Could this be the year the bond bubble bursts? It certainly could, and we would see a tremendous rotation from bonds to stocks.
Bonds have been extremely popular with investors in recent years. With the financial crisis, recession, Europe’s sovereign debt woes, a slowing global economy, the fiscal cliff and any number of other scary headlines, investors were clearly more concerned with return of principle rather than return on principle. As a result, a lot of money flowed into bonds because people were more comfortable knowing they wouldn’t lose their money even though they wouldn’t gain much, either.
But just like the stock market, the bond market reflects supply and demand. The more people want to buy bonds, the higher the price you have to pay. And the higher the price you pay, the lower your yield is. That’s why 10-year Treasuries yield only about 1.8%.
The reality is that it’s a dangerous time to buy most bonds, and they could end up doing more harm than good for investors. Interest rates have nowhere to go but up. When that happens, whether it’s a long time coming or rates starting to tick up sooner than people expect, the value of the bond decreases. That’s because investors will naturally prefer the newer bonds with higher interest rates.
You can hold the bond and collect the yield, which is probably low if you bought it within the last few years, but if you need to sell it, you’ll probably end up losing money.
In addition to bonds being extremely expensive, investors won’t stay happy with the low yields much longer. Most people won’t be able to retire making a couple of percent on their money, which is why we’re beginning to see investors move from bonds to stocks. They have little choice if they’re after higher returns. They can even get a better yield in fundamentally strong dividend stocks.
Plus, many headlines risks from recent years have subsided a bit, so signs of increasing investor confidence are appearing. Just Friday, the S&P moved above 1,500, a high we haven’t seen in over five years! That will also pull investors into stocks.
If you’ve been reluctant to put money to work in stocks, you may want to reconsider. A few good candidates for your money right now are 3M (NYSE:MMM), Honeywell (NYSE:HON) and United Technologies (NYSE:UTX). These are still modestly attractive and conservative stocks to buy that should benefit from an improving global economy, which GE (NYSE:GE) recently mentioned. The yields are all appealing, with HON at 2.5%, MMM at 2.4% and UTX at 2.4%. That puts money in your pocket, and it helps support share prices.
It will certainly be interesting to watch, but it’s good to finally see this rotation. With the added benefit of being able to invest in dividend-yielding stocks, more people will pull out of bonds and into stocks.