Debt Disorder Takes a Toll on Dividend ETFs

by: Gary Gordon

Roughly one hour before bond and stock markets closed on Monday, 7/25/11, congressional Democrats expressed that the House Republican debt plan was a “non-starter” in the Senate. Wince! Six hours later, President Obama spoke to the American people about a potential catastrophe that could see interest rates on credit cards, mortgages and car loans skyrocket. Yikes! And one hour before the markets finished on Tuesday, 7/26/11, the White House threatened the possibility of vetoing the Boehner 2-step approach. Geez!

In spite of the scary public discourse, neither the bond market nor the stock market have taken the bait yet. Indeed, I’ve discussed the probability that markets would remain relatively calm in earlier features. (See “Bond ETFs Predict Debt Ceiling Will be Raised Without Incident” and/or “Debt Ceiling ETFs: A Different “Gang of Six.”)

Who has profited the most from the high profile political theatre? Those who chose to combine ”Fear ETFs” like SPDR Gold (NYSEARCA:GLD) and/or CurrencyShares Swiss Franc (NYSEARCA:FXF) with riskier cyclical ETFs like iShares DJ Oil Equipment & Services (NYSEARCA:IEZ) and/or PowerShares NASDAQ 100 (NASDAQ:QQQ).

Yet questions persist. Why haven’t there been bigger sell-offs in stocks and bonds? Moreover, regardless of the compromise reached, won’t the rating(s) on U.S. credit be downgraded?

Personally, I expect a downgrade from one of the credit agencies within 3-9 months. That said, Moody’s and Standard & Poors may not want to be seen as villains that drove up interest rates, so they may wait for the bond market to blaze the trail first. In addition, as some market watchers have pointed out, the U.S. still has 10-year debt at a scant 3%. There may not be another time in history when a major agency downgraded a sovereign nation with 10-year debt so remarkably low.

Perhaps, however, others have been revisiting risk elsewhere in their portfolios. Whereas treasuries may still be viewed as safe enough for a portion of the pie, whereas economically sensitive risk assets (e.g., IEZ, QQQ, etc.) may be winning due to corporate earnings successes, higher-yielding dividend payers may be suffering from the rate jitters.

Consider the heated rhetoric over the previous five trading sessions. How have a variety of popular ETFs performed?

Popular U.S. Stock ETFs: Leaders and Laggards
Approx 5 Days %
iShares DJ Oil Equipment & Services (IEZ) 3.3%
iShares DJ Financial Services (NYSEARCA:IYG) 3.2%
SPDR Select Financials (NYSEARCA:XLF) 2.6%
SPDR Select Sector Energy (NYSEARCA:XLE) 1.7%
SPDR S&P Semiconductor (NYSEARCA:XSD) 1.7%
WisdomTree Small Cap Dividend Fund (NYSEARCA:DES) -1.0%
Vanguard Telecom (NYSEARCA:VOX) -1.2%
Vanguard Dividend Growth ETF (NYSEARCA:VIG) -1.3%
iShares FTSE NAREIT Mortgage REITs (NYSEARCA:REM) -1.6%
JP Morgan Alerian MLP ETN (NYSEARCA:AMJ) -1.7%
Click to enlarge

Energy stocks may be rising due to crude oil trends, while financials may be relieved vis-a-vis Europe’s bailout of Greece. Select areas of tech are benefiting from product demand. Of course, no matter how you slice it, many of these cyclical segments have received a boost due to a relatively robust earnings season.

In contrast, some of the most popular dividend plays began slumping in the last week, ever since the debt ceiling decibel level turned up. The Mortgage REIT ETF (REM) can be a popular play for yield hungry investors, but not when homeowners face higher interest rates. Energy pipeline partnership exposure via AMJ has been remarkably profitable for 5% yield seekers. On the other hand, if credit spreads between treasuries and pipeline partnerships contract, pipeline partnerships are often seen as too risky.

Obviously, the last five days isn’t indicative of a longer-term trend. What’s more, dividend investors are typically more patient for their assets to produce. On the flip side, like the record runs for gold and the Swiss franc, these may be indications of investor concern over the state of U.S. debt.

Disclosure: 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.