The "Bond King" has issued a dire warning for income investors. If he's right, it could affect how much money people earn from dividend and interest payments for the next two decades.
The "Bond King" is Bill Gross, one of the biggest names on Wall Street. Not only is he co-founder of Pacific Investment Management Co. (PIMCO), one of the largest investment firms in the world, but as money manager of the PIMCO Total Return Fund, he's directly responsible for over $270 billion in assets.
So what is the "Bond King" predicting?
In short, Gross thinks interest rates could stay low -- ridiculously low -- for a long, long time. According to his analysis, interest rates could stay as low as 1% until sometime around 2035.
The reason for the perennial low-rate environment, as Gross explains, is the government's desire to create a "beautiful deleveraging" -- which is financial lingo for saying the U.S. wants to lower its dependency on debt without sacrificing the health of the overall economy.
As Gross explains in his most recent Investment Outlook letter:
"If the Fed's objective is to grow normally again, then there is likely no more beautiful or deleveraging solution than one that is accomplished via abnormally low interest rates for a long, long time."
He goes on to say...
"The last time the U.S. economy was this highly levered (early 1940s) it took over 25 years of 10-year Treasury rates averaging 3% less than nominal GDP to accomplish a "beautiful deleveraging." That would place the 10-year Treasury at close to 1% and the policy rate at 25 basis points until sometime around 2035!"
In other words, in order to get the economy firing on all cylinders, U.S. policymakers may have no choice but to keep supporting this low-rate environment for years to come.
Federal Reserve Chairman Ben Bernanke seems to agree with Gross' assessment. At his most recent Federal Open Market Committee press conference, not only did Bernanke say he would continue buying assets a record pace... he also mentioned the Fed would keep the target interest rate near zero through at least 2015. Both of these decisions indicate the Fed believes the United States isn't ready for higher borrowing rates yet...
If true, this is horrible news for income investors. As Gross goes on to say in his letter, this "beautiful deleveraging" comes at the expense of "private market savers." The longer rates stay low, the worse off the average income investor stands.
After all, gone are the days where investors can earn a 5% return on a savings account or an 8.5% yield on corporate debt. Today, you'd be lucky to get 0.1% from a savings account or 3% from AAA-rated bond fund.
That doesn't mean there aren't high-yield opportunities in today's market though. If this low-rate environment really is the "new normal," then income investors simply need to get "creative" with their investment strategies in order to increase their returns.
One solution is to focus on high-yield dividend stocks like the ones my colleague Amy Calistri recommends in her premium newsletter, The Daily Paycheck. Right now, the average yield for Amy's Daily Paycheck portfolio is 6.7% -- well above anything you'll find in traditional income securities or corporate debt.
But this strategy has been popular for a few years now. Since the recovery began in early 2009, dividend stocks have been on a tear.
Because stock prices and dividend yields move in opposite directions, the meteoric rise in stocks has put downward pressure on yields. In fact, right now the average yield in the S&P 500 Index is a paltry 1.9% -- 2.5 percentage points below its long-term average of 4.4%.
As a result, it's becoming harder and harder to find reliable "high-yield" securities in today's environment. Even utility stocks, which have historically been a "safe haven" for income investors, are currently only yielding 3.9%.
But Amy has found one corner of the market that still offers above-average dividend yields. Not only does this group of high-yield investments pay a modest dividend every quarter, they also have a track record of paying a significantly higher "irregular" dividend one quarter out of every year, too. (Amy talked about these "Wall Street Irregulars" recently.)
While popular financial websites might list their yields at 2% or even 1.5%, in reality, these stocks are paying dividend yields as high as 7.6% and above.
What's more, even with stocks sitting near all-time highs, you can still buy these companies at a decent price. Since most of these stocks make their "irregular" payments toward the end of the year, investors usually flock to these stocks when the size of the large dividend is declared, driving up the share price. Right now, you can get a better value -- and a better yield -- by jumping in ahead of the crowd.
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- Bill Gross
- interest rates