SAN DIEGO (ETFguide.com) Who doesn't want to have their
cake and eat it too? When it comes to investing, we all would like
to have our money in a safe place that pays plenty of dividends (or
interest) and goes up in value.
However, juicy yields and dividends have been hard to come by
recently. The benchmark 10-year Treasury Note (Chicago Options:
^TNX ) yields 2.52% and remains within striking distance of its
Like animals searching for water holes in the desert, investors
are on a constant mission to find the best yields. If one yield
source has dried out, they move on to the next. Unfortunately,
shallow watering holes are safe but dry out fast, while abundant
watering holes tend to host crocodiles and other dangers.
Metaphorically speaking, where can investors find the most
secure and abundant watering hole, or income and safety?
The Highest Yields
High yield bonds such as the SPDR Barclays Capital High Yield
Bond ETF (
) and iShares iBoxx High Yield Corporate Bond ETF (NYSEArca: HYG)
have filled investors thirst for income with yields around 9%.
The term 'high yield corporate bond fund' understates the
potential risk associated with such tempting returns. The ticker
JNK - which stands for junk - more appropriately, describes the
credit worthiness of the underlying issuers.
Junk is not treated as junk as long as it's perceived to be
'safe.' Perception, however, is a fickle thing and can change in an
instant. The chart below shows that JNK and HYG perform like stocks
but are labeled bonds.
There is no free lunch, and if an investment offers the same
upside potential as stocks, don't be surprised if it delivers the
same downside risk. The downside risk of the S&P (SNP: ^GSPC)
and Dow Jones (DJI: ^DJI) in 2008/2009 was nearly matched by junk
Corporate bonds like the iShares iBoxx $ Investment Grade
Corporate Bond ETF (NYSEArca: LQD), with a yield of 4.53% have
found favor in the eyes of yield-hungry investors as well. As the
chart above shows, even LQD is subject to significant swings.
Despite a skyrocketing balance sheet, debt issued by the U.S.
Treasury is still considered safe. This doesn't mean though that
you can't lose money.
In fact, long-term Treasuries (20 years and more) are very
susceptible to interest rate changes. Due to the inverse
correlation between price and yield, an increase in yield can cause
a serious decline in your capital.
From August 25 to September 16, the iShares Barclays 20+ Year
Treasury Bond ETF (NYSEArca: TLT) dropped as much as 8.49 points or
7.76%. TLT has an annual dividend yield of 3.7%. In other words,
the capital losses accrued within a matter of two weeks wiped out
over two years worth of yield. How is that for safety?
On the exact day TLT topped, the ETF Profit Strategy Newsletter
published the following research, which applied the same technical
analysis the newsletter generally applies to stocks:
'Today's spike pushed /ZB (the futures ticker for the 30-Year
Bond) to 136'31. From there prices retreated and formed a red
candle high on the daily chart that closed at 135'08. Today's high
coincided exactly with the weekly r2. In addition, ZB's overbought
condition can be seen by the fact that ZB has closed above the
upper accelerations band for nine consecutive trading days. From
its December 2008 high at 123.15, the iShares Barclays 20+ Year
Treasury Bond ETF (
) fell as low as 87.3. At today's high of 109.34, TLT retraced
precisely 61.8% of the points lost during the previous decline.
Technical analysis along with fundamentals suggests that T-Bonds
are getting ready to roll over.'
Since its September 16 low, bond prices have recovered somewhat
and may even attempt to rally to new highs, but the long-term
outlook for the 30-year and 10-year Treasuries is not pretty.
Short-term ETFs like the iShares Barclays 1-3 Year Treasury
(NYSEArca: SHY) won't satisfy yield junkies, but will keep you
sleeping better at night.
Is it better to focus on dividends or capital gains? Ideally,
you would like to get both, but in a worst-case scenario you could
end up with neither. Since dividend rich stocks are not synonymous
with safety, discernment and common sense are an absolute
Ask yourself, would you rack up your credit card debt just
to earn points? If that doesn't make sense, why would you want to
risk your principal just to earn dividends?
In 2008, the ETF Profit Strategy Newsletter warned: 'The highest
dividends are paid by the worst performing sectors. If history is a
guide, dividend ETFs will not be able to protect investors as the
stock market slides further.'
Throughout 2008 and early 2009, dividend rich stocks and ETFs
continued to disappoint investors. As prices of the iShares DJ
Select Dividend ETF (NYSEArca: DVY), SPDR S&P Dividend
(NYSEArca: SDY), Vanguard High Dividend Yield (NYSEArca: VYM), and
Financial Select Sectors SPDRs (
) tumbled more than 50%, dividend yields for those ETFs moved close
Was the 50% drop worth the yield increase? No, especially since
dividends didn't really increase, the percentage yield simply
doubled as a result of stocks losing half their value.
There was, however, a time when it made sense to bargain shop
and cash in on juicy yields and capital appreciation potential.
On March 2nd, 2009, the ETF Profit Strategy Newsletter sent out
the following buy alert: 'Dividend ETFs with a higher allocation to
financials are likely to rise higher than the broad market. Some of
the dividend yields are quite juicy and can help to offset 'timing
mistakes'. There are two things to keep in mind: 1) dividend yields
will go down over the next few months 2) the ETFs with the highest
yields are likely to be the most volatile.'
who loaded up, at a time when yields were high and prices were low,
got to have their cake and eat it too.' At the time, the Select
Sector Financial SPDR had a near 10% yield and a $6 price tag.
Today it has a 0.92% yield and a $14 price tag.
Just Not a 'Dividend-Environment'
A look at history shows that periods of extremely low yields are
generally followed by periods of low prices. Dividend yields for
the Dow Jones reached an all-time low in 1999. This was followed by
the 2000 tech (NYSEArca: XLK) bust from which neither stocks nor
the economy have yet recovered.
Today, dividend yields are still close to their 1999 lows.
History suggests that investors hunting for yields in risky places,
such as junk bonds, run a fair risk of getting burned.
Dividend yields provide a quick, easy and unadulterated look at
valuations. Low yields equal overvaluation. Unlike P/E ratios,
dividend yields can't be 'spiked' (the 'E' of P/E can easily be
manipulated via accounting tricks).
While dividend yields are not a short-term timing tool, they
point towards troubling times ahead. A detailed analysis of
dividend yields and other valuation metrics, along with their
long-term implications, is available via the
Profit Strategy Newsletter
and its semi-weekly updates on the market's whereabouts.