Time to Exit Treasury Bond ETFs? - ETF News And Commentary
January 17 2013 - 6:36AM
Zacks
2012 was another good year for the bond markets as the investors
continued to pour money into bond funds even though the yields
plunged. The benchmark 10-year note ended the year at 1.76%--the
lowest closing since 1962 and five-year note yield ended at
0.73%--their lowest year-end closing level since 1986.
However as the two parties managed to arrive at a last-minute
compromise to avoid the cliff, bond yield soared while the stocks
rallied. The investors have put more than $18 billion in stock
funds during the first week of this year—largest inflow since June
2008, when the recession began.
As a result, 10-year note's yield rose to 1.97% earlier this
month--its highest level since April but has since moved down to
1.87% as of this morning. (Read: 3 Great ETFs for the Earnings
Season)
The minutes of the last FOMC meeting of 2012 released earlier
this month further supported the trend as many investors worried
that the Fed may end its QE program in 2013. Fed’s massive
purchases have been the main factor in keeping the yields at
dangerously low levels. Per FOMC minutes “several members now think
that it would probably be appropriate to slow or stop purchases
well before the end of 2013”.
In all, Fed currently buys about $85 billion of longer-term
bonds each month. Further they have pledged to keep the target
range for the fed funds rate between 0% and 0.25%-- as long as the
unemployment rate remains above 6.5% and medium-term inflation does
not exceed 2.5%. Overall the Fed may purchase about $1 trillion in
bonds this year.
Fed’s balance sheet has exploded since 2008 but despite
significant monetary expansion, inflation has remained benign so
far. Bernanke has often said that the aim of the Fed policy is to
push the investors to take more risk. On the other hand, may
economists have expressed apprehension that large scale asset
purchases by the Fed are disrupting market dynamics.
During a speech earlier this week the Fed Chairman downplayed
the fears of inflation and reiterated that the economy was still in
a “relatively fragile recovery”.
Rates will have to go up eventually but that doesn’t appear to
the case anytime soon. Many market gurus have proclaimed deflation
of the bond bubble in the last few years but that did not
happen.
The idea about the bear market in bonds being finally on the
horizon based on one week of fund slows appears to be rather
premature. Further it is difficult to predict a market that is
driven by the Fed and not by fundamentals. (Read: 4 Best ETF
Srategies for 2013)
Also, in the short-term, the movement in yields may follow the
developments on the debt ceiling debate. If the negotiations turn
nasty, the investors may seek refuge in treasuries again as they
did when the lawmakers failed to arrive at an agreement to raise
the debt ceiling in 2011 till the eleventh hour. Further if
economic growth continues to be lackluster or stalls, the yields
may stay low.
While a massive sell-off in the bonds is not likely anytime
soon, it is quite possible that the rates may finally start to move
up later this year, ending the 30 year down-trend in yields. And as
the yields are currently very low, the losses will be very high if
the yields go up. So, it may finally be the time when the treasury
bond ETF investors should start looking at much better options
available to them.
At current valuations, stocks look much more attractive than
bonds and will deliver much better returns in the longer-term. Most
large US blue chips are sitting on piles of cash and are in a
position to increase dividends. Average dividend yield of S&P
500 companies is currently 2.12%. We recommend Vanguard Dividend
Appreciation ETF (VIG) which holds stocks of high quality
companies that have a record of increasing dividends for at least
10 years. It is Zacks rank 1-‘Strong Buy’ ETF.
Emerging market sovereign bonds still look attractive even
though the spread has tightened in the last couple of years. Many
of the emerging countries have better fiscal health than developed
countries and further they still have scope to cut rates, whereas
interest rates in developed countries are already at historic low
levels. Investors should look at J.P. Morgan USD Emerging Markets
Bond Fund (EMB) or PowerShares Emerging Markets Sovereign Debt
Portfolio (PCY) which yield around 5% currently (Read: Emerging
Markets Sovereign Bond ETFs-Safe with attractive yields)
The investors wanting some exposure to US treasury bonds in
their fixed income portfolios may consider shorter-end of the curve
as the yield curve may continue to steepen this year. Renowned bond
guru Bill Gross recommends buying 5-year treasuries and predicts
their yield to come down to 0.7% this year. iShares Barclays 3-7
Year Treasury Bond (IEI) charges an expense ratio of 0.15% only but
yields 0.87% currently.
Investors betting on bond market collapse using inverse treasury
ETFs like ProShares UltraShort 20+ Year ETF (TBT) or ProShares
Short 20+ Year Treasury ETF (TBF) need to keep in mind that these
ETFs are meant for short-term trading or hedging purpose only. Many
of them are designed to achieve their stated performance goal on a
daily basis. Over a period longer than one day their performance
can differ significantly from their stated daily performance
objectives. Further the expense ratios of these ETFs are on the
higher side. (Read: Leveraged and Inverse ETFs--Suitable Only For
Short Term Trading)
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ISHARS-JPM EM B (EMB): ETF Research Reports
ISHARS-BR 3-7TB (IEI): ETF Research Reports
PWRSH-EM SVN DP (PCY): ETF Research Reports
SCHWAB-US ST TR (SCHO): ETF Research Reports
PRO-SH 20+ TBI (TBF): ETF Research Reports
PRO-ULS L20+YRT (TBT): ETF Research Reports
VANGD-DIV APPRC (VIG): ETF Research Reports
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