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Don't Buy Bonds... Buy This 8% Investment Instead

By Tom Dyson, publisher, The Palm Beach Letter
Monday, September 27, 2010

Some people buy bonds that yield nothing...
 
Each week, investors are pouring billions of dollars into bond funds and pulling billions out of stock funds. In the latest week on record, for example, investors put almost $8 billion into bonds and withdrew $3 billion from stocks. So far this year, investors have dumped more than $200 billion into bond funds... Experts expect the total to reach $250 billion by year-end.
 
These are by far the largest inflows into bond investments in the history of finance.
 
The deluge of money into bonds has pumped up bond prices and pushed bond yields to ridiculously low levels. IBM recently issued corporate bonds with a yield of 1%, for example.
 
 
The madness is even worse in the government bond markets. Despite the government's obviously precarious financial position, billions of dollars have poured into government bonds, which has flattened yields. The Treasury bill, for example, pays no interest whatsoever. The two-year Treasury pays just 0.5%.
 
While other folks pump money into bonds that pay nothing, today I'm going to show you how to buy an investment that yields 7.2%. Unlike regular "fixed" bond payments, the yield on this investment is predicted to rise 16% in 2011, to around 8.4%.
 
There have only been two previous times in the last 50 years when this investment has yielded so much compared to government bonds. Both times, there was a huge rush of money into this investment, causing it to rise in price by at least 33%...
 
So what is this investment? I'm talking about the S&P 500 stock index. Compared to bonds, the S&P has as high an earnings yield as it's had in the last 50 years.
 
To calculate the yield on a bond, you divide its annual cash payout by its price. Take the IBM bond I mentioned above as an example. It pays $1 per year in interest and it trades for $100 in the market. You get annual interest of 1%.
 
While interest is the reward for bondholders, profit is the reward for shareholders. If you divide a company's annual profits by its price, you get the earnings yield. Right now, IBM produces $10 a share per year in profit, and a share of IBM trades for $130. IBM has an earnings yield of 7.7%.
 
You can do the exact same calculation for a stock market index like the S&P 500. You simply add up the annual profits of the index and divide by the index value. In 2010, analysts expect the S&P to produce $83 in profits. The current value of the S&P 500 is 1,145. So the S&P 500 has an earnings yield of 7.2%.
 
According to Bloomberg, analysts expect the S&P 500's profits to rise 16% in 2011 to $96... which is an earnings yield of 8.4% on today's price.
 
Russell Napier is a famous stock market historian. According to Napier, the gap between bond yields and stock yields has only been as wide as it is today twice in the past 50 years... in July 1974 and June 1979. Each time marked the beginning of a sharp rally in the stock market.
 
Between June 1974 and February 1976, stocks rose 47%. Between June 1979 and April 1981, stocks rose 33%.
 
The conclusion is simple. Right now, investors are pouring money into bond funds, even though they're getting the worst deal in history. Meanwhile investors are pulling money out of stock funds, even though stocks are offering one of the best deals of the last 50 years.
 
So what are the best stocks to buy if you're looking for a large earnings yield? Here at DailyWealth, we like large-cap tech stocks like Intel, Cisco, and Microsoft. These three stocks have earnings yields around 10% right now.
 
If the stock market bounces like it did in 1974 and 1979, big tech stocks should soar with it... And they all have large cash balances and recession-resistant businesses to keep you safe in case the bear market returns.
 
Good investing,
 
Tom




Further Reading:

"You want to buy what's cheap and sell what's dear," Steve recently reminded DailyWealth readers. "That's how you make money investing." And both Tom and Steve think bonds are way too dear right now. If you own bonds, you're looking at a gruesome worst-case scenario. Get the details here: Why Are You Buying a Stinkin' Bond Fund Now?
 
Not every bond is a bad deal, though. Last month, Tom told readers to consider investing in one of the 1,000 or so "stock market bonds." You should have no trouble finding safe bonds issued by cash-rich companies yielding anywhere from 6% to 9%. Learn where to look here: The Safest Source of High Income Today.

Market Notes


NEW HIGHS OF NOTE LAST WEEK
 
Gold, Silver... we told you so
Barrick Gold (ABX)... giant gold miner
Newmont Mining (NEM)... giant gold miner
Randgold Resources (GOLD)... giant gold miner
Silver Wheaton (SLW)... silver royalties
Pan American Silver (PAAS)... silver miner
Keegan Resources (KGN)... gold exploration
Rare Element Resources (REE)... rare element exploration
Anheuser Busch InBev (BUD)... beer
Kraft (KFT)... manufactured food
Netflix (NFLX)... movies at home
Apple (APPL)... dominating the world
Amazon (AMZN)... online retail
Oracle (ORCL)... software
New Oriental Education (EDU)... China trade is on
China Southern Airlines (ZNH)... China trade is on
Corn, Soybeans, Cotton, Orange Juice

NEW LOWS OF NOTE LAST WEEK
 
Not many... it's a bull market!

In The Daily Crux



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