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Sunday, February 20, 2011

Can Fixed Income ETFs Recapture Any Mojo?

At the end of August, every imaginable Fixed Income ETF had cracked the top half of the exchange-traded universe in relative strength percentile rank. Here on Thanksgiving Thursday, these same investments from the fixed income world have all dropped into the bottom half. In a “risk-on-risk-off” environment, few may find the change in momentum all that surprising. After all, stocks rocketed throughout the months of September and October; riskier assets have managed to hold onto those gains after three-and-a-half weeks in November. Yet even in November of 2010, where stocks have had their troubles, several different types of Bond ETFs have failed to act as “safe havens.” Consider the following examples:

1. International Bond ETFs and Emerging Market Bond ETFs. Fears of a sovereign nation failing to pay back its creditors have weighed heavily on international treasuries and international corporate bonds. Meanwhile, the US$ has bounced higher against the “euro” as well as emerging market currencies, creating some weakness in emerging bond offerings.
Popular International Bond and Emerging Market Bond ETFs (10/25/10-11/24/10)

Approx %

SPDR Barclays International Treasury Bond (BWX)
SPDR Barclay International Corporate Credit Bond (IBND) -4.4%
SPDR DB International Inflation Protected Bond (WIP)
JP Morgan Emerging Market Bond (EMB)

PowerShares Emerging Market Sovereign Debt (PCY)
WisdomTree Emerging Market Local Debt (ELD)

S&P 500 SPDR Trust (SPY)

2. Muni Bond ETFs. You’d have to classify the recent mauling of state and national munis as bearish. Investors may be taking their cues from the bond crisis in the European Union. Is California next? Even though a massive wave of defaults inside of diversified baskets is improbable, the time spent waiting for bailouts may surpass shareholder pain thresholds.
Popular State Muni Bond and National Muni Bond ETFs (10/25/10-11/24/10)

Approx %

SPDR Barclays California Muni (CXA)

Market Vectors High Yield Muni (HYD)

PowerShares Insured New York Muni (PZT)

iShares S&P National Muni (MUB)

SPDR Barclays National Muni (TFI)

Market Vectors AMT Free Intermediate Muni (ITM)

S&P 500 SPDR Trust (SPY)

3. High Yield Bond ETFs. In my estimation, high yield is just about where it should be on the relative strength rankings… higher than the rest of the fixed income offerings and a little lower than the S&P 500. Yet that doesn’t change the fact that 7- and 10-year yields have actually climbed since the QE2 announcement, while the long end of the treasury bond yield curve has surged. It follows that high yield bond ETFs are starting to see detractors.
Popular High Yield Bond ETFs (10/25/10-11/24/10)

Approx %

SPDR Barclays High Yield Bond (JNK)

iShares High Yield Corporate Bond (HYG)

PowerShares High Yield Corporate (PHB)


S&P 500 SPDR Trust (SPY)

For the time being, I am committed to diversified high yield. I also believe SPDR Convertible Bond (CWB) remains an attractive alternative to Treasury Bond ETFs.
Nevertheless, the higher intermediate and long-term investment grade yields climb, the greater the threat to credit spreads. The smaller the spread between investment grade and “junk,” the further out on the risk spectrum you may need to go. (That may not be a bad thing… as “aristocratic” dividend payers have phenomenal earnings yields.)

Disclosure I am long SPY, JNK, HYG, PHB, CWB, MUB and PCY.

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