Bookmark and Share Aug 18, 2010 Great American Bond Bubble

"If 10-year interest rates, which are now 2.8%, rise to 4% as they did last spring, bondholders will suffer a capital loss more than three times the current yield."

Jeremy Siegel, Professor of Finance, Wharton, Wall Street Journal, Aug 18, 2010

If you own bonds you owe it to yourself to read the August 18 Opinion page of the Wall Street Journal regarding the current bond bubble. Professor Siegel states "stocks, particularly stocks paying high dividends, may offer investors a more attractive income and inflation protection than bonds over the coming decade."

He then mentions the ten largest dividend payers in the US today: AT&T, Exxon, Chevron, Proctor & Gamble, Johnson & Johnson, Verizon, Phillip Morris Intl, Pfizer, General Electric, and Merck. These have an average dividend yield of 4%, approximately three percentage points above the current yield on 10-year TIPS, and over one percentage point ahead of the yield on standard 10-year Treasury bonds. Their average P/E ratio, based on 2010 estimates, is 11.7, compared to 13 for the S&P 500. And, their earnings are expected to cover their dividend by more than 2 to 1.

After running a covered call screener against these ten companies we found the following (as of August 18, 2010, 1pm ET):

  • MRK buy-write Sep 35s for 34.29, annualized return if flat/called = 37.7%
  • GE buy-write Sep 15s for 14.73, annualized return = 30.6%
  • XOM buy-write Sep 60s for 58.49, annualized return = 29.4%
  • PM buy-write Sep 52.50s for 51.29, annualized return = 24.7%
  • VZ buy-write Sep 30s for 29.38, annualized return = 24.7%

These returns include any dividends that go ex-div before the September expiration date, and they all have better than 2%/month annualized rates of return.

If you own a high yielding bond (or bonds) you may want to do what Professor Siegel suggests and move some of those assets into these big dividend payers to hedge against a inflation-driven bursting bubble. And then we would suggest you write calls against them to increase the yield.

Bond Bubble? CNBC's take...

CNBC segment from Aug 23 with Peter Schiff and Marc Faber. "This decade is going to be the worst decade for bonds in U.S. history," says Schiff. Faber chimes in regarding the current bond bubble "There isn't much upside potential in treasuries unless it is for the short term." And both refer to the massive flow of funds into the equity markets earlier this decade and warn viewers not to think of it as an intelligent leading indicator. 8 minutes long:

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