What are the risks facing us in the next year or two? The inversion of the yield curve which has happen on three separate occasions has me worried. It signals more stock market volatility, it is a sign that the bond market fears subpar economic growth and that a trade war could cause a global recession.
Historically an inverted yield curve has been a reliable, though not perfect, predictor of a recession. Each of the last five recessions was preceded by the two and 10 year Treasury yields inverting. (the two year yield is higher than the 10 year yield)
So, is the Bond Market Insane?
We now have $17 trillion worth of negative interest rate bonds, mostly in the sovereign bond space. That is about 25% of the entire bond market and 43% of bonds outside the US. In simple terms, you buy a $100 bond but pay $105 for it and you are guarantee to get $100 back when the bond matures. Who in their right mind would buy an investment that if held to maturity would lose money?
There has never been such an animal in the classification of bonds. Until a few years ago, traders and investors around the world would have considered negative rate bonds as imaginary as a children’s fairytale.
Mark Grant wrote this about negative interest rates in Europe:
While the European Union is not creating “Pixie Dust Money,” at the ECB, and then buying their own nations’ sovereign, and corporate debt, to purposefully hurt the financial markets, or the United States, that is exactly the “collateral damage,” that they are causing. The nations of the EU cannot afford to pay for their budgets, or their social programs, so the ECB has moved down their borrowing costs to less than zero, in most cases.
Check out their 5-year sovereign debt yields:
Why I am reducing my bond holdings and switching to dividend paying stocks.
- Since I am retired, the recommended withdraw rate from my retirement account is 4%. Interest from bonds are not meeting my needs.
- Dividend paying stocks will lose some value during the next recession but less than the overall stock market. Plus, I will get paid to wait for the stock market to recover.
- In Canada, the dividend tax credit increases my after tax return by 25% over bonds.
- The next recession could be extra long because Central banks have already lowered interest rates. They will have less tools to stimulate the economy when a recession hits.
- The yield of both Canadian & U.S. 10 year bonds are below inflation which reduces the value of money over time.
Telecommunication companies like AT&T (Ticker: T) and Bell Canada (Ticker: BCE) have dividend yields of 5.7% and 5.08% which are much higher than bond yields. Some Canadian banks also have dividend yields in the 5% area and they continue to raise them. (ticker symbols: BNS & CM).
These are not recommendations but examples to illustrate that they are a wide variety of dividend paying stocks with higher yields than bonds. They are not recession proof but do provide a steady income stream. Keep in mind that even cash isn’t safe because inflation will over time reduce its purchasing power.