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Super Safe Bonds That Yield 6%-10%By
Saturday, August 28, 2010
There's a tremendous bubble forming in the bond markets.
I'll give you some examples of this madness in a second. I'll also show you the best way to buy bonds... including a kind of super-safe bond paying 8% income right now.
First, let me explain what's going on...
When you buy a bond, you're making a loan to the issuer of the bond. A Citigroup bond, for example, represents a loan to Citigroup. This is a totally different transaction from buying Citigroup stock.
When you buy stock, you become an owner of the company. You can vote on management decisions, you're invited to the annual meeting, and most importantly, you're entitled to a share of the company's profits, if it decides to distribute them.
When you buy a bond, you have none of these rights. You're a lender. You earn interest. When the loan period is up, you receive your money back in full. If the borrower fails to meet either of these obligations, you force it into bankruptcy.
When the economy is booming, generally speaking, you want to own stock. Markets expand and businesses make larger profits. Companies return these profits to shareholders as large dividends. Shareholders get rich.
When the economy is shrinking, companies cut their dividends, but bonds keep paying interest. Share prices fall, but bondholders still get their capital back in full (assuming the borrower doesn't go bankrupt). Shrinking economies often cause deflation, too. Overcapacity causes credit to contract and prices to fall. Deflation exaggerates bond yields.
In other words, in recessions, you want to own bonds.
Right now in America, the economy is in terrible shape. Every day, a new economic report comes out showing how slow the real estate market is, how high unemployment has risen, or how depressed economic growth has become. Outright price deflation hasn't been more likely since the Great Depression.
The stock market has burned investors with big declines and the highest volatility in decades. Investors are fleeing stocks. Income and safety are king in recessions, so investors are buying any bonds they can find, from government bonds to corporate bonds. They're even buying junk bonds, the riskiest of all.
When investors pile into bonds, their prices rise. Rising bond prices drive bond yields lower. The worse the news about the economy gets, the more money investors rush into bonds. To give you some examples...
Last week, the two-year Treasury note hit an all-time low of 0.49%. With a yield of 0.49%, you're paying $204 to earn one dollar in annual income. If this Treasury bond were a company, analysts would say it has a price-to-earnings ratio of 204 – outrageous.
Yields on 10-year Treasury are currently 2.60%... and approaching their all-time lows of 2% from December 2008. This is the rough equivalent of paying 38 times earnings. You only want to buy a stock at that level if earnings are growing tremendously. But if you buy a Treasury note, your coupon will never grow.
Yields on bonds issued by companies have also moved to all-time lows. According to Deutsche Bank, the top 10 lowest-yielding corporate bond deals in history all occurred in the last 14 months. Johnson & Johnson broke the record for 10-year bonds earlier this month. It issued 10-year bonds at 2.95%. A week earlier, IBM issued three-year bonds at 1%.
If you think these yields are bad, consider how bond-fund investors are faring...
Remember the Internet bubble and the big boom in stocks at the end of the millennium? In 1998 and 1999, investors poured $497 billion into stock mutual funds.
Over the last two years, investors have poured virtually the same amount into bond funds. According to Bloomberg, between June 2008 and June 2010, investors added $480 billion to bond mutual funds.
Bond funds offer the same low yields as the individual bonds I mentioned above, but as my colleague Steve Sjuggerud points out, they also charge management fees from 0.75% to 1.5%. These are huge fees for funds that may only yield 3%.
Here's the thing: As low as yields are, I still love the income and safety of bond investments. I'd never recommend these bond funds, though... or any of the corporate and Treasury bonds most other investors are buying.
Instead, I've been recommending preferred stocks. I've found they're just as safe as the bonds everyone else is buying, but because most investors don't understand them, they have income yields that are much higher. My 12% Letter readers are earning an average 7% yield on our preferred stocks.
If you want a quick overview of preferred stocks, read my essays here and here. And on Monday, I'll show you one of my favorite preferred stocks. It was issued by one of the most rock-solid companies in the country. And right now, it's yielding a guaranteed 8%.
Good investing,
Tom
Further Reading:
Earlier this week, Steve warned DailyWealth readers against stocking their money in bond funds. The high management fees are one problem... but there's another big issue that could shrink your $10,000 investment into just $8,200 in as little as 12 months. "The miniscule interest" he writes, "is not worth the horrible risks." Learn how to protect yourself here: Why Are You Buying a Stinkin' Bond Fund Now?
Tom likes preferred stocks as an alternative to low-yield bonds. But Doc Eifrig has a different solution... He's telling his readers to buy what he calls "retirement stocks" – stocks that yield at least 5%, paying safe and growing dividends. His favorite retirement stock has raised its dividend 42 years in a row. Get the stock's name and details here: Don't Buy Bonds Now... Buy These Instead.
Market NotesCHART OF THE WEEK: THERE ARE NO BARGAINS IN GOLD THIS YEAR This week's chart is a picture that has frustrated lots of gold bargain hunters. It shows the past year's trading in gold.
Gold is one of the world's most volatile assets. It is impossible to accurately value. You can't say "I'll pay 10 times earnings" for gold like you would with a stock. You can't say "I'll pay eight times annual rent" like you would with a property. Gold tends to trade on wild swings in investor fear.
That's why many seasoned investors expected gold to endure a substantial correction after its massive 2009 rally... or after its similar rally this year. They expected to add to their gold holdings well off the short-term high... at short-term bargain prices.
But as you can see from this week's chart, there's no gold bargains to be had this year. Gold is not suffering natural selloffs after rallies. Instead, small price declines now trigger huge buying interest from Asia, the Middle East, and giant institutional investors... folks who want to diversify assets out of paper and into "real money." For those looking to buy more gold, we say, don't worry much about the current price... just keep accumulating ounces.
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Stat of the week
21%
Percent of individual investors who say they are bullish right now, according to the widely followed American Association of Individual Investors (AAII)... one of the gloomiest readings in five years. In The Daily Crux
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