2018 is stacking up to be a nasty year for bond investors. The 10-year Treasury yield has jumped from less than 2.5% to just shy of 2.9% in a matter of weeks.
And while that might not sound like a big deal, remember that rising bond yields mean falling bond prices. An investor holding a 10-year Treasury note would have seen the value drop by 3.4% since the start of 2018, which washes out more than a year of bond coupon payments.
Harry has written for months that he expects the 10-year yield to peak at around 3% before rolling over again, and that buying 10- and 30-year Treasurys at these yields represents a safe and profitable “trade of the decade.”
But, in the meantime, let’s see what other yields we can find on offer.
Last week’s hiccup in the stock market didn’t have much of an impact on the S&P 500’s dividend yield. The index has yielded less than 2% for years, and prices haven’t fallen enough to materially change that.
Bonds sport almost respectable yields these days.
The 10- and 30-year Treasurys both now yield around 3%, which is close to five-year highs for both. But, keep in mind, the inflation rate sits near 2%… so “real” yield is hovering around 1%. (We see inflation rates falling over the next few years, but we’ll leave that conversation for another day.)
You’re getting a higher yield these days in the utilities sector, at around 3.3%. But dividend growth has been sluggish for years, and the sector faces an ugly competitive environment going forward as solar and other alternative energies make inroads.
Real estate investment trusts (REITs) are a more attractive option, sporting a current yield of more than 4%. The sector faces long-term challenges from the rise of e-commerce, but it’s also evolving to meet those challenges.
All the same, the spread between REIT yields and bond yields is a little lower than what’d I’d ideally like to see, so I’m not exactly backing up the truck to load up on REITs… at least not yet.
The yield picture gets a lot more interesting when you start looking at municipal closed-end bond funds (CEFs) and master limited partnerships (MLPs). You can put together a diversified basket of muni CEFs yielding over 5% – tax free.
To put that in perspective, if you’re in the 32% tax bracket, a 5.4% tax-free yield is the equivalent of a 7.9% taxable yield. That’s not too shabby.
I’m not allocating to muni CEFs just yet, as my risk management system had me leave the sector during the recent bond-market rout. But you can bet the sector is on my watch list.
I am, however, pushing into MLPs… and their 7% yields.
The MLP sector hit a major rough patch in 2015. The sector had become far too dependent on debt financing, and some of the biggest names in the space were forced to slash their dividends in order to pare back their debt to reasonable levels.
Well, three years later, the sector looks a lot healthier, yet investors are still gun shy about returning to it.
That’s good news for us. Their fear is what makes the 7% yields possible. MLPs are one of the last truly cheap pockets of the market, and we have our pick of the litter.
Editor, Peak Income