Today's Hot Topics   ▲  |  ▼

Bonds and dividend stocks are looking pricey, and inflation will eventually take them out. Let's try to figure out when—and how to keep the income coming in, writes MoneyShow's Jim Jubak, also of Jubak's Picks.

We are looking at a bubble in the market for income assets.

Money continues to pour into the government bonds of the United States, Japan, Germany, and other "safe haven" countries, even though yields are negative (after adjusting for inflation), and even though some of these "safe havens" rank among the world's most indebted governments.

Dividend stocks, too, have risen to historic highs even as yields have dipped. For example, an index that tracks the S&P 500 "dividend aristocrats," a basket of 51 stocks that have increased their dividends annually for at least 25 years, hit an all-time high in October.

We all understand the reasons behind this love affair with income assets. Stocks have been scarily volatile for the past decade or more—and threaten to become even more so.

The world's central banks have flooded financial markets with cash, crushing yields, but at the same time promising to keep interest rates extraordinarily low for "an extended period," to quote the Federal Reserve. A sputtering global economy has resulted in low rates of inflation, and deflation often seems a more immediate threat.

But we know we're nearing the end of this cycle. Here's when the bubble might burst, and how to find income right now.

A Bubble That Will Burst
The yield on two-year Treasury notes could drop below the current 0.24%—that's a negative 1.96% yield at recent US inflation rates—but the yield is unlikely to go below zero.

At some point—mid-2015 in the Federal Reserve's most recent formulation—the world's central banks will start raising interest rates again. A return to global growth, simple demographic pressures or the aging of the world's population will lead to higher inflation rates, which will make those paltry yields unpalatable.

And we all know the big questions, too: "When?" and "What?"

Knowing what we know—about the likelihood this is a bubble that will eventually break—when do we take action to avoid getting caught up when it bursts? And when we take action, what do we do?

We're all friends here, so let's be frank: Everyone investing in the markets for income assets believes he or she will be able to anticipate the breaking of the bubble with enough lead time to exit the markets.

Of course, financial history says that won't happen. Financial logic, indeed, says it is true only if you believe you will see the bursting of the bubble before everyone else does. If everyone sees it at once, we're looking at a mad panic at the exits. If just a large chunk of the market sees it coming, we're looking at the kind of move to the exits that accelerates the bursting of the bubble.

Moreover, timing the breaking of this bubble seems especially problematic.