As the market declines and fear sets in, there has been a pronounced movement from equities to bonds. This cash in-flow has helped fuel higher bond prices and lower interest rates. For some portfolios, bonds have been one of the few positives over the last 24 months. Is it possible that bonds are the next big bubble to burst?
Jeremy Siegel certainly thinks so based on his recent Wall Street Journal article The Great American Bond Bubble. In the article, he opined that the bond bubble may have far more serious consequences for investors than the internet and technology bubble that burst some 10 years ago. The Nasdaq has yet to recover those losses as it is currently selling at less than half the peak it reached a decade ago.
The longer a bond’s maturity, the more volatile its price. Thus, long and intermediate bonds stand to lose substantially when rates reverse, as noted in the aforementioned article:
If over the next year, 10-year interest rates, which are now 2.8%, rise to 3.15%, bondholders will suffer a capital loss equal to the current yield. If rates rise to 4% as they did last spring, the capital loss will be more than three times the current yield. Is there any doubt that interest rates will rise over the next two decades as the baby boomers retire and the enormous government entitlement programs kick into gear?
Over the next several months I plan to move my bond allocation to those with shorter duration and redeploy excess allocations into quality blue-chip dividend stocks that are yielding in excess of my bond holdings. Consider these dividend stocks that have a current yield in excess of 2.8%:
|Pepsico, Inc. (PEP)||2.88%||9.01%||38|
|Procter & Gamble (PG)||3.20%||6.96%||54|
|ADP, Inc. (ADP)||3.37%||5.47%||34|
|Chevron Corp. (CVX)||3.64%||5.95%||23|
|Harleysville Grp (HGIC)||4.17%||8.00%||24|
|Leggett & Platt (LEG)||5.04%||2.96%||38|
|AT&T, Inc. (T)||6.12%||2.44%||27|
Let me be clear, I am not predicting the imminent collapse of long-term bonds. As an investor (not a trader), I am not in the prediction business. However, I believe we have reached a point where there is much more to lose than gain by holding long-bonds. Interest rates will eventually rise and for those holding long-term bonds, it will have painful implications.
Disclosure: Long PEP, MCD, PG, ADP, JNJ, CVX, KMB, HGIC, LEG, T. See a list of all my income holdings here.