Perhaps never again, or at least not for a long time, will we see the combination of cheap energy, low interest rates, and inexpensive labor that drove the financial markets to record highs over the past 40 years.

Oil prices were already rising prior to the war in Ukraine. A month ago, oil prices had gained 50% over the previous year. Since then, the price of a barrel of oil has spiked above $130 before falling back below $100.

The last time oil soared above $130 a barrel was in 2008, just before the stock market crashed. That’s not to say that another stock market crash is necessarily on the way, but it is a troubling data point.

Very low interest rates will soon be a thing of the past. Last Thursday, Federal Reserve Chair Jerome Powell announced an increase in the fed funds overnight rate. That was likely the first in several rate hikes, depending on how much higher inflation rises before cooling off.

I’m surprised the yield on the 30-year Treasury bond is below 3%. That’s less than where it was three years ago while the Fed was still pursuing a zero interest rate policy (ZIRP). Now, its yield is less than a third of what it was in 1989 when it peaked near 10%.

Cheap labor is also on the way out. Low unemployment is driving wages higher, especially in the service sector. The federal minimum wage is now $15.55 an hour, more than double what it was six years ago.

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To some extent, robotics may reduce the need for human labor in certain industries. But once wages go up, they seldom come back down.

Got You Covered

All of that adds up to a single word: inflation. The cost of energy is a net drag on economic output, as is the cost of labor.

That is why higher interest rates in the years to come is all but certain. The fastest way to cool off an overheating economy is to increase the cost of money.

That is also why I don’t own any bonds in my personal account. As interest rates rise, the value of fixed-coupon bonds must fall to provide an equivalent rate of return.

For my money, I’d prefer to own the Global X S&P 500 Covered Call ETF (XYLD) to generate high income in retirement. As its name implies, this exchange-traded fund sells call options on the 500 companies that comprise the index.

While the stock market is rising, most of those call options end up getting exercised. That’s why its share price has barely budged over the past five years.

However, the premiums received for selling those covered call options currently equate to an annual distribution yield of 11.6%. Those dividends are paid monthly and can vary based on the options premiums received for selling the covered calls.

That is not to say that this fund is without risk. When the stock market plummeted two years ago in the wake of the coronavirus pandemic, so did XYLD.

For a few months in 2020, the fund’s monthly distribution also fell as investors paid less to buy call options. But less than six months later, the monthly distribution soared as the stock market rallied.

Something similar to that will happen again sooner or later. But due to the self-correcting nature of the options market, XYLD should eventually recover and keep paying out high dividends.

Just Passing Through

There are other high-dividend securities that should perform better than bonds in a rising interest rate environment. In particular, I like:

• Master Limited Partnerships (MLPs)
• Real Estate Investment Trust (REITs)
• Business Development Companies (BDCs)

All of these “pass-through” vehicles must pay out at least 90% of their net operating income as dividends to be exempt from paying federal income taxes. Unlike a fixed-coupon rate bond, the size of their cash distributions can rise over time.

Similar to XYLD, they are vulnerable to stock market corrections and can lose value during a recession. They are also subject to changes in tax laws that could lessen demand for them.

But on the whole, I’d rather own a diversified portfolio of thriving businesses that pay high dividends instead of being locked into a fixed coupon Treasury bond. Over the long haul, equity almost always outperforms debt.

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