There’s increasing reason to believe that the Treasury market has stabilized on the fundamentals—until the next panic when the Federal Reserve again begins to talk as if a decision to taper off its program of buying $85 billion a month in Treasuries and mortgage-backed assets is just around the corner.
And if the Treasury market has stabilized, it means that the weakness in dividend stocks (calling it a sell off would be an overstatement) is at an end—for a while—too.
The latest piece of evidence comes from a Wall Street formula called the term premium, which measures the risk of holding long-term bonds by factoring in the market’s outlooks on inflation and economic growth.
If you assume that consumer inflation will continue for the rest of 2013 at something like the current low rate–the lowest rate since 2009; and if you assume that U.S. economic growth will stumble ahead for the rest of 2013 by something like 2% or so rather than “racing” ahead at 3%, then the current 10-year Treasury yield of 2.54% is about right.
The long-term reading on the term premium has been an average reading of 0.40% in the decade before the financial crisis in 2007. It’s now at 0.46%, according to Bloomberg. As recently as May 2013 the term premium was a negative 0.5%. The term premium has been in negative territory since October 2011 and turned positive only in June 2013.
What does all that mean? The term premium is the extra yield that investors require before they will buy a long-term bond instead of a series of short-term bonds. If, for example, the yield on a 10-year Treasury were 5.5% and holding a series of 1-year Treasury bills over the next 10 years would be expected to yield 5%, then the term premium would be 0.5 percentage points or 50 basis points.
In most periods you’d expect the term premium to be positive since investors would, normally, require extra yield to induce them to hold a longer-term bond. But under some circumstances the term premium would be negative. If, for example, investors wanted to lock in a long term yield instead of taking on the risk of rolling over shorter term bills—with the chance that interest rates might be lower on each subsequent roll over—then the term premium could well be negative. That is indeed why the term premium was negative in early 2013—bond buyers actually preferred locking up their money for the long term instead of taking the risk that short-term interest rates might fall for subsequent rollovers. It wasn’t necessarily that yields on 10-year Treasuries were so attractive in comparison to short-term yields. It’s just that they were preferable given the assumed unpredictability in short-term yields. Predictability is a valuable commodity for pension funds and insurance companies that want to match the timing of their cash outflows and the timing of their cash inflows.
The big reason that bond buyers have started to see 10-year Treasury bonds as fundamentally attractive again—aside from their big recent drop in price and rise in yields—is the absence of any signs of inflation. Look around the globe—can’t find it. Can’t even find a scenario that might produce it relatively soon. At current economic growth rates, the global economy is awash in capacity whether it’s capacity for manufactured goods or production capacity for commodities. With China’s economy slowing that global overcapacity doesn’t look likely to go away quickly. (The one exception to this pattern of modest inflation is, perhaps, food commodities but even there the potential for a record harvest this year has pushed down near-term prices.)
Real yield on the 10-year Treasury—that is the yield once you subtract current inflation—is 1.56 percentage points, the highest level since March 2011. As recently as November, real yields were negative.
This hasn’t been a great first half for Treasuries and other bonds. Treasuries, according to the Bank of America Merrill Lynch bond index, lost 2.48% in the first half of 2013, the biggest loss since 2009
But Wall Street now believes that bond prices have stabilized within a likely range for the 10-year Treasury of 2.4% to 2.8% for the rest of 2013. High levels of bond market volatility and the uncertainty over when the Fed might begin The Taper argue that bonds yields aren’t going back to former lows, however.
What does this mean to you? Read more
This is a tough one and I’d bet that many of you would disagree no matter what I decided.
The name in question is Magellan Midstream Partners (MMP), a member of my Dividend Income portfolio http://jubakpicks.com/jubak-dividend-income-portfolio/
This master limited partnership has been a very, very good addition to the portfolio. At the time of the initial buy, these units paid a 7.3% distribution. Since I added the units to the portfolio on December 6, 2005, they’ve gained 60.3% (to the close on June 7, 2013.)
And that’s the problem.
The partnership has increased distributions every year. From $1.45 in 2010 to $1.56 in 2011 to $1.78 in 2012, but the increases in distributions haven’t kept up with the increase—27.4% in 2011 and 30.6% in 2012, for example, in the price of the units.
Consequently, the yield on this holding has come down every year—from 6.55% in 2009 to 5.15% in 2010 to 4.52% in 2011 to 4.13% in 2012 to 3.9% right now.
