Seeing a Seismic Shift in the Bond Market

A big sell-off in the U.S. bond market has coincided with a sharp rally in cyclical stocks, causing the yield on the benchmark 10-year Treasury to rise recently.bonds-screen-918x516

The 10-year Treasury rate rose to 2.46% on Dec. 9 as it continues to rise along with inflationary expectations. As a result, dividend stocks tied to defensive sectors have come under severe selling pressure.

The situation conjures up images of trigger-happy traders and fund managers pushing their defensive dividend stocks in a wave of selling. It reminds me of an attack political ad that portrayed Rep. Paul Ryan TV pushing an old retiree over a cliff.

U.S. Treasuries took their cue from the economic calendar and it was all downhill for bond prices thereafter. Durable goods orders jumped by 4.8% month over month in October (versus consensus estimates of 1.1%).

Existing home sales were stronger, rising to 5.60 million in October from 5.49 million in September (versus consensus expectations of 5.40 million). Topping the headlines was the Atlanta Fed’s GDPNow model forecast, now at 3.6% for Q4 U.S. real gross domestic product (GDP) growth.

The U.S. economic recovery looks to be gathering speed from the sluggish pace that prevailed for most of 2016. Thus, interest rate markets have priced in a lot more growth and inflation in just three weeks and the Fed’s work of raising interest rates to stem inflation and rising GDP is all but done.

While stronger current U.S. economic data has been supporting Treasury yields, the size and composition of any fiscal stimulus in 2017 remain big unknowns.

imgresThe Republican-controlled White House and Congress are expected to enact some combination of tax cuts and infrastructure spending next year. The larger the package and the more oriented toward infrastructure it is, the more it should push nominal interest rates higher.

The pronounced move in Treasury yields has priced in a good portion of future expectations as to where the move looks overdone, with many blown-out dividend growth stocks that have strong organic growth in earnings and dividend payouts trading at attractive entry points.

It is as if a Richter-scale-7.5 earthquake rippled through many income-paying sectors simultaneously and pulled down several terrific growth and income stocks. At the same time, it provided an opportunity for income investors to buy these now-reduced-price assets.

Plus, some high profile market gurus, including DoubleLine’s Jeff Gundlach and legendary value hedge fund manager Stanley Druckenmiller, are predicting U.S. gross domestic product (GDP) to rise to 6.0% by 2019, which would take the 10-year T-Note yield above 3.0% before that time in anticipation of further Fed interest-rate tightening.

It is an incredible turn of events that investors are having to rapidly adjust to quickly that is unsettling for those holding tight to their long-dated bonds. The only solace is that all bonds mature at par, and that’s the new course for those that failed to sell.

If the chorus of respected Wall Street mavens gets louder on the topic of hotter economic growth going forward, then these seemingly terrific entry points for the dividend payers are only going to get more enticing.wpid-thumbnail-96071424b0b614f9882f45b27f430c88.jpeg

It is just too early to tell, and because of that, it would be wise to stand aside and see just how high the market wants to take interest rates heading into the year’s end before attempting to bottom-fish too heavily.

We are in the kind of market where more than one shoe could drop for bond investors if the data keeps improving at a better-than-expected pace. Buying partial positions in nice dividend stocks is recommended, as is dollar-cost averaging as the market allows.

If bonds are the security class of choice, then the ultimate sweet spot on the yield curve would be five- to seven-year maturities.

History is on the side of owning maturities in this time frame when rates are on the rise and, as the bond market crushes everything with a longer maturity than seven years, the real hidden opportunity will be for investors to buy into the junk-bond space through closed-end funds that have durations that don’t go out beyond 2022.

As the economy strengthens, this debt class gains more balance sheet credibility, and because maturities are reasonably visible, the investment proposition becomes quite compelling.

bp-1

The chart above is that of the iShares iBoxx $ High Yield Corporate Bond ETF (HYG), which investors interested in this trade should monitor closely. You can read more about this forthcoming scenario in Cash Machine, as well as how to position for what should a good buying opportunity in 2017.

youtubechannelsfordaytraders-5661a2d33df78cedb0b64e94My high-yield investment newsletter, Cash Machine, is a way for me to help income investors gain the benefit of my three decades of investing experience and asset management to work.

As 2016 starts to wind down and the New Year approaches, there will be substantial changes in a number of industries after Donald Trump is inaugurated as the next U.S. president.

The result will have favorable effects on certain asset classes and unfavorable ones on others.

To stay ahead of the curve about a host of variables, including Fed policy, taxes, foreign exchange volatility, regulations and commodity risk, I encourage you to click here to learn how my Cash Machine investment newsletter can help you, as it does so many others. I can identify great dividend-paying stocks and high-yield assets for you. Let me help you fulfill your goals.

Until next time,

Bryan Perry

 Bryan Perry has spent more than 20 years working as a financial adviser for major Wall Street firms, including Bear Stearns, Paine Webber and Lehman Brothers. Bryan co-hosted weekly financial news shows on the Bloomberg affiliate radio network, and he’s frequently quoted by Forbes, Business Week and CBS’ MarketWatch. With three decades of experience inside Wall Street, Bryan has proved himself to be an asset to subscribers who are looking to receive a juicy check in the mail each month, quarter or year. Bryan’s experience has given him a unique approach to high-yield investing.