It seems I find myself in a bit of a conundrum. I write a newsletter, Peak Income, dedicated to finding profitable income investments at a time when bond yields are rising and income-oriented investments are coming under pressure.
As I write this, the 10-year U.S. Treasury yields just shy of 2.6%. As recently as September, the 10-year yield was touching 2%. That’s a big a move in a very short period of time.
Hey, I get it. Some of this is understandable. The U.S. economy has picked up steam of late, growing at over 3% in each of the past two reported quarters. And this was before the corporate tax reform package, which promises to give at least a mild boost to the economy.
But what does this mean for bond yields? And does investing for income still make sense in a market like this?
What’s Next for Bond Yields?
Inflation – or the expectations for inflation – is the single biggest factor in determining the direction of bond yields.
On this count, I don’t think we have much to worry about. As Harry has written for years, aging populations are deflationary as older consumers tend to borrow and spend than younger and middle-aged consumers. You don’t see a lot of 70-year-old Americans buying expensive new homes or cars. They’re far more likely to be downsizing and adjusting their lifestyles to stay within their retirement budgets.
But there is far more than just demographics at work here. We’re also in the midst of one of the biggest technological shifts in history.
One of the biggest themes of last year was the “Amazon effect,” and I don’t see that slowing down any time soon. Amazon disrupts every industry it touches, lowering prices and forcing new efficiencies into the supply chain.
But it’s not just Amazon. In virtually every consumer-facing industry, kiosks and smartphone apps are replacing human labor. In everything from McDonald’s to your local airport, expensive humans have been replaced by cheaper machines or software. And should we start to see a hint of inflation, that trend will only accelerate.
Even Bitcoin, despite being one of the greatest bubbles in history, is deflationary. The blockchain ledger technology that supports Bitcoin is the future of data, and the blockchain is vastly cheaper to support and requires far less in security outlays.
Sure, we may continue to see inflation in certain pockets of the economy, like healthcare. Because of its dependence on a doctor’s or nurse’s one-on-one time with a patient, healthcare seems to be the one industry that has (thus far) been immune to the deflationary effects of new technology. But, overall, inflation should be very tame going forward.
What does this mean for bond yields?
They may go a little higher in the short term. But a long-term rise in yields such as that of the 1970s isn’t in the cards.
This is a long way of saying that I expect my income recommendations in Peak Income to do just fine in 2018.
Where Are the Best Bargains in 2018?
I feel good about my U.S. income recommendations this year. But that hasn’t stopped me from looking elsewhere for market gains.
Peak Income does more than just invest in bonds or bond funds. In fact, most of the portfolio is invested in high-yielding stock funds that offer competitive capital gains in addition to current income.
But today, U.S. stocks are looking pricey. After more than eight years of uninterrupted bull markets, the S&P 500 today, as measured by the Shiller P/E ratio, is as expensive as it was in late 1997… in the final years of the dot-com mania.
Expensive stocks can always get more expensive. Fed Chairman Alan Greenspan made his famous “irrational exuberance” comments in late 1996, and stocks went on to double in price again before eventually crashing in 2000.
But that’s not a game I want to play. Rather than trying to squeeze out a little more profit from the late innings of a long bull market, I’m hunting for real value. And across Europe and most emerging markets, stock valuations are cheaper by 30% to 50%.
A cheaper price doesn’t guarantee higher returns. But it certainly puts the odds in our favor.
In the last issue of Peak Income, I recommended a closed-end fund with exposure to China, Taiwan and Hong Kong. It trades at a deep discount to net asset value and yields a fat 8% yield.
An emerging market play like this is not without risks, of course. But in 2018 I see this as our best opportunity to make outsized profits while also collecting a nice stream of income. Click here to learn more about how we’ll do it.
Editor, Peak Income