While the financial media fawns over new records being set by
the Dow… one important story has fallen through the cracks.
And it could have dire consequences on your investment
Interest rates. They've been steadily rising for the last
month. Rates on 10-year U.S. Treasuries have risen from 1.66% to
Now that may seem like a small move of roughly ½ percent. But
on a percentage basis, it's a whopping 28% increase. Even if you
haven't noticed this move, it's significant…and it's been more
than enough to lure some foolhardy investors back into bonds.
The comments from our esteemed Federal Reserve Chairman Ben
Bernanke are sending interest rates higher.
Earlier this month, Bernanke hinted that the Fed could slow
its $85 billion per month bond buying program. The timing of
changes remains uncertain.
But the key point is that the Fed is prepared to cut back on
bond purchases if the U.S. economy continues to improve.
With home prices rebounding, unemployment trending down and the
stock market at record highs, Bernanke is now considering taking
his foot off the gas.
In many ways, any slowdown in Fed bond purchases will signal a
better outlook for the economy. And this changing environment
obviously has some implications for income investors.
When the Fed slows its bond purchases, interest rates on
Treasuries will start rising. And it's already started with just
a mere hint that this might happen.
As a rule of thumb, bond prices fall when interest rates rise.
And that's what's happening today. In fact, during May the
iShares ETF tracking 7-10 year U.S. Treasuries fell more than 3%,
while the 20-year tracking ETF dropped more than 7%.
Investors in bonds are suffering some small initial losses
already. If interest rates continue rising, bondholders could
face considerable principle losses.
Rising interest rates similarly affect dividend stocks.
If yields on Treasuries improve considerably, income investors
may be tempted to allocate more cash to bonds. And this would
result in selling pressure on dividend stocks.
For example, on Wednesday Treasury yields rose to a one-year
high. That rise sparked some selling of dividend stocks, as the
iShares Dividend Index (
) - an ETF of dividend stocks - fell 1.3% for the day. That drop
nearly doubled the decline in the broader market.
But one day doesn't define a new trend. In fact, it appears
this week's decline in dividend stocks was short-lived.
While it may seem counterintuitive, weaker economic data sent
stocks rising yesterday. Weekly unemployment rose slightly, and
first quarter GDP growth of 2.4% was just shy of estimates.
This seemingly negative economic news could mean that the
Fed's bond buying program will continue undisturbed for months to
come. And that's good news for investors who are long
stocks, especially dividend stocks.
It appears that the best thing for the stock market is a slow
and steady economic recovery. That's exactly what's been
happening since 2009. And there is little evidence that the pace
of economic recovery will change anytime soon.
Looking at the big picture, dividend stocks will continue to
dominate. Reasonable valuations and a higher yield than the
10-year Treasury makes stocks a better bet for total return over
the coming years.
Some investors may be lured into bonds by the
rising interest rates. But you and I know better…now is the
time to stay the course, keep buying dividend stocks,
and continue collecting more income for years to come.