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Weekend thought: asset allocation strategies need to ditch bonds, seriously



February 26, 2010 – Comments (27)

A common investment strategy, used by both individuals and some of the best and most famous money managers on the planet is an asset allocation strategy where some % of assets is kept in stocks and some % of assets is kept in bonds. 

This type of strategy can be helpful by instrinsically buying stocks when they are down, selling stocks when they are up, ditto bonds.  You have a 50/50 allocation, the stock market crashes 40% the bond market rallies 10% and now you have 2:1 bonds to stocks, so you would re-balance, buying stocks and selling bonds.  Later when equities have doubled and bonds have come back to earth you'd take some stock profits off the table and add to bonds.  Fine strategy.

But, the challenge facing this strategy, and bond funds like PIMCOs are several fold:

1.  Treasuries have been in an almost unprecedented 30 year bull market.  Here is yield on the 10 year in a picture.    30 years of declining yield.  Before that we had almost 30 years of rising yield on the 10 year.  

2.  Interest rates are basically at all time lows.  The value of bonds is inverse to interest rates.  If interest rates rise, bonds will fall (meaning the yield on the bonds rises).  Its difficult to imagine that interest rates can drop significantly from here or stay here forever.  

3.  Money has been pouring into bonds and out of stocks.  In 2009 bond funds saw 100's of billions of dollars of inflow, equity funds saw outflows (save hedge funds, which saw modest inflows).  

The table is set for bonds to experience some pressure, or possibly the table is set for a new secular bear market in bonds.  

And if I may add one more point, I'd like to observe that the yield on bonds right now is less than stellar.  The 10 year yields 3.6%, the 30 year yields 4.5%, forget about shorter time-frame bonds, they yield nearly nothing.  High quality, investment grade corporate bonds aren't all that much better than long-dated treasuries.  Andlower grade corporate bonds, while offering a better yield, come with credit risk.  I read on realmoney silver over at, in a note from the resident bond guru, that the expected default rate on junk bonds puts their expected actual yield just better than investment grade corporates.

So bonds are at or near all time highs, interest rates at or near all time lows...  but the stock market remains reasonably priced, trading at levels still 30% below recent highs, and is not up in 12 years.  

Therefore, at this time, I think it is emminently reasonable to consider the holding of bonds in an asset allocation strategy imprudent.  

Rather, one should sub, for bonds, low beta high yielding large cap blue-chip stocks with good financial condition.  I would suggest the following:

T.  AT&T.  Telecom/wireless provider for the ages.  Big, growing, growing profits, trading at a p/e of 10, in absolutely no financial trouble and yielding 6.7%.  Thats a dividend, so you pay 15% tax instead of up to 35% tax for income from other bonds (except some municipal bonds, which can be tax free on the federal level).  6.7% taxed @ 15% leaves the holder with about 5.7% take-home.  If you're in the top federal tax bracket you'd be paying up to 35%, meaning that a bond would have to yield about 9% to match that.  AT&T has a long history of dividend growth as well.  

If you put $1,000,000 into bonds right now, at 9%, you'd make $90k a year, take home about 50-60k depending on your state and tax bracket.  And in 10 years you'd still be taking home 50-60k.  

If you put $1,000,000 into T right now, at 6.7% yield, you'd make $67k a year, take home about 50-57k depending on your state, but...   and this is a BIG BIG BUT, 10 years ago T was paying about $1/share, right now it is paying $1.68/share. Stocks like T grow their dividend.  In 10 years you'd be recieving perhaps $2.50/share, meaning thatbased on your $1mil investment now your income would be ~$100k, and you'd take home perhaps $75-80k based on todays tax rates. 


So in light of the issues with bonds and these facts about stocks

1.  They are not expensive today, especially big high yielders like the ones I mention above and below

2.  They can and have and will grow their dividends over time

3.  The value of the shares themselves can, has, and will go up over time whereas the value of bonds over time is very unlikely to, and if held to maturity, of course, bonds are worth only par.

4.  And this is the real kicker here, ...  over the chaos of 2008/2009, T had LESS PRICE FLUCTUATION THAN BONDS.


It is simply prudent today to replace bonds with high yielding, reasonably valued, financially uber-stable blue-chip stocks.  Make them low beta stocks just to help yourself sleep better at night.  May I suggest, for your consideration


T - AT&T, as discussed above, pe of 11, forward pe of 10 (big moat in landlines, cell phones is growth)

VZ - Verizon wireless, forward pe of 10, secular growth industry (although largely mature)

BP - massive oil company, shares not up in 10 years, trading at a p/e of 10

LLY - Eli Lilly, pharmaceutical giant, yielding 5.8%, trading at pe of 9, shares not up in 14 years

BMY, GSK, AJG also make the list.

