Trend: Stocks and ETFs – especially leveraged and financial ETFs – that rebounded rapidly after the March lows could drop rapidly in a correction.
Simon Maierhofer at ETF Guide says that investors are actually feeling good about owning stocks and optimistic about the future prospects. However, now is the time to examine your portfolio and decide what to sell for investors who have gains from ETFs that rebounded after the March lows. Excerpts below.
Link: ETF Guide: 11 ETFs You Should Not Own.
Extreme investor optimism, or pessimism, tends to signal a change in direction. The current 30%+ rally was born amidst the doomsday atmosphere surrounding the March lows. Conversely, the biggest bear market since the Great Depression started its reign at Dow 14,000, when financial stocks were the top performers and investors couldn’t be more optimistic about their future prospects.
The current rally has rekindled this optimism to a surprisingly large extent. Wall Street, along with stock markets around the globe, was quick to regain its confidence. The Wall Street Journal’s May 11th front page headline read: “World Regains Taste for Risk.” This should serve as a red flag for savvy investors.
High octane funds like financial and leveraged ETFs will obviously get hit hardest by any sort of pullback. The Financial Select Sector SPDRs (NYSEArca: XLF), a basket of 81 financial companies, has rallied more than 115% over the past two months. The Ultra Financial ProShares (NYSEArca: UYG), a double leveraged financial ETF, is up about 210% in the same time-frame. Even the Ultra S&P 500 ProShares (NYSEArca: SSO), a double leveraged ETF linked to the S&P 500, gained over 80%.
Such high octane ETFs can rise or drop 10-20% in a single day. Taking profits at this time is a conservative move and surely no sin. Sometimes it’s simply better to forego some of the potential upside in return for protection against serious downside risks.
Keep in mind that most of the high yielding dividend ETFs have significant exposure to financials. The iShares Dow Jones Select Dividend Index sports, has a 25% stake in financials. Juicy dividends can cushion the fall, but will fail to even make a dent when the next leg down resumes.
Funds linked to any of the major benchmark indexes are next in line to be slated for liquidation. Once again, this does not have to be right away, but anyone adhering to savvy management principles should formulate an exit strategy now.
Such ETFs include the Dow Diamonds (NYSEArca: DIA), S&P 500 SPDRs (NYSEArca: SPY), iShares S&P 500 Index ETF (NYSEArca: IVV), iShares Russell 3000 ETF (NYSEArca: IWV), MidCap SPDRs (NYSEArca: MDY), and many others.
Many find it hard to resist the allure of stock-like bond yields. The iShares iBoxx $ High Yield Corporate Bond Fund (NYSEArca: HYG) pays a juicy 11%. The iShares iBoxx Investment Grade Corporate Bond Fund (NYSEArca: LQD) pays 6%. Don’t allow yourself to be tricked by double digit yields or the “investment grade” label.
When the financial turmoil started, investment grade corporate bonds lost 20% within a matter of days. High yield and junk bonds did even worse. This might just be a glimpse of what the future holds for bonds. The same holds true for municipal bond funds such as the iShares S&P National Municipal Bond Fund (NYSEArca: MUB).
Many municipalities find themselves struggling as their tax revenue stream dwindles away. Falling real estate prices, closing businesses, and declining consumer spending has hurt most municipalities.
Many believe that U.S. Treasuries are risk free. Over the past 30 years, U.S. Treasuries have morphed from investment wall flower to investment pop star. Even traders like long-term Treasuries.
In reality, Treasuries come with a fair shot of interest rate and issuer risk. Long-term Treasuries such as the iShares Barclays 20+ Year Treasury Bond Fund (NYSEArca: TLT) are most sensitive to interest rate changes. Yields on 30 year Treasuries have risen from 2.5% to over 4%. TLT has fallen nearly 30% over the past several months.
Short term government bonds, such as represented by the iShares Barclays Short Treasury Bond Fund (NYSEArca: SHV), reduce the interest rate risk. Nevertheless, all government bonds bear credit risk. Even though this might be a moot point right now, it will become more of an issue as the government continues to manipulate its financial stability.
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