company's name tells us, Safe Bulkers is a player in the international dry-shipping market. That market has been struggling - in fact, it has suffered through the biggest slump in rates in more than a decade.
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But here's the great part: In response to that slump, ship owners are now anchoring the most commodity carriers since 2008. That should lead to the biggest jump in shipping rates in three years - which could send Safe Bulkers shares up more than 30%.
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"Bill, this stock is cheap," Martin told me in a private briefing this week. "Safe Bulkers has a trailing P/E of 4.9 and forward P/E of 4.3, and trades at a modest premium to book value. The yield is significant, but the dividend being more than twice covered, based on trailing earnings. The combination of price, earnings and the high-dividend yield makes this an exceptional value in these markets."
To avoid the pounding of this inevitable "Whac-a-Mole" bond market, Martin suggests that income investors use higher-yielding dividend stocks as a partial replacement for bonds.
.
However, don't necessarily pursue the "blue chips" that are yielding 2.5% to 3.5%. Martin cautions that those shares have already been bid up by other income-seekers and now trade at expensive premiums. That means these stocks are trading at pretty high valuations, and are inherently more risky as a result.
.
Instead, go for the next tier - the shares of companies with dividend yields high enough to make a real difference in your pocket.
.
One such play that Martin has recommended both to Permanent Wealth Investor and Private Briefing subscribers: Safe Bulkers Inc. (NYSE: SB), a global shipper with a 9.12% dividend yield.
.
As the company's name tells us, Safe Bulkers is a player in the international dry-shipping market. That market has been struggling - in fact, it has suffered through the biggest slump in rates in more than a decade.
.
But here's the great part: In response to that slump, ship owners are now anchoring the most commodity carriers since 2008. That should lead to the biggest jump in shipping rates in three years - which could send Safe Bulkers shares up more than 30%.
.
"Bill, this stock is cheap," Martin told me in a private briefing this week. "Safe Bulkers has a trailing P/E of 4.9 and forward P/E of 4.3, and trades at a modest premium to book value. The yield is significant, but the dividend being more than twice covered, based on trailing earnings. The combination of price, earnings and the high-dividend yield makes this an exceptional value in these markets."
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