MO - Altria, cigarettes in the US

RAI, PM, other tobacco stocks may qualify

And a small part of the bond portfolio could be devoted to REITs and BDCs.  I'm no REIT expert, but for BDCs I'd take a look at AINV, ARCC, FSC.  Remember, these will be less stable and higher in beta than the stocks above.

But seriously, ditch the bonds, buy the blue chips.  Just consider them bonds with better yield and take the dividend raises and share price appreciation as mega-extra bonus stuff.

Happy hunting!

27 Comments – Post Your Own

#1) On February 26, 2010 at 7:15 PM, checklist34 (99.06) wrote:

I would pick the telecoms and the pharma companies, and the oil companies, over tobacco if the yields were equal.  Reason is that I think tobacco is in a secular decline, even if it is a slow, prolonged decline in which they have tremendous pricing power.  I would not be shy about buying the tobacco companies at higher yields, though.

Steve Leuthold himself, who runs asset allocation, has adopted this philosophy to some extent (maybe a big extent).  Hence I cannot take full credit for this idea.

But ferpetessake, if you want stable low beta investments with yield, these big blue chips are >>> than bonds at this time IMO.

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#2) On February 26, 2010 at 9:19 PM, checklist34 (99.06) wrote:

TOT also, although I know little about them


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#3) On February 27, 2010 at 9:14 AM, kaskoosek (29.91) wrote:



At least they produce some shit. Telecoms are monopolies that have very little competitive advantage.

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#4) On February 27, 2010 at 9:41 AM, alexpaz (28.45) wrote:

Damn good idea! +1 rec

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#5) On February 27, 2010 at 10:51 AM, rexlove (99.70) wrote:

Good call checklist. I agree with you 100% - bonds (considered a safer investment) could be the worst place to put your money right now. Higher dividend paying stocks are the way to go. One of my favorites here right now is CODI.  Not only does this stock have a nice yield but it should appreciate in stock price as well.

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#6) On February 27, 2010 at 12:38 PM, PaxtorReborn (28.93) wrote:

Prefered shares in stable industries might also be the way to go

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#7) On February 27, 2010 at 2:06 PM, checklist34 (99.06) wrote:

Paxtor, thats a great idea, I hadn't thought of that.  Are the dividends paid on preferred shares dividends or are they income for tax purposes?

These, historically (although not so much in therecent crisis) are pretty price stable.  The divi's dont grow over time, though.



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#8) On February 27, 2010 at 2:09 PM, checklist34 (99.06) wrote:

kask, why is being a monopoly a bad thing for this purpose?  VZ and T may have little competitive advantage, but dear god the barrier to entry is high!

Thanks alex.

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#9) On February 27, 2010 at 2:20 PM, portefeuille (98.32) wrote:

Preferred shares from the "financials" sector have recovered quite a bit as the chart of this ETF demonstrates.

PowerShares Financial Preferred Portfolio (Fund).



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#10) On February 27, 2010 at 3:31 PM, checklist34 (99.06) wrote:


     Can't you see it?  Money rolls from the dot com bubble, which popped causing great pain, to the real estate bubble, which popped causing greater pain, to the bond bubble (? are bonds in a bubble?) which, if a bubble, would have to pop, causing more pain...


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#11) On February 27, 2010 at 3:31 PM, checklist34 (99.06) wrote:


     Can't you see it?  Money rolls from the dot com bubble, which popped causing great pain, to the real estate bubble, which popped causing greater pain, to the bond bubble (? are bonds in a bubble?) which, if a bubble, would have to pop, causing more pain...


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#12) On February 27, 2010 at 3:41 PM, checklist34 (99.06) wrote:

porte, I wonder if any permanent dilution occured in that financials preferred ETF via TARP and all that?  So maybe the new "par" isn't $25, but $19 or whatever?

Anybody know?

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#13) On February 27, 2010 at 4:54 PM, Momentum21 (97.35) wrote:

glad to see you back checklist 

nice post...I like the thought and T is certainly better than bonds it seems but if you are in bonds how about just a high yielding index fund? I bought some T in December and it is down about 10%. many of the higher yielding stocks have been underperforming the broader index and there seems to be a fair amount of risk in drugs (legislation) and tobacco (lawsuits). 

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#14) On February 28, 2010 at 2:22 AM, checklist34 (99.06) wrote:

momentum, T did have quite a dip early this year...  I am a buyer here, though, at $24.XX, if I decide I want some stability in my portfolio. 

If I went all in on T I would sleep well at night and never check the market.  I wouldn't buy it for big moves or 3.5x my money ina  year glory, but I'd go to bed knowing i had $X of income from the dividends, and that over time those dividends would rise as fast or faster than inflation.  