Why is that an issue? Because that falling yield is a sign that dividend stocks have gotten too popular. Especially recently. Read more
On January 11 in my post http://jubakpicks.com/2013/01/11/reformatting-my-dividend-income-portfolio-for-a-period-when-dividend-investing-gets-more-important-and-tougher-too/ I sold Brazilian utility CPFL Energia (CPL) out of my dividend income portfolio http://jubakpicks.com/jubak-dividend-income-portfolio/ . As of the end of 2012 I had a loss of 2.5% on this position (including dividend income.)
The logic behind this sell is pretty simple. As part of Brazilian President Dilma Rousseff’s drive to take costs out of the Brazilian economy, Brazilian utilities have been told to cut the price they charge for electricity if they’d like to see their concessions on electric power plants renewed. I think that’s good for Brazil, which has some of the world’s highest electricity costs, but it’s not good for revenue and cash flow at Brazil’s utilities.
Since the announcement of the new policy on September 11, shares of Brazil’s utilities in general have taken a beating. In particular the New York traded ADRs of CPFL Energia are down 8.6% from September 11 through my January 10 sell call.
What concerns me about CPFL Energia as a dividend stock is that the utility has paid out 95% of net income as dividends on average over the last seven years. The payout ratio hit 100% in the third quarter of 2012. That doesn’t leave CPFL with any room to increase dividends if net income falls as a result of new government initiatives. (The company’s dividend policy requires a minimum 50% payout.)
I don’t think the September 11 policy change is the last one that Brazilian utilities are likely to see either. Read more
I think the argument that we’re in an income asset bubble is easy to make–deciding when it might burst and what to do about it are much harder
We are looking at a bubble in the market for income assets.
Money continues to pour into the government bonds of the United States, Japan, Germany and other “safe haven” countries even though yields there are negative after inflation and even though some of these “safe havens” rank among the world’s most indebted governments.
Dividend stocks too have risen to historic highs even as yields have dipped. For example, an index that tracks the Standard & Poor’s “dividend aristocrats,” a basket of 51 stocks that have increased their dividends annually for at least 25 years, hit an all-time high in October.
We all understand the reasons behind this love affair with income assets. Stocks have been scarily volatile for the last decade or more—and threaten to become even more so. The world’s central banks have flooded financial markets with cash, crushing yields, but at the same time promising to keep interest rates extraordinarily low for an extended period, in the formulation of the U.S. Federal Reserve. A sputtering global economy has resulted in low rates of inflation and frequently, in fact, deflation seems a more immediate threat than inflation.
But we know that we’re nearing the end of this cycle. The yield on two-year Treasury notes could drop below the current 0.24%–that’s a negative 1.96% yield at recent U.S. inflation rates—but the yield is unlikely to go below zero. At some point—mid-2015 in the Federal Reserve’s most recent formulation—the world’s central banks will start raising interest rates again. A return to global growth or simple demographic pressures or the aging of the world’s population will lead to higher rates of inflation.
And we all know the big important questions too: When? And What? Knowing what we know—about the likelihood of a bubble and the eventual breaking of that bubble—When do we take action to avoid getting caught up in the bursting of that bubble? And when we take action What do we do? Read more
If you want to earn more dividend income, you’ll have to put up with more volatility–what you want to avoid is a permanent impairment of capital
“What do you mean, get paid while you wait? A stock with a 4% dividend that falls 25% in price is still a losing proposition,” read an email I got recently in response to a post where I added Ensco (ESV) to my watch list http://jubakpicks.com/tag/ensco/
And that is, of course, absolutely right. A 4% dividend gets wiped out pretty quickly when a stock tumbles in price.
Ideally, you’d like to buy dividend stocks that never go down in price and that don’t share in market volatility—except to the upside.
Unfortunately, in my experience, “ideally” doesn’t exist. Dividend stocks may go down less than the average stock—after all they have that dividend yield to support their price—in a down market but they do go down nonetheless. Dividend stocks do turn in bad quarters and when they do they go down in price. Even stocks with long uninterrupted histories of never cutting dividends and, of raising them every quarter, fall in price.
And if you’re going to wait until you’ve found a dividend stock that never goes down before adding one to your portfolio, you’re never going to buy a dividend stock. For that matter, you’ll never buy a bond either—since bond prices fluctuate with interest rates, inflation, fear, and the credit ratings of the issuer.
What we hope for from a bond is that despite the fluctuations in the price of the bond, it will 1) pay the interest promised to buyers and on time, and 2) when it comes time for the bond to mature pay off 100% of its promised maturity value.
Now dividend stocks are riskier than bonds. Read more