There has been a lot of talk about how Federal Reserve Chairman Ben Bernanke has stated he will keep interest rates at record lows until 2014.
This is one reason why some people continue to buy bonds and expect a low interest rate of 1-2 percent. Since the beginning of 2007, $790 billion has gone into taxable bonds and $82 billion into tax-free bonds for a total of $872 billion invested in bond mutual funds.
Over this same period, $450 billion has come out of stock mutual funds. Investors may have forgotten that when interest rates go up, the value of bonds go down. They may also have a false sense of security that interest rates will not go up because Bernanke said he won’t raise interest rates.
I like Bernanke. I think he is doing a great job and is a smart man, but market forces can overcome him and no matter what he does, interest rates will go up.
There are a number of factors that could cause this to happen, over which Bernanke would have no control. If the economy continues to grow in 2012 at a 3 percent rate or so, businesses will continue to see higher profits. Some of these companies will increase their dividends. If the market settles down with no big declines of 10 percent or more, investors will begin to come back to the stock market for a better return than their current 1-2 percent.
As I’ve said in the past, I’m hearing talk of people discussing investing into high-paying dividend stocks. If, or should I say when, this happens, people investing in bonds will see the value go down, and the demand for bonds will go down as well. If the supply is still high, which it will be, the only way to get investors to buy bonds is to increase the interest rates.
Another scenario I have not heard lately: What if China decides to invest its money somewhere else other than our debt market? Foreign governments do own about 46 percent of our government debt, and China is the largest foreign country that holds our debt, which equals about 8 percent of the total debt. If China cut its holdings in half, the government would have to raise around $700 billion to replace that loss, which would probably be done by offering higher interest rates.
As a debtor nation we do not control our own destination, which is why Bernanke can’t guarantee to hold down interest rates. He can keep short-term rates as low as he wants, but he does not have any control over long-term interest rates.
If you’re looking for yield, look at companies like RadioShack (NYSE: RSH), which currently yields 6.6 percent because of the recent pullback in the stock. The company only uses 24.5 percent of its earnings to pay out the dividend. It has seen its earnings tumble 40 percent year over year when the industry was only down 12.3 percent. Yet sales did climb by 2 percent for RadioShack, not quite as good as the industry average of 5.4 percent.
The industry average only pays a 1.1 percent dividend, so there is some give and take here. Return on equity for RadioShack is good at 12.7 percent, the same as the industry average.
Investors need to keep an eye on the debt; current debt to equity is 83.3, well above the industry average of 22.4. To ease some of the pain, RadioShack does have a high current ratio of 2.8. Receivable turnover also looked good at 16.9, above the industry average of 13.6.
The company’s recent wide miss on earnings per share of 21 cents, coming in at actual earnings per share of 15 cents, scared many investors out of this stock. There are 20 analysts who follow the stock, and for December 2012, the mean estimate on earnings is 76 cents; 90 days ago that estimate was $1.40 but at 76 cents the forward PE is just under 10 times. Place a multiple of 15 times on those earnings, and the stock price could hit $11.40.
Just last week, Warren Buffett said, “Bonds are dangerous.” If you’re in bonds, I suggest getting out now before the rush. It won’t be pretty. A 1 percent decline in a 10-year Treasury will be about an 8.9 percent drop in your principle. There are many stocks with some nice yields, begin your search and look forward.