Why 36 Bond ETFs Hitting 52-Week Highs May Be Bad For Bonds Rather Than Stocks

08 May 2012 at 3:37 pm by Gary Gordon

I’ve never been shy about criticizing the momentum-based mutual fund ratings or fair value estimates at Morningstar. At this moment, however, it’s the cynic in me — not the critic — who is taking note of a “NEW” section at the information provider’s web site.

Until recently, major tabs at the Morningstar home page included “Stocks,” “Funds” and “ETFs.” Today, the fire engine red lettering for ”Bonds” commands the surfer to click accordingly.

Want to get a list of analyst favorites? Would you like to screen by risk or return? Then you better have a premium membership. Yet if you’d like to know whether adding any more bond exposure to your portfolio is sensible… recognize how the media inadvertently contribute to herd behavior.

Before the investing public gathered all of its news from the web, the “Magazine Indicator” used to serve as a reliable guide for when to travel the opposite direction. For instance, in March of 2000, Smart Money adorned its cover with 15 Great Tech Stocks: What’s Next for the Market’s Hottest Sector — And How To Profit From It. March of 2000, of course, was the beginning of the tech collapse. And those 15 great tech stocks? They are collectively down 75%… 12 years later.

The media’s job is to get eyeballs. When we are greedy, they tap into our greed, and when we are fearful, they tap into our fears. I remember when I received another magazine in December of 2007. The Economist’s cover portrayed George Washington piloting a $1 airplane going down in flames. Like a good contrarian, I remember thinking that the U.S. dollar would probably get stronger — not weaker – in a matter of months. (And it did.)

Here is what happened to PowerShares DB Dollar Bullish (UUP) in the year following the cover depicting the dollar’s demise:

Morningstar’s cherry “NEW” focus on bond investing is tapping into the same psychology as in the examples above. Money inflows into bonds have dwarfed inflows into equities. In many instances, equity funds are seeing outflows as bonds keep up their winning streak. And whether by subscription or advertising, Morningstar understands that investors want more “cow bell” bonds.

Unfortunately, investors may not understand that Morningstar is giving us what we want, even if it may not be what we need. With a 10-year Treasury Bond yielding 1.85%, even a conservative utilities stock fund like SPDR Select Utilities (XLU) with a 4% yield could trade at the same price a decade from now, and XLU would double the performance of a comparable Treasury note.

I am not suggesting that investors abandon every ETF with the name “bond” on it. Indeed, not all of the 36 Bond ETFs hitting fresh 52-week highs are in danger of a bond bubble bursting. With yield spreads as wide as they were at the start of 2012, I still maintain an allegiance to funds like iShares iBoxx High Yield Corporate (HYG) with an annual payout of 7.25%, high-yielding taxable equivalents like PowerShares Insured National Muni (PZA) as well as iShares MBS Fixed-Rate (MBB).

I am suggesting that there’s no reason the 10-year yield couldn’t surge from 1.8% to 3% by year’s end, or the 30-year hopping from 3.0% to 4.5%. Under this scenario, Treasury Bond ETFs could see price depreciation in the 10%-15% range.

Stock ETFs may or may not be popular in the summer or fall. Nevertheless, just as one would employ hedges or stop-limit orders on stock assets, one needs to protect against loss in bond assets as well.

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Disclosure Statement: ETF Expert is a web log (”blog”) that makes the world of ETFs easier to understand. Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc., and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships.

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