Here's a Way Out of Your Dead-End Relationship With Bonds -- and Some Great Dividend Stocks

Amid cratering stock prices during the brunt of the financial crisis it was no surprise that investors high-tailed it out of stocks.

Long-Term Mutual Fund Flows, Equities Chart

Long-Term Mutual Fund Flows, Equities data by YCharts

But five years later, stocks are still getting the cold shoulder as investors can’t seem to get enough of bonds.

Long-Term Mutual Fund Flows, Equities Chart

Long-Term Mutual Fund Flows, Equities data by YCharts

Fidelity estimates that since the end of 2007 for every $1 that’s found its way into stock mutual funds and exchange traded funds, $33 was invested in bond funds and ETFs. 33:1! Just for some context, if someone was following a middle-of-the-road allocation of 60% stocks/40% bonds that would suggest a 2:3 ratio. Not 33:1.

And all that bond money is pretty much sitting on a fixed income cliff.

Back in 2007 and into 2008 a fear trade into high quality bonds was fundamentally okay—as you were getting paid a real (inflation adjusted) yield.

10 Year Treasury Rate Chart

10 Year Treasury Rate data by YCharts

And for the next few years, while yields fell that meant prices rallied. So for total return investors, the bond trade continued to look just fine. Here’s the post-crisis path of the iShares Core bond ETF (AGG)-which tracks the benchmark of bond land, the Barclays Aggregate index.

AGG Total Return Price Chart

AGG Total Return Price data by YCharts

But going forward that same bond index is not going to be able to churn out that sort of performance. For the simple reason that bond interest rates are now so low there’s no room for them to keep falling from here.

Here’s the same chart of the 10-year Treasury rate and high-grade corporates, but with the time frame extended to today.

10 Year Treasury Rate Chart

10 Year Treasury Rate data by YCharts

Owning a Treasury at 4% when core inflation is around 2% makes plenty of sense. Owning a Treasury at 1.75% when inflation is still around 2%, well, not so much? Sure, there is the eternal flight-to-safety reason for always owning bonds. But to gorge on them at this juncture is being blind to a very changed world.

Yes, Ben Bernanke has said the Fed is committed to keeping rates low through mid 2015. That means you don’t have to worry about falling bond prices just yet (remember, when yields rise, prices fall.) But all you’re likely to get between now and then is a bond return that doesn’t outpace inflation.

Take a lead from the bond giants. Pimco has spent the past few years expanding its roster of stock funds and ETFs. Not bonds, stocks. DoubleLine’s Jeffrey Gundlach, who has built a $40 billion bond empire in just three years is now contemplating jumping into the other side of the allocation pie and adding stock funds to the firm’s lineup. He recently told Bloomberg:

“I like the way equities are out of favor and I like doing things when they’re unpopular…Equities are a superior investment to bonds for an inflation hedge.”

And unlike bonds, stocks aren’t overly expensive right now. S&P Capital IQ estimates that the S&P 500 index is trading at 12.5x estimated 2013 earnings. That’s well below the 14.7x in 2011 (which wasn’t itself expensive) and below the expected 13.8x for 2012. Not dirt cheap, but not uber-pricey either.

Investors with an eye on mitigating roller coaster rides might look to their pantry for some stock ideas. Among the largest holdings in the PowerShares S&P 500 Low Volatility ETF (SPLV) are Kimberly Clark (KMB), General Mills (GIS), Procter & Gamble (PG) and Campbell Soup (CPB).

All four just happen to be dividend-paying stalwarts, with dividend growth rates the past five years that far exceed inflation.

KMB Dividend Chart

KMB Dividend data by YCharts

Their current dividend yields aren’t too shabby either.

KMB Dividend Yield Chart

KMB Dividend Yield data by YCharts

In a world where high quality bonds aren’t yielding more than 2%, maybe it’s time to shift some money back into stocks with bond-beating yields.

Carla Fried is a contributing editor at YCharts, which includes the just-released YCharts Pro Platinum for professional investors.



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