You're not as safe from the crashing bond market as you think. You may be familiar with the "butterfly effect" -- the idea that a small event like the flapping of a butterfly's wings can cause a hurricane half a world away. But the United States bond market is the opposite of the butterfly. The bond market is the hurricane that influences nearly everything else in the financial world. Everything else is a relative butterfly in comparison.
Frankly, I'd be shocked if you purchased any long-term bonds in the recent past. I've been telling people for the past few years to avoid long-dated bonds entirely. But if you think you're insulated from the bond market simply by avoiding the bond market, you're dangerously mistaken. Treasury yields are the benchmark for every other interest-bearing security in the world. It's impossible to underestimate the magnitude of sharp moves in the bond market.
For a small example of what I mean:
Every bond issuance from every corporation, state, country, and municipality is dependent on the Treasury benchmark. I've been watching a bond debate in a local town here in Vermont -- and it really illustrates the Treasury's influence. Waterbury, Vt., a town of just over 5,000 people, is weighing the pros and cons of issuing a municipal bond to pay for new construction. One of Waterbury's town managers Bill Shepeluk was quoted in the The Waterbury Record about the issue:
Shepeluk believes that both interest rates and the cost of construction are likely to go up over the next year. ‘If the economy heats up at all, two things happen, building costs go up and interest rates go up.'
Shepeluk is pushing for the town to take advantage of low interest rates today -- to decrease long-term borrowing costs. That's just a small example of what's happening on a global scale. Millions of businesses, governments, and individuals pay attention to the Treasury bond yield as a major factor determining whether they'll borrow to build a new municipal building, buy a new house, raise or lower taxes, put money away for their children's education -- and much more. And that's to say nothing of the Federal deficit and what the effect of long-term "easing" (aka, money printing) will be on the economy over the coming decades.
But the investment implications are somewhat more urgent. Today, bond yields are still relatively low -- meaning that dividend stocks remain an attractive alternative to traditional income investments like corporate bonds and savings accounts. With yields ticking higher, you may want to keep a close look at your dividend holdings. Which companies do you currently own that will be hurt by higher Treasury yields? Which of your investments is yield-sensitive?
Those are the kinds of questions you should ask yourself -- but I also caution against dumping all of your investments at this point. Though rates have risen dramatically (1.7% to 2.6% on the 10-year Treasury since May), I'd expect them to be drop before they rise much further. The historical average yield for the 10-year Treasury is closer to 5% -- so yields would need to double from current levels just to hit "normal" levels.
I believe there's still plenty of upside for dividend stocks and other income alternatives. I'm urging the readers of my paid publications to keep an eye on their trailing stops, and to cut losers -- but my main belief is that the dividend stock boom is far from over.