(By David Sterman) The grand sum of $1.4 trillion is a remarkably large number, no matter how you slice it. It's so large that it can single-handedly impact the direction of the stock market
. And thanks to recent events, it is a number you should be thinking about.
That huge sum of the money is the amount that has been shifted from stock funds to bond funds during the past five years. It's a fairly historic shift, but may likely have run its course. History tells us so.
Rising rates = rising risk
Over the past century, investors have poured into bonds during periods of severe economic crises that were often associated with higher inflation and higher interest rates. The most recent bond rally, back in the 1970s, was a perfect example. A lengthy period of stagflation pushed rates toward (and eventually past) the double-digit mark on the heels of anemic economic growth and rising inflation. Many investors came to the same conclusion: who would want to own stocks when a risk-free bond can deliver 7%, 8% or even 10% annualized gains?
Fast-forward to 2012, and history has been turned on its head. Bonds are rallying even though inflationary pressures are virtually non-existent. Still, global investors have become so wary of stocks that they are increasing their exposure to bonds, even though they carry insulting yields. In Europe, German 10-year bonds are yielding just 1.5%, which could turn out to be a negative return for non-European investors if predictions of a further drop in the euro come true.
Here in the United States, our own 10-year Treasuries are heading down a similar path. The yield, which has quickly plunged toward the 1.5% mark, is actually negative when adjusted for inflation.
Remember that $1.4 trillion figure noted earlier? That's a key factor behind the absolute plunge in rates. As money has poured into bonds, rates have sunk ever lower. Frankly, all those investors pouring into bonds have proven to be quite prescient. As bond yields have fallen, bond prices have risen. In fact, bond funds have turned out to be strikingly good investments in the past year as European economic concerns swelled. Want to see a great 52-week chart? Check out the iShares Barclays 20+ year Treasury Bond fund(NYSE: TLT).
Yet here's the rub. With yields already so low, and such strong gains in bond prices already in hand, it's simply unrealistic to expect further gains. Instead, even as it's awfully scary out there, it's time to walk away from the perceived safety of bonds.
This isn't an argument to simply flee toward all kinds of stocks, especially if you suspect the economic picture will get worse before it gets better. But one class of stocks matches up quite well with bonds, and now looks to deliver far more robust gains.
I'm talking about the dividend stocks.
Many of these income-producing stocks have been punished in this market (albeit to a lesser extent than stocks that carry no yield), and as stock prices have fallen, dividend yields have risen.
Just three months ago, before the stock market swooned and bond prices staged yet another rally, several of my colleagues at StreetAuthority began to discuss an unusual anomaly in the market: Dividend yields for stocks in the S&P 500 were higher than the yield on 10-year T-bills. That has not happened very often in the past century.
Now, there's no comparison. The average dividend yield on S&P 500 stocks is now 50% higher than the 10-year yield, which is virtually unprecedented. As long as you focus on companies that have a history of maintaining or boosting their dividend, it's very hard to see how you won't make more money in these stocks than in bonds right now. In fact, many of these same companies have downside support in terms of solid cash balances, robust historical cash flow and recurring revenue streams. At the same time, a host of factors are in place to cause bond investors to suffer major losses. These include:
• Long-awaited inflationary pressures that result from the Federal Reserve's massive balance sheet expansion program
• Signs that the U.S. economy may look healthier in 2013 or 2014
• An inability for policy makers in Washington to agree on a way to avert the looming "fiscal cliff" that leads foreign investors to sharply cut their exposure to the U.S. economy through their bond holdings.
Safe and growing
A longstanding investment strategy is to find companies with a history of stable and growing dividend payouts in any climate (In fact, it's a cornerstone of Amy Calistri's Daily Paycheck strategy).
Frankly, I tend to shun stocks that sport dividend yields of less than 2%, only because you can usually do so much better than that. Many companies have historically sought to have dividend yields in the 2% to 3% range, though a combination of rising cash flow and falling stock prices has unwittingly pushed these stocks into a higher-yield threshold. Of the 1,500 companies that make up the S&P 500, roughly 22% of them (or 335) now yield more than 3%. That's roughly twice the payout of the 10-year Treasury.
Many companies now realize how important it is to return cash flow to shareholders in the form of dividends. In fact, of the 335 stocks noted above, about 20% of them have boosted their dividend, on average, at least 10% annually over the past five years.
I've taken things a step further, focusing on those recent bold dividend hikers, and looking at only those that have raised their dividend annually for the past decade. Good times or bad, rain or shine, hell or high water, these dividend payouts keep rising.
Excluding defense contractors such as Lockheed Martin (NYSE: LMT), Raytheon (NYSE: RTN) and Northrup Grumman (NYSE: NOC), all of which may need to cut their dividend if defense spending shrinks, I found 17 stocks that have stable and growing dividends and yield at least 3.5%...
Risks to Consider: These companies boosted their payouts in 2008 and 2009, even as the economy slumped, but any possible deeper slump in the quarters ahead would cause these payouts to at least be frozen.
Action to Take --> If you've made a fortune in bonds, then you need to see the reasons why further gains will be hard to achieve. The stocks in the table above bring the income stream stability of bonds -- with much higher yields.
(Note: If you believe like me that the bond rally is over, then you simply MUST look for other options for income. Amy Calistri's Daily Paycheck strategy is quite possibly the best way I've seen for investors to invest in solid dividend-paying stocks and collect regular, monthly paychecks. To learn more about how Amy used this strategy to collect $1,357.52 in income in one month, go here (you won't have to sit through a long video).)
-- David Sterman
David Sterman does not personally hold positions in any securities mentioned in this article. StreetAuthority LLC does not hold positions in any securities mentioned in this article.
This article originally appeared on StreetAuthority
Author: David Sterman