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Big Yields In A Low-Rate Environment
Market fear is again overcoming investors. The yield on the U.S. 10-year bond continues to drop as investors race into "safer" fixed-income securities to avoid the volatility of equity markets. Yet these investors who feel safe hiding behind fixed-income securities offering historically low interest rates may be susceptible to more risk than they realize. (To help you measure and understand the risk involved, read Use Duration And Convexity To Measure Bond Risk.)
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A Decade of Regret
Today, U.S. 10-year bonds are yielding approximately 1.97%. Buyers are effectively saying that they are more comfortable earning a fixed annual return of 1.97% over the next decade versus investing capital elsewhere. While I have no crystal ball to see the future, my guess is that over the next 10 years, the U.S. could likely experience moderate to high inflation rates. In that case, those who felt comforted by a 2% annual return will wake up to a very painful reality when they realize the "hidden tax" levied by inflation. Not only that, but investors will look back with regret and wonder why they don't consider alternative high-yielding income options.
Obvious Options
In order to seriously consider owning 10-year Treasuries today, investors have to a have a convincing argument that better alternatives do no exist elsewhere with a similar degree of risk. Contrary to the notion that Treasuries are "risk free", they are anything but that when you factor in inflation. On the other hand, owning a name like Johnson and Johnson (NYSE:JNJ) is not as risky as investors perceive, especially if the security is held for 10 years. In the 100-plus year history of JNJ, its value has always grown over a rolling 10-year period. In fact, over the last 10 years, shares were up 22% while the S&P 500 was up 2.2%. Today, JNJ yields 3.6% - nearly double that of the 10-year Treasury.
ExxonMobil (NYSE:XOM), one of four companies with a AAA credit rating, is up over 70% over the past 10 years. Over the next decade, the company will likely be worth more than it is today. Shares today yield 2.6% for a AAA rated business. If you believe in the certainty of death, then Stonemor Partners (Nasdaq:STON), with a yield of 8.1%, may appeal to income-seeking investors. Stonemor is the second-largest owner and operator of cemeteries in the U.S. Penn Virginia Resource Partners (NYSE:PVR) manages coal and natural gas-producing properties. Demand for both coal and natural gas will likely grow over the next decade, especially if oil prices remain high. PVR shares yield 7.6%.
The Bottom Line
Buyers of Treasuries at today's ultra-low interest rates may likely be getting a false sense of security. Over a period of years, it's likely that carefully chosen dividend-paying stocks will provide a more attractive return by assuming minimal additional risk. (For more on interest rates, check out How Interest Rates Affect The Stock Market.)
Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!
Investopedia Markets: Explore the best one-stop source for financial news, quotes and insights.
A Decade of Regret
Today, U.S. 10-year bonds are yielding approximately 1.97%. Buyers are effectively saying that they are more comfortable earning a fixed annual return of 1.97% over the next decade versus investing capital elsewhere. While I have no crystal ball to see the future, my guess is that over the next 10 years, the U.S. could likely experience moderate to high inflation rates. In that case, those who felt comforted by a 2% annual return will wake up to a very painful reality when they realize the "hidden tax" levied by inflation. Not only that, but investors will look back with regret and wonder why they don't consider alternative high-yielding income options.
In order to seriously consider owning 10-year Treasuries today, investors have to a have a convincing argument that better alternatives do no exist elsewhere with a similar degree of risk. Contrary to the notion that Treasuries are "risk free", they are anything but that when you factor in inflation. On the other hand, owning a name like Johnson and Johnson (NYSE:JNJ) is not as risky as investors perceive, especially if the security is held for 10 years. In the 100-plus year history of JNJ, its value has always grown over a rolling 10-year period. In fact, over the last 10 years, shares were up 22% while the S&P 500 was up 2.2%. Today, JNJ yields 3.6% - nearly double that of the 10-year Treasury.
ExxonMobil (NYSE:XOM), one of four companies with a AAA credit rating, is up over 70% over the past 10 years. Over the next decade, the company will likely be worth more than it is today. Shares today yield 2.6% for a AAA rated business. If you believe in the certainty of death, then Stonemor Partners (Nasdaq:STON), with a yield of 8.1%, may appeal to income-seeking investors. Stonemor is the second-largest owner and operator of cemeteries in the U.S. Penn Virginia Resource Partners (NYSE:PVR) manages coal and natural gas-producing properties. Demand for both coal and natural gas will likely grow over the next decade, especially if oil prices remain high. PVR shares yield 7.6%.
The Bottom Line
Buyers of Treasuries at today's ultra-low interest rates may likely be getting a false sense of security. Over a period of years, it's likely that carefully chosen dividend-paying stocks will provide a more attractive return by assuming minimal additional risk. (For more on interest rates, check out How Interest Rates Affect The Stock Market.)
Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!
by
Sham Gad
Sham Gad is the Managing Partner of Gad Partners Fund's, value inspired investment partnerships modeled after the Buffett Partnerships of the 1950's. Previously, Gad ran the Gad Investment Group and delivered annualized returns of 22% from 2002 to 2005. Gad is also the author of "The Business of Value Investing" which will be out in the fall of 2009. Gad earned his MBA at the University of Georgia in May of 2007. Gad runs a value investing blog. He can also be reached by visiting the Gad Partners Funds site. When not writing or analyzing businesses, Gad enjoys hanging out with his wife Maggie, reading, golf, and yoga
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