I may sell it if it traded to a 4% yield, anticipating thatone day it'd be back at 6%.  

But i'd sure sleep well at night.  And while I enjoy investing and all of this...  And its been incredibly good to me...  

But I wonder if my life, overall, would be richer if I worried about returns and money less and spent more time away from a computer screen?

good luck with T!

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#15) On February 28, 2010 at 4:27 AM, portefeuille (98.32) wrote:

You might want to have a look at Telefónica if you are really looking for somewhat boring stocks with high dividends and "growth".

2009 results (pdf)

2009 results presentation (pdf)

2009 results webcast

Telefónica's Net Profit up 2.4% in 2009 to 7,776 Million Euros

Telefonica FY net helps shares, doubts persist

Telefónica closed on 02/26/10 at 17.25 EUR.

Telefónica in Frankfurt trading.


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#16) On February 28, 2010 at 4:37 AM, portefeuille (98.32) wrote:

analyst estimates.


So there you have a stock with estimated dividend yield of 8% and P/E of 9.45 for 2010 and quite a bit of Latin America exposure. EBITDA/"net debt" is less than 2 and shrinking (unless they do want to a takeover of Telecom Italia, hehe).

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#17) On February 28, 2010 at 4:42 AM, portefeuille (98.32) wrote:

to a

to try a

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#18) On February 28, 2010 at 4:56 AM, portefeuille (98.32) wrote:

and somewhat similar but from a different sector.

Banco Santander.

Results Presentation 4Q 2009 (pdf).




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#19) On February 28, 2010 at 5:11 AM, portefeuille (98.32) wrote:

Banco Santander in Frankfurt trading.


Maybe not the most sleep inducing chart ...


#83) On March 05, 2009 at 1:21 PM, portefeuille (99.96) wrote: STD - 5.32 - outperform

#859) On November 22, 2009 at 7:21 AM, portefeuille (99.96) wrote: STD - end outperform - 16.97 - new rating: market perform

#967) On February 06, 2010 at 5:58 PM, portefeuille (99.96) wrote: STD - end market perform - 12.74 - outperform


(from here

STD closed on 02/26/10 at $13.04.

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#20) On February 28, 2010 at 5:21 AM, portefeuille (98.32) wrote:

Stoxx 50 components sorted by 2010 expected dividend yield (DIVe. KGVe is the 2010 expected P/E ratio.).




My favourtites are the two companies mentioned above and BASF.

BASF and Telefónica are two of my largest positions.

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#21) On February 28, 2010 at 5:28 AM, portefeuille (98.32) wrote:

BASF in Frankfurt trading.


okay, enough of those boring dividends and back to some good old biotech analysis!

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#22) On February 28, 2010 at 6:17 AM, portefeuille (98.32) wrote:

A boring stock that does not pay a dividend but does grow "nice and steady" and has a P/E 2011 of close to 10 if you strip out the "net cash" and use the consensus earnings estimate of around $1.30 per share for 2011 is EMC. They are the majority shareholder (around 82% I think) of VMW.

The not so boring part is that someone might want to buy either VMware or EMC. The usual suspect is CSCO.

Cisco and EMC, Together with VMware, form Coalition to Accelerate Pervasive Data Center Virtualization and Private Cloud Infrastructures






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#23) On February 28, 2010 at 6:18 AM, portefeuille (98.32) wrote:

if the old checklist34 is still alive he might want to consider buying a few long term in the money EMC call options ...

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#24) On February 28, 2010 at 6:38 AM, portefeuille (98.32) wrote:

Ackman has sold his EMC shares by the way. Probably too boring for him, hehe ...

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#25) On February 28, 2010 at 7:42 AM, deltafox2 (< 20) wrote:

Banco Santander: wouldn't Spanish financials seem a little couragious at this point in time with massive write-downs on private and commercial real estate (my guess) yet to take place? 

EMC/VMW certainly seem interesting, virtualisation is really taking off as a THE cross-platform technology in IT infrastructure. Whoever is well established here can hardly avoid to make real money. 

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#26) On February 28, 2010 at 7:59 AM, portefeuille (98.32) wrote:

#25 see slides 9-14 of the presentation linked to comment #18 above (pdf).

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#27) On February 28, 2010 at 11:02 AM, deltafox2 (< 20) wrote:

Thanks, very impressive presentation. SAN seems to have done most things right. AFAIK they also managed to stay away from the US toxic asset trash. A hypothetical doubling of the Spanish (and the UK's) NPLs in 2010 probably wouldn't make a big dent in their figures either, considering exposure and risk provisions. Clearly a "buy on dips" rec.


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